Investors got the closest thing thus far to a bitcoin ETF or mutual fund when the ProShares Bitcoin Strategy ETF started trading this week. But buying shares of a bitcoin futures fund is very different from buying shares of an actual bitcoin ETF — and not fully understanding the difference could cost you.

Crypto advocates have long been pushing for a bitcoin ETF, which would give everyday investors the ability to track cryptocurrency's price and invest in it without actually having to buy the digital coins. But the Securities and Exchange Commission (SEC) has rejected the proposals, and warned investors of bitcoin's volatility and potential for fraud.

With crypto fans crying that the U.S. is falling behind other countries and retail investors are missing out, the SEC cleared the bitcoin futures ETF from ProShares and the ETF began trading Tuesday. And another bitcoin futures ETF from financial firm Valkyrie hit the market Friday. A third is expected soon from VanEck.

But futures ETFs — whether for oil, metals like gold or cryptocurrencies like bitcoin — don't always track the price of the underlying asset they are designed to target in the long run. In other words, while buying one of the new bitcoin ETFs might be convenient, it also means that, next time you see headlines proclaiming bitcoin has hit a new record high, you shouldn't necessarily expect ETF investors to be reaping the same gains.

“This is a great product for short-term traders, and it’s maybe a good enough product right now for long-term investors,” says Matt Hougan, chief investment officer at Bitwise Asset Management. “But it’s not a perfect product and investors should understand that it won’t track the price of bitcoin perfectly over long periods of time."

Why a bitcoin futures ETF won’t track the price of bitcoin

Investing in a bitcoin futures ETF means you don’t own bitcoin directly, the way would with an ETF that hold stocks or bonds. Instead, you own bitcoin futures.

Futures contracts are basically bets between two investors about where the price of a good — be it wheat, oil or bitcoin — will be at a certain time in the future (hence the name). The bitcoin futures contracts, traded on the Chicago Mercantile Exchange, typically last for six months. So, each month one batch of contracts expires and the exchange creates a new batch that will expire several months in the future.

Naturally the price of bitcoin futures contracts can rise above or fall below today's price for bitcoin (known as the spot price), depending on whether investors think the cryptocurrency will end up being worth more or less in six months time than it is right now. However, as the date of the contracts approaches, the contracts' price should converge with the spot price of bitcoin — until they eventually match on the final day.

The bitcoin ETF works by buying futures contracts whose expiration dates are relatively near — perhaps a month or two out, which should roughly, but not perfectly match, the current price of bitcoin. As the date approaches, the ETF sells these about-to-expire contracts and buys a new set of contracts that expire in another month or two — basically "rolling" them over.

Because the value futures of contracts dated a month or two typically won't match the price of bitcoin today, the ETF is expected earn or lose a little during this process. That money, known as the "roll yield" when it ends up being a profit, means the ETF's returns will always be a bit different from the returns of bitcoin itself.

This process isn’t unusual; many commodity ETFs work this way. The most popular oil ETF, the United States Oil Fund (USO), doesn’t hold crude oil but instead holds crude oil futures. Over short periods of time — think days or weeks — these price discrepancies usually don't amount to much. But over longer periods of six months or a year, they can become significant, Hougan says.

How much will the price difference be?

So are we talking about bitcoin future ETF investors missing out on a ton of the money bitcoin investors are making? Not necessarily.

Historically, it’s been about a 5% headwind per year in the bitcoin market, Hougan says.

Simeon Hyman, ProShares’ head of global investment strategy, declined to project on what the difference would be. However, he says that the difference in September was 20 basis points (or hundredths of a percentage point) and if you annualized that (as in, repeated it 12 times in a row) it would be around 2.5% for the year — if every month looked like September.

While Andrew Hambleton, an advisor at Telemus Capital, says he would be surprised if the difference is more than 5%, he says he’s a bit concerned with how the space could change when (and if) a pure-play bitcoin ETF hits the market, since that may be many investor’s preference. It could cause even more volatility and uncertainty surrounding bitcoin futures ETFs, Hambleton says.

Is this a good move for you?

Those familiar with how oil futures contracts work may wonder if there’s a risk of the bitcoin futures market facing the same dramatic problem the oil futures market did in April 2020. During that early stage of the COVID-19 pandemic, oil oversupply led to an oil price collapse. USO, which uses the futures contracts on West Texas Intermediate (WTI) oil as a benchmark, plunged more than 100% and investors were wiped out.

Bitcoin’s future is extremely uncertain due to its speculative nature. Some of the investors who predicted the 2008 housing crash think bitcoin is a speculative bubble, and The Bank of England's deputy governor for financial stability said bitcoin's price falling to zero is "a plausible scenario."

In theory, bitcoin’s futures market could implode much like the oil futures market did in April. But from a practical perspective, Hougan says it’s unlikely, since much of the issue in the oil scenario had to do with the cost of storage, and there’s no problem with storing bitcoin (since you can’t even hold it).

There is no perfect way to invest in bitcoin today. You can buy it on an app and have to pay commissions, you can buy it through a product like the Grayscale Bitcoin Trust which may also trade at a discount compared to bitcoin’s actual value or you can buy it through this new futures ETF.

“You just have to understand the pros and cons of each and select the best one for you if you want to get exposure to this space,” Hougan says.

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