The closest thing to a risk-free bet has re-emerged on the bitcoin market as traders - eagerly awaiting the launch of the first Bitcoin exchange traded funds bid up the price of futures. The spread between Bitcoin futures and digital currency’s price offers the widest annualized return in five months, according to data from FRNT Financial. That means the so-called basis trade, whereby a speculator buys Bitcoin on the spot market and sells long to secure the discrepancy between the two prices, turned back on. And it's happening amid a price surge in Bitcoin that's being boosted by optimism the Securities and Exchange Commission is poised to permit the first U.S. Bitcoin futures ETF to begin trading soon, because of the price hike in Bitcoin.
It is a dynamic that comes back again and again in crypto and is one that is rarely seen at other markets, according to Strahinja Savic, head of data and analytics at FRNT Financial. It is primarily driven by individual investors, who are using futures for leverage and to make price predictions.
Crypto is unique in that it has a much higher institutional participation versus sophisticated retail actors who would normally drive down the exaggerated contango by arbs trades, said Mr Savic, referring to arbitrage. Considering the lack of those actors' participation, relative to other assets, BTC is prone to these aggressive contangos in bull markets - we find this kind of an opportunity to be an extremely lucrative strategy in crypto. Futures trade infrequently at a premium to spot, a phenomenon called contango. Contango and backwards are terms for curve structures which map traders' guesses about what a given contract could be worth in the future. Contango means it's downward sloping, while backward mean upward.
Futures in Bitcoin include that the supply of Bitcoin is plentiful because there is a cap on futures open interest, says Steve Sosnick, Chief Strategy At Interactive Brokers. As long as sufficient traders post sufficient margin with a clearinghouse, any two counterparties can initiate a new futures contract by initiating a trade, he said. Right now, a lot of investors might be betting that a futures-based ETF would be a big forced buyer in the market. The money invested into the product will have to be used to buy futures contracts, the thinking goes.
There is a highly-pokerized new asset class that has to contractually buy these futures, and traders are adjusting and front-running accordingly, he said. It is very possible that the market got ahead of itself, which is certainly a risk in crypto space, but there is clearly a bet being placed that fresh money will be coming into crypto via futures ETFs. To be sure, more traders could look to take advantage of the spread, meaning that it could shrink, explains Zhu Su from Three Arrows Capital, a hedge fund.
You'll have a lot of capital come in to arbitrage because it will get to the point where it is very attractive. If you can get 6 per cent, 10 per cent, on dollars there's a lot of guys that will want to do that, said the firm's co-founder. It just takes one bank or one participant with a few billion dollars to come in. If you zoom out, it isn't going to be that bad. Though it had broken earlier in the year amid a sell off in crypto prices, the basis trade has been one of the most pervasive in the crypto industry. It's been widely used by hedge funds, thanks to its ability to reliably produce double-digit annual gains.
The spot price is higher than the future market and this is where we see a lot of arbitrage plays by the big boys, said Howard Greenberg, president of the American Blockchain and Cryptocurrency Association in Washington D.C. and cryptocurrency educator at Prosper Trading Academy, said via phone. They'll play this spread - they'll sell the underlying asset at an less expensive price and then bid up the futures and buy into the strength of the market.