ANALYSIS: US spot ETF markets driving crypto basis trades

The emergence of US spot exchange-traded funds (ETFs) and futures referencing the same rate has made it easier institutional investors to make trades designed to benefit from divergence in prices between the markets.

Increased interest in basis trades – a strategy involving long and short positions across spot and futures on the same asset – can be inferred from the increase in short positioning by hedge funds, according to specialist benchmark provider CF Benchmarks. Proprietary traders and leveraged investors looking to benefit from “positive basis” opportunities since the launch of US regulated spot ETFs earlier this year. There has been an increase in net short positioning by “leveraged funds” as reported to the Commodity Futures Trading Commission (CFTC).

CF Benchmarks is the benchmark rates provider to CME Group, the largest traditionally regulated cryptocurrency venue, as well as six of the 11 bitcoin ETFs that were listed in January. In March 2024, the two-week tenor on the CF Bitcoin interest rate curve (BIRC) reached 25%, indicating a significant premium of futures prices over the spot price. At the same time, the CME Bitcoin futures market saw an addition of $1.6 billion (£1.2bn) on the short side, suggesting that institutional investors were anticipating a convergence of futures and spot prices (see graph 1).  

“What we are seeing is more willingness to step in front of the basis trade, whereas before the approval of the spot ETFs, large hedge funds would typically be more reluctant to take the risk associated with the short futures leg of that trade,” Gabriel Selby, head of research at CF Benchmarks, told FOW. “With the emergence of fully regulated spot products, I believe there is greater confidence stemming from the 'price singularity' dynamic of our CME CF Bitcoin Reference Rates (BRR), which can run through both legs of the basis trade and can yield a profit and loss benefit as the basis compresses over time.

“That flow is largely tactical, and the positioning is looking to take advantage of periods of basis widening, which is partly what is driving the growth in net short positioning we have observed.”

Graph 1

Source: CF Benchmarks, Bloomberg (data to July 2)

That compression has already begun to take effect. The CFTC commitments of traders report for July 19 shows 24,710 bitcoin longs held at CME Group, versus 25,289 shorts, indicating a reduction of that positive basis flow. What is clear is that the funds are much more comfortable taking those positions. Overall, CME saw a record of 480 large open interest holders across cryptocurrency futures on average in the second quarter, up 9% from the previous quarter’s high bar. Across futures and options it saw a record $13.7 billion in open interest in the quarter, according to figures published by the exchange. For bitcoin futures, July 19 reported 33,553 contracts in open interest, surpassing the month end record of 31,769 set in March this year, according to FOW data.

“During bullish movements, a widening basis allows traders to roll futures contracts forward, arbitraging the higher basis,” Selby added. “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.”

The nature of those swings can be seen by observing how the number of short contracts held by leveraged funds and the BRR index movements correlate (see graph 2). Reductions in the spot price are typically accompanied by reductions in the leveraged fund short positions (top chart), as the basis between the spot and futures market compresses, and leads to covering of short positions (bottom chart). The fact that the data does seem to indicate some correlation between market moves, it is likely that some of this short positioning is driven by the basis, rather than simply hedging, according to CF.

Graph 2

Source: CF Benchmarks

Cboe Global Markets on Friday confirmed that it will list its first Ether spot ETFs on Tuesday, according to filings on its website. The SEC approved in May rules that paved the way for Ether ETF listings on Cboe, the Intercontinental Exchange (ICE) and Nasdaq. The move gives rise to expectations of similar dynamics in that market, as well as more trading of the basis between the two main cryptocurrencies.

Rival Eurex has said it will launch its first Ether futures and options on August 12, adding to its bitcoin product suite.