Selling into a frothy futures market one month ago has enabled some Bitcoin investors to take home an extra 14% in Bitcoin terms, while facing risk largely limited to the counterparty risk of the exchange itself.
For anyone following along with the strategy I outlined one month ago in “Selling the Froth: A Simple Hedged Forex Strategy for Bitcoin-Denominated Returns”, the gradual decline in the value of Bitcoin versus the dollar — a drop of around 23% — has provided a goldmine of returns after just one month. In Bitcoin terms, the simple strategy of shorting futures offset with additional long exposure in the spot market has generated gains of over 14% in just one month. These numbers assume that one is borrowing fiat at 10% per annum and directly deploying a conservative 25% of available Bitcoin capital to establish the position; someone deploying a higher percentage of available capital would obviously see larger gains, while someone with higher borrowing costs would see lower.
As I outlined in the earlier article, the aim of the strategy is to capitalize on froth in the futures market, selling into that froth while simultaneously protecting against the impact of gains in Bitcoin versus fiat by buying additional BTC. Since futures must eventually converge with the spot market, and futures had been trading at a large premium to spot, hedging in this way can exploit that premium to offer resilience against even quite large moves in the exchange rate. The strategy would have remained profitable all across the range from a 90% fall in BTC vs. fiat to a 400% gain.
While I would normally analyze a strategy like this relative to the settlement date — after all, futures will not yet have converged with the spot market when settlement is still five months away — I think it’s useful to check in with the strategy after just a month. Clearly it has done well.
(Naturally, one might object that the strategy has lost money in fiat terms: a gain of 14% is not enough to offset a fall of 23%. However, the strategy was explicitly designed to create gains in Bitcoin terms, not in fiat terms, and to do so while remaining robust to significant changes in the exchange rate. Someone concerned primarily to avoid losses in fiat terms would simply have used the futures market alone to lock in a fiat price which was at a greater than 50% premium to the spot market, without regard for hedging against a gain in BTC versus fiat.)
While significant gains may well continue to pile up for anyone holding a position like this, there’s much to be said for taking a 14% monthly gain off the table, reducing risk to zero, and saving the interest costs for maintaining the position until settlement.
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