Bitcoin Futures Basis Trading: Lesson 2

Lesson 1 explained the time value of money and how to calculate the annualised basis of a futures contract. Lesson 2 will focus on the basis term structure and different ways to profit from curve shifts.

The basis term structure is a graphical representation of the annualised percentage basis for different maturity futures contracts.

Contango Term Structure

For a Bitcoin/USD future, being in contango means that the USD interest rate is higher than Bitcoin’s. Or put another way, traders believe that Bitcoin will appreciate in the future vs. the USD.

Assume there are three futures contracts:

Spot = $250

XBTU15 (September 2015): $260, t = 0.08 (days until expiry, Days/360)

XBTZ15 (December 2015): $290, t = 0.25

XBTH16 (March 2016): $340, t = 0.5

Below is a graphical representation of the upward sloping term structure.

image (11)

The best trading strategy for playing an upward sloping yield curve is a carry trade. Selling the longer dated XBTH16 and buying the shorter dated XBTU15 allows traders to capture the interest rate differential. When XBTU15 expires, the trader will purchase the XBTZ15; after XBTZ15 expires, the trader purchases XBTH16 to close the position.

Numerical Example:

T0 days:

Buy 1,000 contracts XBTU15 @ $260

Sell 1,000 contracts XBTH16 @ $340

 

T12 days:

XBTU15 expires at the spot price of $250

XBTZ15 = $258

XBTU15 Realised PNL = ($250 - $260) * 1,000 * 0.00001 BTC = -0.1 BTC

Buy 1,000 XBTZ15 contracts @ $258 (this replaces the long XBTU15 position)

 

T30 days:

XBTZ15 expires at the spot price of $250

XBTH16 = $310

XBTZ15 Realised PNL = ($250 - $258) * 1,000 * 0.00001 BTC = -0.08 BTC

Buy 1,000 XBTH16 contracts @ $310 (this closes out the XBTH16 position)

XBTH16 Realised PNL = ($310 - $340) * -1,000 * 0.00001 BTC = 0.3 BTC

 

Total PNL:

-0.1 BTC from XBTU15

-0.08 BTC from XBTZ15

+0.3 BTC from XBTH16

Total Profit = 0.12 BTC

 

As time elapsed the trader gained profited more from the fall in XBTH16’s price, than the loss experienced when XBTU15 & XBTZ15 expired. This is called positive carry, or positive Theta. The risk to this strategy is that the interest rate differential between XBTU15 & XBTZ15 or XBTZ15 & XBTH16 increases dramatically when the trader short rolls the position. The trader is short rolling, because he is short the near month contract and must buy it back, and then short the farther month contract to stay hedged against his long XBTH16.

Backwardation Term Structure

For a Bitcoin/USD future, being in backwardation means that the USD interest rate is lower than Bitcoin’s. Or put another way, traders believe that Bitcoin will depreciate in the future vs. the USD.

Assume there are three futures contracts:

Spot = $250

XBTU15 (September 2015): $240, t = 0.08

XBTZ15 (December 2015): $200, t = 0.25

XBTH16 (March 2016): $120, t = 0.5

Below is a graphical representation of the downward sloping term structure:

image (10)

The best trading strategy for playing a downward sloping yield curve is a carry trade. Buying the longer dated XBTH16 and selling the shorter dated XBTU15 allows traders to capture the interest rate differential. When XBTU15 expires, the trader will sell the XBTZ15; after XBTZ15 expires, the trader sells XBTH16 to close the position.

Numerical Example:

T0 days:

Sell 1,000 contracts XBTU15 @ $240

Buy 1,000 contracts XBTH16 @ $120

 

T12 days:

XBTU15 expires at the spot price of $250

XBTZ15 = $240

XBTU15 Realised PNL = ($250 - $240) * -1,000 * 0.00001 BTC = -0.1 BTC

Sell 1,000 XBTZ15 contracts @ $240 (this replaces the short XBTU15 position)

 

T30 days:

XBTZ15 expires at the spot price of $250

XBTH16 = $163.33

XBTZ15 Realised PNL = ($250 - $240) * -1,000 * 0.00001 BTC = -0.1 BTC

Sell 1,000 XBTH16 contracts @ $163.33 (this closes out the XBTH16 position)

XBTH16 Realised PNL = ($163.33 - $120) * 1,000 * 0.00001 BTC = 0.43 BTC

 

Total PNL:

-0.1 BTC from XBTU15

-0.1 BTC from XBTZ15

+0.43 BTC from XBTH16

Total Profit = 0.23 BTC

As time elapsed the trader gained profited more from the rise in XBTH16’s price, than the loss experienced when XBTU15 & XBTZ15 expired. This is another example of positive carry or Theta. The risk to this strategy is that the interest rate differential between XBTU15 & XBTZ15 or XBTZ15 & XBTH16 decreases dramatically when the trader long rolls the position. The trader is long rolling, because he is long the near month contract and must sell it, and then buy the farther month contract to stay hedged against his short XBTH16 position.

