Bitcoin Future-Spot Divergence

As of last night’s close, the price for a January bitcoin future was $1,171.21 higher than the price for a bitcoin. That means anyone could:

• Buy one bitcoin for about $16,500
• Sell a bitcoin future for about $17,500
• Wait until January
• Sell off the bitcoin and pay off the future contract
• Pocket over $1,000.

That’s a return of ~6% in just one month, and you can lock it in instantly - once the bitcoin is bought and the future sold, their values will move in tandem, so there’s no risk of losing money. Normally, we expect these kinds of arbitrage opportunities to disappear quickly - especially for assets like bitcoin, which are easy to acquire and cost nothing to store. So why haven’t the prices converged?

If you want to know why an apparent arbitrage opportunity hasn’t disappeared, an easy way to find out is to try to exploit it, and see what stops you.

In this case, the main issue is that a bitcoin future is a future. Futures require both parties to hold margin: money available to cover their side of the contract as prices move. Usually, margin on a future isn’t huge, since prices aren’t too volatile. But bitcoin? Very volatile. That means very high margin requirements.

As usual, Interactive Brokers has everything you need to know on one page: margin requirement to sell a single bitcoin future is $40,000. Now, that margin can still earn interest while it’s sitting around, so it isn’t a “cost” per se. You don’t need to spend it in order to take advantage of the arbitrage opportunity. But you do need to have it available, and you can only arbitrage one bitcoin per $40,000 available.

This is still a pretty good opportunity, but you can only put so much money into it. That explains why small traders aren’t wiping out this arbitrage opportunity. So, next question: why aren’t the usual big institutions arbitraging away that price difference?

Usually, here’s how the situation would play out. A trader would buy a bitcoin and sell a future. Now, the trader would like to repeat this trade in order to make more money. So, the trader would go to a banker and say “hey, I have this low-risk arbitrage opportunity, I’d like to take out a loan collateralized by my one bitcoin in order to leverage my position.” Banks love collateral, so they’d give the trader a loan, and the trader would make the same trade again. Now the trader has another bitcoin, gets another loan, rinse, lather, repeat. In actual practice, many of the middle steps happen automatically, and the whole process is called “leveraging”.

With bitcoin, this is not so easy. Good luck finding a banker who will make a loan collateralized by bitcoin (i.e., look for a margin account which allows direct bitcoin trading). Even setting aside that issue, a trader would also have to borrow for the futures’ margin requirement. Now, the whole arbitrage together is actually very low risk, so it should be possible in theory to get a loan to do this… but it would require a personal relationship with a banker who understands the nitty-gritty and is willing to dip their toe in untested waters.

Put it all together, and we have a beautiful, persistent arbitrage opportunity limited by liquidity. It will disappear eventually, but it’s going to take time for the bankers to warm up.