What are the disadvantages for investors of holding a Bitcoin futures ETF?

Last month's launch of the first U.S. exchange-traded fund tied to the price of Bitcoin went down in history as the strongest ETF launch ever, quickly amassing more than $1 billion in assets.

Valkyrie Investments' Bitcoin Fund was a close second to the ProShares Bitcoin Strategy ETF. Several other Bitcoin futures ETFs are expected to launch soon.

For U.S. investors, it's a chance to make up lost ground against Canada and Europe, where dozens of exchange-traded products track both the spot price and futures in Bitcoin and other cryptocurrencies have already amassed billions of dollars in assets.

But one feature of the new US launches could limit their success: they are not based directly on the Bitcoin price, but on Bitcoin futures. That's why the amount of outstanding Bitcoin futures transactions on the Chicago Mercantile Exchange rose from $1.5 billion to an all-time high of $5 billion last month, according to Glassnode, a crypto analytics firm.

Why does that matter?

Futures fix a price for Bitcoin in the coming months. However, they may differ from the spot price of Bitcoin on a particular crypto exchange.

That's partly because CME Group's Bitcoin futures prices are based on composite prices across five crypto exchanges.

Additionally, any ETF based on futures may underperform the underlying asset it is intended to track. Futures contracts expire on a fixed date and must be “rolled over” to newer versions. The transaction costs and management fees for thousands of new contracts come from the fund.

The United States Oil Fund, the $2.4 billion oil futures ETF, underperformed the price of WTI crude oil it is designed to track over the past decade by 70 percent, according to data from Refinitiv.

Solactive, an index provider, estimates that futures have made about 13 percentage points less than Bitcoin's nearly 120 percent rise so far this year.

“Investors in futures-based ETF funds face additional price volatility risk and tracking discrepancies between Bitcoin and futures prices,” said Alastair Sewell, senior director of fund ratings at ratings agency Fitch.

Can a futures Bitcoin ETF be too successful?

In a way, yes. The ETFs are designed to closely track the price of Bitcoin so that the most in-demand futures contract is the one that expires closest to the current date, known as front-month or spot contracts. For this reason, ProShares holds all of its 3,900 futures positions in November contracts.

However, CME Group has limited the number of contracts a party can purchase to prevent one company from cornering the market. This could cause problems with Bitcoin futures as the market is relatively small.

When a company reaches the limit of 4,000 contracts per unit, it must purchase longer-term futures contracts, for which there are no limits.

This comes with costs. If the market expects the Bitcoin price to rise in the longer term, then the price of longer-term futures contracts will rise above the short-term contracts, which is known as contango. This creates higher costs for the fund when the futures contract is rolled into the next month, effectively selling low and buying high.

These costs could mean the ETF underperforms the price of the underlying asset, averaging up to 5-10 percent per year, according to industry estimates for Bitcoin.

Theoretically, the CME could also ask the ETF provider to stop buying longer-term contracts.

ProShares has indicated that it believes the risks arising from these positions are overstated.

"We have . . . the potential to purchase additional contracts pursuant to an exception. We are pursuing that and believe we will qualify," said Michael Sapir, CEO of ProShares.

"We have additional capacity available. This is an evolving and growing market. We believe the market will continue to grow and new entrants will emerge," he added.

What other potential problems arise from the structure of the crypto market?

Crypto developers disagree on how the underlying blockchain technology should work, and if they cannot resolve their differences, the final step is to create a fork in the network.

In this case, it is unclear which branch of ETFs to follow. One site will use newer software and the existing network will use the older version. Prices may vary between the two.

Bitcoin has already been subject to several forks. Ethereum, another cryptocurrency, also forked this summer. The version used to form a Bitcoin price index is not in the hands of the ETF sponsor, but rather a decision by an industry benchmark committee.

Many investors are hoping that US regulators will approve an ETF backed by Bitcoin itself in the coming months. This official green light could open the doors to funds from institutional investors seeking exposure.

For retail investors who want exposure, a tempting alternative may simply be to buy Bitcoin.