Sign in Subscribe
Featured

Exploring Bitcoin Basis Trades: How Price Singularity in ETFs and Futures is Bolstering Market Activity

Spot Bitcoin ETFs and CME futures contracts using the same price benchmark (BRRNY) enables precise arbitrage. This alignment facilitates efficient basis trades and streamlines ETF creation and redemption processes, enhancing market efficiency.

Gabriel Selby, Mark Pilipczuk

• 5 min read
Exploring Bitcoin Basis Trades: How Price Singularity in ETFs and Futures is Bolstering Market Activity

The alignment of price benchmarks between spot Bitcoin ETFs and CME futures contracts plays a crucial role in enabling precise arbitrage opportunities. Six of the spot Bitcoin ETFs utilize the CME CF Bitcoin Reference Rate - New York Variant (BRRNY) to determine the Net Asset Value (NAV) for creation and redemption. Simultaneously, CME futures contracts settle using the same reference rate. This synchronization ensures that both instruments are inherently linked to the same price benchmark, facilitating more efficient basis trades.

Understanding the Fundamentals of Basis Trades

At its core, a basis trade involves simultaneously taking positions in the spot market and the futures market for the same asset. The objective is to profit from the convergence of the spot and futures prices at the expiration of the futures contract. When the futures price is higher than the spot price (known as a positive basis), traders typically buy the underlying asset and sell the corresponding futures contract. Conversely, when the futures price is lower than the spot price (a negative basis), traders sell the asset and buy the futures contract.

The success of a basis trade hinges on the expectation that the futures price will converge towards the spot price as the contract approaches maturity. This convergence allows traders to lock in the price difference as profit, while hedging against potential price fluctuations in the underlying asset.

Source: CF Benchmarks, this illustration is a simplified representation for educational purposes only

Institutional Involvement in Basis Trades

Basis trades are primarily executed by institutional investors, such as hedge funds, proprietary trading firms, and large financial institutions. These entities leverage their substantial capital and sophisticated trading tools to identify and exploit market inefficiencies. Market makers and arbitrageurs also engage in basis trades, employing advanced strategies to profit from the convergence of futures and spot prices.

The participation of institutional investors in basis trades contributes to improved market efficiency and liquidity. By actively trading on price discrepancies, these entities help to narrow the gap between spot and futures prices, promoting more accurate price discovery and reducing market fragmentation.

The Interplay of Spot Bitcoin ETFs and Futures Markets

The recent launch of spot Bitcoin exchange-traded funds (ETFs) has had a significant impact on the dynamics of basis trades in the cryptocurrency market. These ETFs provide institutional investors with a more accessible and regulated avenue to gain exposure to spot Bitcoin, enabling them to capitalize on positive basis opportunities.

Source: Bloomberg, CF Benchmarks as of 5/31/24

Since the introduction of spot Bitcoin ETFs, the CME Bitcoin Futures market has witnessed a notable increase in net short positioning among levered funds. This surge in short positions has coincided with an upward shift in the short-term tenors of the CF Bitcoin Interest Rate Curve (BIRC). For instance, in March 2024, the 2-week tenor on the BIRC reached 25%, indicating a significant premium of futures prices over the spot price. Concurrently, the CME Bitcoin futures market saw an addition of $1.6 billion on the short side, suggesting that institutional investors were actively engaged in basis trades, anticipating a convergence of futures and spot prices. 

Source: Bloomberg, CF Benchmarks as of 5/31/24

Conversely, in mid-April, when the BIRC dropped to 0%, the futures market recorded over $1 billion in net long positions. This shift likely reflects the closing out of basis trades initiated in the preceding weeks, as traders sought to realize profits from the convergence of spot and futures prices.

The Role of Price Singularity in Facilitating Arbitrage

The alignment of price benchmarks between spot Bitcoin ETFs and CME futures contracts plays a crucial role in enabling precise arbitrage opportunities. Six of the spot Bitcoin ETFs utilize the CME CF Bitcoin Reference Rate - New York Variant (BRRNY) to determine the Net Asset Value (NAV) for creation and redemption. Simultaneously, CME futures contracts settle using the same reference rate. This synchronization ensures that both instruments are inherently linked to the same price benchmark, facilitating more efficient basis trades.

Source: CF Benchmarks, this illustration is a simplified representation for educational purposes only

The establishment of robust and replicable price benchmarks enhances market transparency and reduces the risk of price discrepancies arising from disparate valuation methodologies. This, in turn, fosters a more level playing field for market participants and encourages greater liquidity in both spot and futures markets.

Bitcoin futures basis fluctuations offer market participants opportunities to optimize exposure. Investors with long Bitcoin positions can tactically sell futures contracts against their holdings, generating cash yield similarly to covered call strategies in options trading. However, unlike covered calls, short futures positions don't obligate Bitcoin holders to sell their assets, providing more flexibility. This delta-neutral approach benefits various market conditions. During bullish movements, a widening basis allows traders to roll futures contracts forward, arbitraging the higher basis. Conversely, in a Bitcoin sell-off, the typically compressed futures basis enables profitable closing of futures positions, offsetting losses on long Bitcoin holdings and reducing downside capture. Hedge funds employing this strategy may improve their Sortino ratio, a risk-adjusted performance ratio that focuses only on downside risk, by lowering downside volatility through tactical short futures positions.

