The red-hot new bitcoin ETF could get too big for its own good and warp the futures market, JPMorgan says

• Launch of the ProShares Bitcoin Strategy ETF has been a wild success, with the fund being the fastest ETF ever to attract $1 billion in assets.
• But that success is a double-edged sword and could hurt its investors, according to JPMorgan.
• "Contango in the BTC futures curve can impose a drag on performance for these funds due to the futures carry cost," JPMorgan explained.

The ProShares Bitcoin Strategy ETF saw a surge in inflows when it launched last week, making it the fastest ETF ever to reach $1 billion in assets.

But the futures-based ETF has a big flaw that could lead to lower returns for its investors if assets in the fund grow too large, JPMorgan said in a note last week.

That's because the ETF doesn't own bitcoin as its underlying asset. Instead, the ETF owns derivatives of bitcoin that try to match the return profile of the cryptocurrency through futures contracts. SEC Chairman Gary Gensler has resisted calls for approval of a spot bitcoin ETF, instead favoring the futures-based fund.

"Contango in the BTC futures curve can impose a drag on performance for these funds due to the futures carry cost/roll yield. This carry drag can be several times the products' management fees, and could become even larger if these products gather substantial assets, due to their market impact," JPMorgan explained.

To actively manage a portfolio of bitcoin futures that are closely correlated with the price movements of bitcoin, the ETF must continuously roll over bitcoin futures contracts to the next month just prior to expiration. This creates various trading costs and is less efficient than simply buying bitcoin and holding it, similar to what most gold and silver ETFs do.

According to JPMorgan, the average annual cost to roll over futures contracts was around 9% since mid-2019, nearly 10x the ProShares Bitcoin Strategy ETF's annualized expense ratio of 0.95%. That could leave investors disappointed with their returns as they could significantly lag behind those of bitcoin.

The bank said long volatility ETPs are a good example of how long-term returns can be eroded as costs associated with trading futures pile up. "The more investors position long, the more expensive it becomes to hold due to the ETFs' own market impact," JPMorgan said.

The ProShares Bitcoin Strategy ETF already owns about 25% of the open interest in bitcoin futures contracts, according to the bank, and the fund recently sought a waiver from the CME to allow it to own more than the imposed limit of 4,000 futures contracts.

If the ETF doesn't get its waiver from the CME, it could ultimately stray from its futures strategy and invest in equities with exposure to crypto to better track the price of bitcoin, according to the funds prospectus.