In the Lesson 3, I will explain some basics about risk management. The terms Delta, Dollar Value of 1% (DV01), and Theta (time value) will be introduced.

 

Ether Margin Trading vs. Futures Contracts

Soon after spot Ether trading began, leveraged products on the Ether/Bitcoin (ETHXBT) appeared. BitMEX was the first exchange to offer leveraged trading via a futures contract called ETH7D. The leading spot ETHXBT exchanges Poloniex and Kraken, have just started offering margin trading. This post will explain the differences and costs of margin trading vs. futures trading of ETHXBT.

Margin Trading

Margin trading requires that traders borrow Bitcoin to go long ETHXBT, and Ether to go short ETHXBT. Traders will then place their leveraged orders into the spot order book. The ability to borrow Bitcoin and Ether is not a sure thing. On Poloniex and Kraken other users must lend out their excess Bitcoin or Ether. If there is no supply, margin trading cannot happen. The interest rates paid are very volatile and can be expensive at times.

Futures Trading

The BitMEX ETH7D futures contract expires weekly every Friday. Each contract is worth 1 ETH, and traders must post Bitcoin as margin to go long or short. BitMEX allows 5x leverage. This means that there is no need to borrow ETH in order to short the ETHXBT exchange rate when using ETH7D. There is no daily interest rate charged either. The difference between where you buy or sell ETH7D and the current spot ETHXBT rate at the time represents an implied interest rate. For traders who have Bitcoin, ETH7D represents the easiest and cheapest way to go both long or short with leverage on ETHXBT.

How To Trade Ether

The hottest new altcoin on the block is Ether (ETH). Ether is the token used to power the Ethereum protocol’s smart contracts. Now that Ether is freely tradable, this post will explain the different ways to express bullish and bearish views on this new cryptocurrency.

Spot Trading

Buying and selling Ether on a spot basis is quite simple. The most liquid Ether currency pair is Ether/Bitcoin (ETHXBT). Poloniex and Kraken are the leading exchanges by volume.

Buying Ether

To buy Ether, send Bitcoin to the exchange and exchange it for Ether. This must be done on a fully funded basis (i.e. there is no leverage).

Selling Ether

If you hold physical Ether, you can exchange it back for Bitcoin. Selling Ether you don’t possess is not possible.

Leveraged or Derivatives Trading

For most of the readers of this blog, leveraged trading / speculating presents a more interesting way to trade Ether. With the exception of Bitcoin and Litecoin, leveraged or derivatives trading on altcoins was not possible. BitMEX recognised that Bitcoin traders would like to speculate on Ether with leverage and using only Bitcoin as margin.

BitMEX launched the ETH7D, weekly expiring ETHXBT futures contract, when spot trading became available last Friday. Each ETH7D contract represents 1 ETH. The contract expires each Friday at 12:00 GMT on the ETHXBT exchange rate. All margin, profit, and loss are conducted in Bitcoin. The maximum leverage allowed is 5x.

Buying Ether Futures

BitMEX Ether futures contracts allow traders to speculate on the future value of the ETHXBT exchange rate. A trader who wishes to go long 1,000 ETH, must buy 1,000 ETH7D contracts. The beauty of ETH7D is that it requires Bitcoin as margin. The maximum leverage is 5x. If the ETH7D price is 0.005, the trader must post 1 Bitcoin as margin (1,000 Contracts * 0.005 ETHXBT * 20%). If the price rises to 0.006, the profit is 1 Bitcoin = (0.006 – 0.005) * 1,000.

Selling Ether Futures

Short selling, or selling something you don’t possess is usually impossible with altcoins. Using ETH7D, traders are able to placed leveraged bearish bets on Ether as long as they own Bitcoin. For example, a trader who wishes to go short 1,000 ETH, must sell 1,000 ETH7D contracts. Again only Bitcoin is required for margin. If the ETH7D price is 0.005, the trader must post 1 Bitcoin as margin (1,000 Contracts * 0.005 ETHXBT * 20%). If the price falls to 0.004, the profit is 1 Bitcoin = (0.004 – 0.005) * -1,000.

