What’s Happening in Bitcoin Futures: Shrinking Roll Costs Demonstrate Maturing Market

ProShares Bitcoin Strategy ETF (BITO) enjoyed one of the most successful launches in the history of the ETF industry – with investors adding over $1 billion to BITO in its first two days of trading. Even after the heightened activity in BITO’s first week, investors have added an additional $476 million to BITO and trading remains robust, with over $210 million in average daily volume and tight spreads.1 A welcome development that is enhancing BITO’s value proposition is occurring in the bitcoin futures market, where contract premiums, sometimes called “roll costs,” have recently declined.  Though referred to as “costs,” contract premiums do not impact BITO’s expenses, but rather, impact BITO’s performance.

Bitcoin futures started trading on the Chicago Mercantile Exchange (CME) in December 2017, and, historically, their performance has been highly correlated with bitcoin. The market for bitcoin futures has grown and matured over the past 4+ years, and one sign of this may be seen in the modest and downtrending futures premiums, year-to-date. How and why is this relevant to BITO investors?

When a bitcoin futures contract is nearing expiration, BITO will “roll” the futures contract, which means it will sell the contract it holds and use the proceeds to buy a contract with a later expiration date. Since launching in 2017, bitcoin futures prices have generally, although not always, been higher than the spot price, and longer-dated futures prices have been higher than those of shorter-dated futures. If you were to draw a picture of this, you would see an upward-sloping chart of futures prices over time. Because futures prices move toward the spot price as expiration approaches, the repeated buying of contracts at a premium, relative to spot, causes a performance drag – often referred to as a “roll cost.”

Upward-sloping futures prices is a characteristic commonly seen in commodity futures, like oil, corn, and coffee. However, from a structural and fundamental standpoint, bitcoin futures may be expected to exhibit characteristics more similar to financial futures, like those for equities, treasuries, or currencies.

There is a financing carry cost with all futures, which is typically a risk-free rate (the rate on short-term Treasury Bills) over the duration of the futures contract. While financial futures prices, like those tied to stock or bond indices, need to account for dividends and coupons, there are no related income distributions associated with bitcoin.

Traditional commodity futures prices may be impacted by factors such as storage, transportation, or insurance costs, which may contribute to higher premiums in futures prices. Commodity futures may also reflect an occasional benefit, known as a convenience yield, associated with holding a commodity when inventories are low or shortages are expected. However, these factors associated with commodities may not directly relate to bitcoin given its digital nature. Thus, the absence of transportation, insurance, or significant storage costs suggests only a modest premium in bitcoin futures prices may be warranted.

Since CME bitcoin futures launched in December 2017, the average annualized premium between the front-month (nearest to expiration) and second-month contract and the second- to third-month contract has been approximately 5%. However, year-to-date, and following the launch of BITO, the premiums have contracted.

Average Annualized Bitcoin Futures Premiums (as of 3/31/2022)

Time period

Front Month – 2nd Month

2nd Month – 3rd Month

Since CME bitcoin futures

launch (Dec 2017)

5.5%

5.0%

Year-to-Date

2.4%

3.6%

March 2022

2.1%

3.7%

Source: Bloomberg, average annualized bitcoin futures premium calculated based on daily settlement prices. Full period from 12/18/2017 – 3/31/2022.

More recently, premiums have remained modest, with average annualized second-month to front-month spreads in the month of March showing just 2.1%. These shrinking premia reduce BITO’s roll costs and increase its attractiveness, particularly relative to investing in the spot market which involves brokerage fees, key management, and the complexity of multiple exchanges with multiple prices. While we are hesitant to forecast bitcoin futures premiums and they may move higher, downtrending premiums are logical and consistent with the structure and fundamental characteristics of the bitcoin futures market.

1Source: ProShares, 10/25/2021 – 4/18/2022