• Rasheed Saleuddin

All that is old in arbitrage is new again, BTC edition

Why offer high single-digit (annualized) returns on BTC loans? Turns out it’s just another classic arbitrage that once again takes advantage of “outsiders”, a daily occurrence on Wall Street in previous years.

People want Bitcoin. Many also want leverage. Others want buying BTC to be easy to do and/or tax-efficient.

In the US at this point there are no Bitcoin ETFs, with the closest approximation being the Greyscale Bitcoin Trust (GBTC).

GBTC allows retail (and even small institutional) investors to (1) gain exposure to BTC in a traditional way through traditional channels (eg your stockbroker) with (2) no need to self-custody an awkward asset and (3) with certain US tax advantages. For some this ease of use justifies the large price premium the Trust trades for above the intrinsic value of all of its assets (its NAV).

In the past hedgies incurred the wrath of regulators by entering into agreements with mutual funds to arbitrage the NAV/price discount.

The scramble to BTC, combined with clear “insider”-friendly tactics, has opened up an opportunity for well-connected accredited players with access to BTC borrowing lines to profit from the interest from the outsiders. Funds depositing BTC into GBTC receive shares in the fund at NAV (below the market price) but are locked in for six months. As long as the cost of borrowing BTC is lower than GBTC’s premium to NAV when the shares can be sold to outsiders, a profit is made.

There is still a risk that the premium, currently 12% (see chart), disappears of course. But that spread has never been at zero and has been as high as 90%

The question is what happens to the markets when ETFs become popular. ETFs can be created or destroyed as demand warrants, and so negligible premium to NAV should be the result.

While the GBTC story illustrates how retail pays up for convenience, still other retail investors pay up for leverage. Insiders take advantage of this desire in two ways. By borrowing stablecoins and posting 150% collateral in crypto holdings, light leverage can be obtained (I’ll explain this in a later post). More importantly, however is that the huge premium in GBTC is mirrored in the CME BTC futures market.

In the 1990s we used to do the cash and carry trade where we would be long the asset and short futures against it, taking out a profit over and above the cost of financing. You can read more about that here.

This week, the closest CME BTC future (February) traded 1% higher than the “spot” rate for buying cash BTC in exchange for dollars. That’s a 1% profit, close to risk free, for less than a month of locking up cash by buying BTC and shorting the future. The future is popular because it allows buyers some leverage. Futures buyers pay for that leverage through the basis between spot and futures prices, and right now they are willing to pay more than they otherwise should.

Thus the previous opportunities for insiders to exploit the inefficient financial (stock, bond and derivative) markets of the past have reappeared in crypto, and the same strategies used by hedgies in the previous century are profitable today.