U.S. bitcoin ETF fast running out of its underlying asset
- Bitcoin futures exchange rules prevent over-concentration of bitcoin futures, meaning that the tracking error for the ProShares Bitcoin Strategy ETF could increase
It’s a well-known and well-worn fact that there will only ever be 21 million bitcoin ever minted, but what about bitcoin futures?
Just days after the launch of the ProShares Bitcoin Strategy ETF, seemingly insatiable demand for the first U.S. bitcoin ETF is already running into a shortage of its underlying asset – bitcoin futures,.
Under CME Group (+1.47%) rules, the number of front-month contracts that any trading counterparty can hold is capped at 2,000, yet after just two days of trading, ProShares Bitcoin Strategy ETF owns almost 1,900 contracts for October.
In order to avoid hitting the limit, ProShares, which has already hoovered up US$1 billion through its bitcoin ETF, has also amassed 1,400 contracts for November, but is fast running out of headroom.
Beyond the front month, CME Group regulations also prohibit any single trading counterparty to hold more than 5,000 contracts in any other month before hitting the exchange’s accountability limit, which could include certain regulatory requirements or further trading limits.
While spreading out its holdings into longer-dated contracts as ProShares has done is the immediate solution for its Bitcoin Strategy ETF, it’s not a long-term solution for a product that promises to track the underlying price movement of bitcoin.
Forward month futures contracts are susceptible to contango, where the futures price is higher than the current spot price, but also backwardation, where the current price of the underlying asset is higher than its futures price.
Both phenomenon borne out of the futures market would significantly affect the ability of ProShares Bitcoin Strategy ETF to accurately track the underlying price movement for bitcoin.
The risk is that as the ETF starts taking on tracking error, it is forced to obtain bitcoin price exposure at progressively higher and higher prices as it goes further out on the futures curve, which is currently in contango and sloping upwards.
This in turn could trigger a self-perpetuating feedback loop that could spillover into bitcoin spot markets and rally the cryptocurrency even higher.
As ProShares runs out of near-month futures contracts that it can hold, it is forced to purchase more long-dated long bitcoin futures (obligation to buy), driving up their price and the implied future price of bitcoin.
If traders see that activity as bullish, they may take on more spot bitcoin, driving up the price of bitcoin in the spot markets which in turn attracts more buying interest in the ProShares Bitcoin Strategy ETF which in turn forces the purchase of more long bitcoin futures, leading to a self-perpetuating feedback loop.