Although leveraged funds are showing a record high level of net short interest in Bitcoin futures, this should not be misconstrued as an overwhelming sense of bearishness among hedge funds. This is more likely to be the result of a market-neutral strategy that is becoming increasingly popular.
The basis trade, which is a strategy that seeks to profit between discrepancies in spot and futures markets, is likely responsible for majority of the short interest of almost 18,000 CME Bitcoin futures contracts, according to experts. The basis trade is a strategy that seeks to profit between discrepancies in spot and futures markets.
Ravi Doshi, head of markets at the prime broker FalconX, explained that the popularity of the basis trade is evident from the short interest on CME BTC futures held by hedge funds, with over $7.5 billion in net-short futures currently, compared to a peak short position of only $2B in 2021 when BTC basis was significantly higher.
There is over $7.5 billion in net-short futures currently. In 2021, when BTC basis was significantly higher than it is now, the peak short position was only $2B.
Ravi Doshi
Due to the fact that spot-Bitcoin exchange-traded funds were introduced in January, the basis trade has gained more popularity in the cryptocurrency industry.
This is because it enables traders to purchase the ETFs and sell futures representing Bitcoin at higher levels, thereby allowing them to profit from the difference in prices. ETFs have made it simpler to execute this trade because the pair can be traded through regulated brokers.
Moreover, this has simplified the process of initiating a cash-and-carry strategy, which is a strategy that is commonly used in the cryptocurrency markets.
A popular strategy
According to data compiled by Bloomberg, the increase in short interest in futures coincides with a rebound in demand for the spot—Bitcoin exchange-traded funds (ETFs), which collectively now hold a total of more than $61 billion in assets.
Vetle Lunde, a senior analyst at K33 Research, said that the basis trade is currently a popular strategy; however, it should not be mistaken for the primary driver of flows into exchange-traded funds (ETFs).
As per Lunde, the widely held belief that CME shorts are responsible for offsetting ETF flows is incorrect. She expressed that the organic directional demand is the primary source behind the robust ETF flow; traders who are motivated by the chunky futures premium arbitrage are not the source of this strong flow.
Moreover, she emphasized the basis was significantly more robust from the end of November until the middle of March, after which it hovered around 20% on an annualized basis, with the exception of a brief decline in February.
Since then, the premium had been fluctuating between 11% and 16% over the course of the previous few weeks, before falling to approximately 6% at the present time, he added.
Nevertheless, the fact that the basis trade is so widely used can make the short-term ETF flow data less of a reliable indicator when it comes to determining the level of investor interest in the subject asset class.
In a data compiled by Bloomberg, the funds have experienced net inflows of $15.6 billion since their launch in January, but yesterday they recorded outflows of $65 million. This is despite the fact that they continued to see net inflows.
Furthermore, in spite of the fact that net BTC ETF inflows are scrutinized on a daily basis, Doshi of FalconX stated that these inflows do not always represent organic demand for Bitcoin.
The regulatory environment for cryptocurrencies remains an influential factor shaping the trajectory of the market, as various pivotal decisions and developments are anticipated to unfold in the near term, carrying significant implications for the industry's growth and evolution.
Unraveling the reasons behind hedge funds' escalating fascination with the Bitcoin basis trade is indispensable for gaining a deeper comprehension of the broader dynamics driving the crypto market.