Placing leveraged trades, and shorting Ether are only possible with BitMEX’s ETH7D futures contract. ETH7D Contract Description 

BitMEX for Commercial Hedgers

BitMEX is committed to serving the needs of commercial hedgers. Commercial hedgers are merchants or payment processors who accept Bitcoin as payment and need to manage their Bitcoin vs. fiat currency risk. This manual is meant to instruct commercial hedgers on how to use BitMEX derivative products to reduce the currency risk their business faces when they choose to accept Bitcoin as a form of payment.

In this lesson, Bitcoin will be referred to with the three-letter currency code XBT. The Bitcoin / USD exchange rate is XBTUSD. The lesson will explain hedging strategies using three different types of futures contracts: XBT, XBU, and XU futures chains.

The XBT futures chain’s underlying is XBTUSD, the contract has a multiplier of 0.0001 XBT, and is quoted in USD. The value of each contract in XBT and USD depends on the XBTUSD exchange rate. Margin, profit, and loss are all denominated in XBT. This lesson will use the XBTUSD December 26, 2014 futures contract and will be referred to using the symbol XBTZ14. The below functions describe the value of a XBTZ14 contract in XBT and USD:

XBTZ14 Value in USD = 0.00001 XBT * XBTZ14 Price * Contracts * XBTUSD

XBTZ14 Value in XBT = 0.00001 XBT * XBTZ14 Price * Contracts

The XBU futures chain’s underlying is XBTUSD, each contract is worth $100 of Bitcoin and quoted in USD. Margin, profit, and loss are all denominated in XBT. This lesson will use the XBT/USD December 26, 2014 futures contract and will be referred to using the symbol XBUZ14. The below functions describe the value of a XBUZ14 contract in XBT and USD:

XBUZ14 Value in USD = $100 * Contracts

XBUZ14 Value in XBT = $100 * 1/XBUZ14 Price * Contracts

The XU futures chain’s underlying is XBTUSD, each contract is worth 0.01 XBT, and is quoted in USD. Margin, profit, and loss are all denominated in USD. This lesson will use the XBT/USD December 26, 2014 futures contract and will be referred to using the symbol XUZ14. The below functions describe the value of a XUZ14 contract in XBT and USD:

XUZ14 Value in USD = 0.01 XBT * XUZ14 Price * Contracts

XUZ14 Value in XBT = 0.01 XBT * Contracts

For the examples presented below assume the current date is Oct 1, 2014, the XBTUSD exchange rate is $800, and the USDXBT exchange rate is 0.002 XBT.

Merchant Accepts Bitcoin as Payment

The merchant is a shoe wholesaler. Normally the merchant accepts only USD as payment for their goods. Their clients order large quantities of shoes today, but will pay at the end of December. All the merchants costs are denominated in USD, i.e. salaries, rent, supplies etc. For cost savings, the merchant has decided to accept Bitcoin as a form of payment.

By taking Bitcoin for future payment, the merchant must cover their costs today in USD, but receive payment in the future in Bitcoin. The merchant cannot simply sell Bitcoin and buy USD on the spot market because the merchant has not been paid their Bitcoin yet. The merchant needs a derivative solution to forward sell Bitcoin and buy USD to hedge the currency risk until their client pays.

Merchant Hedges Using the XBTZ14 Contract

A client would like to buy $100,000 worth of shoes. Instead of paying in USD, the client would like to pay the merchant in Bitcoin when he receives the shoes on December 26, 2014. The XBTZ14 contract is currently trading $1,000, and spot XBTUSD is $800. The merchant and client must decide on an exchange rate to use for their deal. The merchant decides that because the client will pay for the goods in Bitcoin in the future, the XBTZ14 price should be used as the exchange rate. The below table summarises the merchant’s cash flows:

Today 12/26/2014
USD Costs -$100,000
XBT Receipts 100 XBT

If the XBTUSD exchange rate rises, the merchant will make an additional profit as the XBT they receive in December will be worth more in USD. If the XBTUSD exchange rate falls, the merchant will make a loss as the XBT they receive in December will be worth less in USD. The merchant is short USD vs. long XBT or long the XBTUSD exchange rate.