Implications for Market Liquidity and Price Discovery

As more institutional investors engage in basis trades, the liquidity landscape of the Bitcoin futures market is expected to evolve. Open interest on Bitcoin futures has already witnessed a 30% increase since the launch of spot Bitcoin ETFs, with a significant concentration of volume at the short end of the futures curve. This trend suggests that traders are actively arbitraging the basis at shorter maturities, seeking to capitalize on the convergence of spot and futures prices.

Source: Bloomberg, CF Benchmarks as of 5/31/24

In Summary

Basis trades are expected to remain a significant driver of activity, with institutional investors capitalizing on price discrepancies between spot and futures markets, particularly following the launch of spot Bitcoin ETFs. This growing engagement of sophisticated participants contributes to enhanced liquidity, efficient price discovery, and price convergence.

As traders continue to seek to arbitrage the basis at various points along the futures curve, liquidity is expected to extend to longer-dated contracts, akin to the dynamics observed in other cash-settled futures markets for financial assets. The alignment of regulated price benchmarks across spot ETFs and futures contracts, combined with increased institutional participation, fosters a more robust and interconnected market ecosystem.

Looking forward, the potential expansion of basis trading strategies to other cryptocurrencies, such as Ethereum, may entice market participants to engage in basis trades. The upcoming launch of spot Ether ETFs is poised to introduce similar trading opportunities in the Ethereum market, likely driving an increase in open interest on CME Ether futures.

Investors and arbitrageurs should continue to monitor these dynamics for potential opportunities for alpha generation and effective risk management in the evolving market landscape.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell any of the underlying instruments cited including but not limited to cryptoassets, financial instruments or any instruments that reference any index provided by CF Benchmarks Ltd. This communication is not intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. Please contact your financial adviser or professional before making an investment decision.

CF Benchmarks Ltd (“CF Benchmarks”), a company registered in England and Wales with company number 11654816 and authorised and regulated by the Financial Conduct Authority. Information about us can be found on the Financial Services Register (register number 847100).

Registered Office: 6th Floor One London Wall, London, United Kingdom, EC2Y 5EB.

You agree not to, and have no rights to, use the CF Benchmarks Data to create, calculate, issue, settle, maintain, support or develop any financial instruments (including but, without limitation exchange traded products, certificates, warrants, contracts for difference, swaps, binary options, structured products), indices, products, services (including but without limitation, portfolio management services, pre- and post-trade risk management services, or valuation services) or any other derivative works without the express written consent of CF Benchmarrks.

You agree not to analyze, reverse-engineer or disassemble any CF Benchmarks data and not to insert any code or product to manipulate the Website content in any way that affects any user’s experience. Unless CF Benchmarks gives you prior written permission, use of any Web browsers (other than generally available third-party browsers), engines, scripts, software, spiders, robots, avatars, agents, tools or other devices or mechanisms (such as crawlers, browser plug-ins and add-ons, or other technology) to navigate, access, copy in bulk, retrieve, harvest, index, search or analyse any portion of the Website is strictly prohibited.

No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of CF Benchmarks Ltd. Use and distribution of the CF Benchmarks data requires a license from CF Benchmarks or its authorized licensing agents.

All information is provided for information purposes only. All information and data contained on this website is obtained by CF Benchmarks, from sources believed by it to be accurate and reliable. Such information and data is provided "as is" without warranty of any kind.

CF Benchmarks, nor its directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or implied, either as to the accuracy, timeliness, completeness or merchantability of any information or of results to be obtained from the use of the CF Benchmarks indices or the fitness or suitability of the same indices for any particular purpose to which they might be put. Any representation of historical data accessible through CF Benchmarks indices is provided for information purposes only and is not a reliable indicator of future performance.

No responsibility or liability can be accepted by CF Benchmarks nor their respective directors, officers, employees, partners or licensors for any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this website or links to this website.

CF Benchmarks and its respective directors, officers, employees, partners or licensors do not provide investment advice and nothing accessible through CF Benchmarks, should be taken as constituting financial or investment advice or a financial promotion. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of any assets.

CF Benchmarks is a member of the Crypto Facilities group of companies which is in turn a member of the Payward, Inc. group of companies. Payward, Inc. is the owner and operator of the Kraken Exchange, a venue that facilitates the trading of cryptocurrencies. The Kraken Exchange is a source of input data for certain CF Benchmarks indices. Payward, Inc. is the owner and operator of the Staked, a venue that operates the block production nodes for decentralized PoS protocols on behalf of institutional investors. Staked.us is a source of input data for certain CF Benchmarks indices.

Please refer to the individual product family documentation for more information about applicable input data sources.