Basis trade has returned to the cryptocurrency market, with the effect most noticeable in ether. This strategy involves buying an asset on the spot market and simultaneously selling a more expensive futures contract. The profit is expected to result from the narrowing of the difference between these prices before the contract expires, as futures and spot prices converge on the expiration date. The sharp rallies of August and September triggered a short squeeze, i.e. forced buybacks of BTC or ETH on crypto exchanges. Such a move may have pushed up the futures premium relative to the spot market. In the following weeks, ETF inflows and growing short positions on futures painted a picture consistent with the rebuilding of this strategy. The change in positioning was more pronounced for ETH than for BTC.
The CFTC report on positions as of August 4 showed 6,128 short contracts on ether in the leveraged funds category. By September 22, this number had risen to 13,220, an increase of 7,092 contracts, or 115.7 percent. Over the same period, short positions on bitcoin increased from 11,483 to 12,698 contracts, an increase of 1,215 contracts, or 10.6 percent.
Such a strong increase in ETH shorts may be consistent with the rebuilding of hedged short positions on futures after the squeezes. Such a position may accompany the purchase of ether on the spot market, creating a setup typical of basis trade.
From August 3 to September 25, spot ether ETFs collected around USD 2.73 billion net. Over the same period, inflows into bitcoin funds amounted to around USD 6.24 billion. ETF inflows may reflect demand for the underlying asset, while the increase in short positions on futures may correspond to the other side of the cash-and-carry transaction. Taken together, the data for the entire period from the beginning of August to the end of September supports the thesis of a return of basis trade, particularly for ETH.
As recently as May, June, or even July, the profitability of basis trade was not high, as the annualized rate of the difference between futures and the spot market minus the cost of financing the position at the SOFR rate stood at 0.66, 0.71, and 1.35 percent, respectively, for BTC. For ETH, it was 0.18, 0.36, and 0.76 percent in those months. In the second half of September, however, the profitability of such a transaction rose to 2.27 percent for BTC and 2.77 percent for ETH annually. This may seem small, but it should be remembered that, firstly, this is a strategy that does not expose one to the direction of price movements, since the essence lies in the basis, and secondly, funds execute these transactions using financial leverage.
In summary, the longer the difference between futures and spot persists, the greater the potential ETF inflows, and the better the sentiment may be for the entire industry, including the companies operating within it. Conversely, a narrowing of the basis could quickly lead to a reversal of the basis trade strategy, as a smaller basis would reduce the willingness to re-enter such a trade at the next contract rollover.