The merchant uses their account at BitMEX to trade XBTZ14 contracts. The XBTZ14 contract has an underlying of XBTUSD, to correctly hedge their risk the merchant needs to sell XBTZ14 contracts. If one sells the XBTZ14 contract, one is short XBT vs. long USD or short the XBTUSD exchange rate. The following function describes how to calculate the correct number of XBTZ14 contracts to sell:

Contracts = XBT Value to Hedge / (XBTZ14 Price * 0.00001 XBT)

The merchant needs to hedge the 100 XBT they are receiving. The merchant needs to sell 10,000 contracts [10,000 = 100 XBT / ($1,000 * 0.00001 XBT)]. On December 26, 2014, the client pays the merchant 100 XBT and the XBTZ14 futures contracts expire. The below table shows the merchant’s cash flow using different XBTUSD exchange rates observed on December 26, 2014:

XBTUSD XBT Received XBTZ14 PNL XBT Total XBT Total Value USD
$800 1,000 XBT 20 XBT 120 XBT $96,000
$900 1,000 XBT 10 XBT 110 XBT $99,000
$1,000 1,000 XBT 0 XBT 100 XBT $100,000
$1,100 1,000 XBT -10 XBT 90 XBT $99,000
$1,200 1,000 XBT -20 XBT 80 XBT $96,000

As described above, the XBTZ14 contracts pay out in XBT. The merchant must now decide whether they will keep the XBT or convert into USD. The table above shows that the USD value of the merchant’s XBT is not fully hedged. Any deviation from a XBTUSD price of $1,000, negatively impacts the total value of the merchant’s XBT. The XBT futures chain is a quanto derivative. It is linear in XBT terms, but non-linear in USD terms. For more information about quanto derivatives, please read the BitMEX blog post XBUU14 vs. XBTU14.

The Merchant Uses the XBUZ14 Contract

A client would like to buy $100,000 worth of shoes. Instead of paying in USD, the client would like to pay the merchant in Bitcoin when he receives the shoes on December 26, 2014. The XBUZ14 contract is currently trading at $1,000, and spot XBTUSD is $800. The merchant and client must decide on an exchange rate to use for their deal. The merchant decides that because the client will pay for the goods in Bitcoin in the future, the XBUZ14 price should be used as the exchange rate. The below table summarises the merchant’s cash flows:

Today 12/26/2014
USD Costs -$100,000
XBT Receipts 100 XBT

If the XBTUSD exchange rate rises, the merchant will make an additional profit as the XBT they receive in December will be worth more in USD. If the XBTUSD exchange rate falls, the merchant will make a loss as the XBT they receive in December will be worth less in USD. The merchant is short USD vs. long XBT or long the XBTUSD exchange rate.

The merchant uses their account at BitMEX to trade XBUZ14 contracts. The XBUZ14 contract has an underlying of XBTUSD, to correctly hedge their risk the merchant needs to sell XBUZ14 contracts. The XBUZ14 is an inverse contract meaning when one goes short one is actually going long USDXBT (the inverse of XBTUSD). Therefore, if one sells the XBUZ14 contract, one is  long USD vs. short XBT or long the USDXBT exchange rate. The following function describes how to calculate the correct number of XBUZ14 contracts to sell:

Contracts = USD Value to Hedge / $100

Each XBUZ14 contract is worth $100; therefore to hedge a USD exposure of $100,000, the merchant needs to buy 1,000 contracts [1,000 = $100,000 / $100]. The below table shows the merchant’s cash flow using different XBTUSD exchange rates on December 26, 2014:

XBTUSD XBT Received XBUZ14 PNL XBT Total XBT Total Value USD
$800 100 XBT 25 XBT 125 XBT $100,000
$900 100 XBT 11 XBT 111 XBT $100,000
$1,000 100 XBT 0 XBT 100 XBT $100,000
$1,100 100 XBT -9 XBT 91 XBT $100,000
$1,200 100 XBT -17 XBT 83 XBT $100,000

As described above, the XBUZ14 contracts pay out in XBT. The merchant must now decide whether they will keep the XBT or convert into USD. At each given XBTUSD rate on December 26, 2014, the value of the merchant’s XBT holdings is $100,000. By hedging with the XBUZ14 contract, the merchant has eliminated their USD / Bitcoin currency risk.

