Bitcoin Cash & Carry Trade

The Bitcoin cash and carry trade is only possible in a specific condition of the futures market, which is called normal backwardation. This concept is explained below.

Most of the investors that want to get exposure to Bitcoin go for the simple way of buying spot and holding, whether it’s through a CEX or direct custody or other products, like an ETF.

Regardless, Bitcoin is a relatively new and small asset compared to the TradFi financial market, carrying high risks that can impact institutional investors’ portfolios considerably. For this reason, cash and carry is a trade that institutions can employ to still benefit from the upside of BTC, while hedging the risks involved.

Hedging comes with smaller profits, but the risk-adjusted returns look more attractive to big players.

How the Bitcoin Backwardation works

In understanding how the Bitcoin backwardation works, it's essential to understand the basics of futures contracts. A futures contract is a financial instrument that allows an investor to buy or sell a particular asset, at a predetermined price at a specified time in the future. The key feature of these contracts is that they allow investors to hedge against price changes or speculate on the price movement of the underlying asset.

When investors anticipate that the price of Bitcoin will rise in the future, they may enter into futures contracts to buy Bitcoin at today's price (take a long position), but the actual exchange of the asset occurs at a future date. Conversely, if they believe the price will fall, they might sell futures contracts (take a short position) to lock in today's price for a future sale.

Backwardation occurs when the futures price of Bitcoin is below the expected future spot price, suggesting that investors expect the price of Bitcoin to rise over time. This creates an opportunity for investors to profit from the anticipated increase in Bitcoin spot price relative to the lower futures price.

Crypto assets future contracts are primarily traded on centralized derivatives exchanges, which offer perpetual futures contracts. These contracts do not have an expiry date unlike traditional futures. Perpetuals introduce the concept of funding rates, which represent the cost to borrow a specific asset for eight hours. These rates are intended to keep the price of the perpetual contract in line with the underlying spot price of the asset.

If the market is in backwardation, meaning the futures price is below the spot price, long position holders will pay funding to short position holders. When the futures price is lower than the spot price, shorts will pay funding to the longs.

The chart below shows the historical Bitcoin funding rates across the main centralized exchanges. The funding rate has been mostly positive, meaning that the longs have been usually paying the shorts, allowing investors to lock in profits through the cash and carry trade.