The Merchant Uses the XUZ14 Contract

A client would like to buy $100,000 worth of shoes. Instead of paying in USD, the client would like to pay the merchant in Bitcoin when he receives the shoes on December 26, 2014. The XUZ14 contract is currently trading $1,000, and spot XBTUSD is $800. The merchant and client must decide on an exchange rate to use for their deal. The merchant decides that because the client will pay for the goods in Bitcoin in the future, the XUZ14 price should be used as the exchange rate. The below table summarises the merchant’s cash flows:

Today 12/26/2014
USD Costs -$100,000
XBT Receipts 100 XBT

If the XBTUSD exchange rate rises, the merchant will make an additional profit as the XBT they receive in December will be worth more in USD. If the XBTUSD exchange rate falls, the merchant will make a loss as the XBT they receive in December will be worth less in USD. The merchant is effectively long XBT vs. short USD, or long the XBTUSD exchange rate.

The merchant uses their account at BitMEX to trade XUZ14 contracts. The XUZ14 contract has an underlying of XBTUSD, to correctly hedge their risk the merchant needs to sell XUZ14 contracts. If one sells the XUZ14 contract, one is short XBT vs. long USD or short the XBTUSD exchange rate. The following function describes how to calculate the correct number of XBTZ14 contracts to sell:

Contracts = XBT Value to Hedge / 0.01 XBT

Each XUZ14 contract is worth 0.01 XBT; therefore to hedge a XBT exposure of 100 XBT, the merchant needs to sell 10,000 contracts [10,000 = 100 XBT / 0.01 XBT]. The below table shows the merchant’s cash flow using different XBTUSD exchange rates on December 26, 2014:

XBTUSD XBT Received XUZ14 PNL USD Total Value USD
$800 100 XBT $20,000 $100,000
$900 100 XBT $10,000 $100,000
$1,000 100 XBT $0 $100,000
$1,100 100 XBT -$10,000 $100,000
$1,200 100 XBT -$20,000 $100,000

As described above, the XUZ14 contracts pay out in USD. The merchant must now decide whether they will keep the XBT received from the client, or convert into USD. At each given XBTUSD rate on December 26, 2014, the value of the merchant’s currency holdings is $100,000. Buy hedging with the XUZ14 contract, the merchant has eliminated their Bitcoin / USD currency risk.

Contango and Backwardation

The future value of any currency pair is determined by the interest rate differential between the two currencies. This means that a Bitcoin futures contract can and does trade at a premium or discount to the spot exchange rate. When a futures contract trades at a premium to spot, the futures contract is said to be in contango. When a futures contract trades at a discount to spot, the futures contract is said to be in backwardation. To understand more about these concepts, please read the BitMEX blog post Bitcoin and Interest Rates.

In all three examples above, the futures price was different from the spot price. A savvy merchant can take advantage of contango and backwardation in the futures contract to earn extra income. Instead of the merchant using the futures price to determine the amount the client pays, the merchant will use the prevailing spot price at the time of the transaction. The client will pay the merchant 125 XBT [125 XBT = $100,000 / $800] instead of 100 XBT. The below tables illustrate for each hedging option, the monetary outcome for the merchant:

Hedging using the XBTZ14 contract, the merchant will sell 15,625 contracts [15,625 = 125 XBT / (0.00001 XBT * $800)].

XBTUSD XBT Received XBTZ14 PNL XBT Total XBT Total Value USD
$800 125 XBT 31 XBT 156 XBT $125,000
$900 125 XBT 16 XBT 141 XBT $126,563
$1,000 125 XBT 0 XBT 125 XBT $125,000
$1,100 125 XBT -16 XBT 109 XBT $120,313
$1,200 125 XBT -31 XBT 94 XBT $112,500

Hedging using the XBUZ14 contract, the merchant will still sell 1,000 contracts as the USD value of the goods has not changed.

XBTUSD XBT Received XBUZ14 PNL XBT Total XBT Total Value USD
$800 125 XBT 25 XBT 150 XBT $120,000
$900 125 XBT 11 XBT 136 XBT $122,500
$1,000 125 XBT 0 XBT 125 XBT $125,000
$1,100 125 XBT -9 XBT 116 XBT $127,500
$1,200 125 XBT -17 XBT 108 XBT $130,000

Hedging using the XUZ14 contract, the merchant will sell 12,500 contracts [12,500 = 125 XBT / 0.01 XBT].

XBTUSD XBT Received XUZ14 PNL USD Total Value USD
$800 125 XBT $25,000 $125,000
$900 125 XBT $12,500 $125,000
$1,000 125 XBT $0 $125,000
$1,100 125 XBT -$12,500 $125,000
$1,200 125 XBT -$25,000 $125,000

In each example, the merchant is earning more money than before. The XBTZ14, XBUZ14, and XUZ14 are all trading at $1,000, while XBTUSD is at $800. Because the merchant is selling these contracts, they are earning an extra $200.

Merchants should always analyze whether the futures contract they use to hedge is in contango or backwardation and price their goods accordingly. An intelligent hedging strategy can allow a merchant to earn additional income.

Margin Considerations

Merchants are only allowed to trade on BitMEX once they have deposited the appropriate margin. Depending on the futures contract, the merchant will either need to post Bitcoin or USD. For XBTZ14 and XBUZ14, the merchant must post Bitcoin as margin. For XUZ14, the merchant must post USD as margin. Depending on the currency composition of the merchant’s working capital, one contract might be more attractive than another from the currency in which margin is posted.

Bitcoin and Interest Rates

Understanding the interplay between USD and Bitcoin interest rates is critical to understanding the spot and derivatives market structure. The difference between where you can borrow and lend unsecured USD vs. unsecured Bitcoin can tell you many valuable things as a trader. The rest of this post will explore how interest rates affect the price of spot and derivatives.

Using borrowed money to buy an asset is the bedrock of finance, and is no different with Bitcoin. A trader who is very bullish Bitcoin, would borrow USD, sell USD, then buy Bitcoin. Traders who expect the price of Bitcoin to appreciate more in percentage terms than what they are paying on the USD loan. The second scenario is borrowing Bitcoin to sell it short on the market. The short seller hopes that Bitcoin will fall by a greater percentage than the interest rate on their loan. The differential between USD and Bitcoin interest rates tells traders about whether the market thinks Bitcoin will appreciate or depreciate in the future.

Besides observing USD and Bitcoin interest rates separately, the premium or discount a futures contract trades at signals whether USD or Bitcoin interest rates are higher. For Bitcoin/USD futures contracts, if the future is more expensive than spot it means that USD interest rates are higher than Bitcoin ones. Conversely if the Bitcoin/USD futures contract is cheaper than spot, it means that Bitcoin interest rates are greater than USD ones.

Covered interest rate parity describes the relationship between a futures contract, the spot exchange rate and the interest rates of the home and foreign currency.

F = S * (1 + R_f) / (1 + R_h)

F = Future price; S = Spot; R_f = Foreign currency interest rate; R_h = Home currency interest rate

A simple example will illustrate how this process works. Jane is a foreign exchange trader. The spot price of Bitcoin is $100, while a futures contract expiring in one month has a price of $200. Jane knows she can borrow money from the bank at 100% per month interest. Jane’s friend James is looking to borrow Bitcoin to sell it short. He is willing to pay 25% per month in interest. Jane’s other friend Jack wants to sell Bitcoin in one month’s time for $200 per Bitcoin. Jane sees an arbitrage, if she borrows USD from the bank, buys spot Bitcoin, lends her Bitcoin to James, and then sells it forward to Jack, when the futures contract expires she stands to make $50.

Jane goes to her local bank and takes out a loan for $100. The bank charges her 100% to borrow the money for one month. Jane must pay the bank back $200 in one month’s time. She takes the $100 and buys 1 Bitcoin. James borrows Jane’s 1 Bitcoin and will pay her back 1.25 Bitcoin at the end of the month. Jane promises Jack that she will deliver 1.25 Bitcoin in one month’s time for $250.

After one month, Jane gets her 1.25 Bitcoin back from James. Jane then delivers 1.25 Bitcoin to Jack and receives $250. Jane then pays back her bank loan of $200; the $50 left over is profit.

Plugging in the numbers to the formula, Jane’s arbitrage opportunity becomes obvious.

$100 * (1 + 100%) / (1 + 25%) = $160

If Jane can sell Bitcoin forward at a greater rate than $160, she can make a risk free profit. Are there arbitrage opportunities in Bitcoin like the one presented above? Of course. The USD rate at which speculators are willing to borrow at and margin trade is much higher than the Bitcoin borrow rate short sellers pay. The market believes Bitcoin will appreciate in the future and speculators are willing to pay a high interest rate to leverage their positions.

For the lucky traders who can borrow USD below the rate speculators are paying on margin trading platforms, can make easy risk free profits. Arbitrageurs give up the potential massive upside in Bitcoin’s value for steady non-volatile profits.