Hours after Cboe Global Markets' bitcoin futures began trading, it's already clear that futures aren't solving a very basic problem: Whether it's bitcoin futures or closed-end funds like Bitcoin Investment Trust (GBTC -3.54%), convenient ways to buy or sell bitcoin trade for high premiums to the value of bitcoin.
Bitcoin on the Gemini Exchange traded for $16,600 per coin as of 11:20 a.m. EST. At the same time, Cboe bitcoin futures expiring in January traded for $18,200 per coin, roughly 10% more than the spot market.
In theory, bitcoin futures contracts shouldn't trade for much more than bitcoin on spot markets. An arbitrager could buy one bitcoin on the Gemini exchange for $16,600, and simultaneously sell a bitcoin futures contract at $18,200, locking in a certain profit due to the difference in price.
Known as "cash-and-carry arbitrage," such trades are a big business for high-speed traders and arbitrage specialists, who make money by helping keep prices on futures markets consistent with prices on spot markets. But the market in bitcoin futures is too small, and still too speculative, to attract arbitragers to keep prices rational.
A thin market
The bitcoin futures market isn't deep enough yet to attract institutional arbitragers, and few are comfortable arbitraging their futures positions by purchasing bitcoin on exchanges like Gemini.
As an anecdote of institutional discomfort with holding bitcoin, Coinbase believes institutional investors will pay an annual fee equal to 1.2% of their bitcoin holdings to keep their bitcoin safe and secure. That's 15 times more than the cost of similar services for keeping physical gold safe from thieves.
The scale of the arbitrage trade is another problem. The Cboe has strict position limits that only allow a person to hold 5,000 contracts or less net long or short. That limit falls to 1,000 contracts for futures that are five business days from expiration. Even if the potential returns are high in percentage terms, it's a rounding error in nominal terms of dollars and cents.
Individual investors, who might view the arbitrage trade as a profitable use of time and effort, have limited access to bitcoin futures. Right now, Interactive Brokers is the only discount broker offering Cboe bitcoin futures, but it doesn't allow speculators to short bitcoin futures, which is a necessary step in the arbitrage trade.
Interactive Brokers fears that if bitcoin rockets in price, short-sellers may incur losses they can't afford to repay, leaving the brokerage firm holding the bag. And though its clients may want to short bitcoin futures only to hedge holdings they have elsewhere, the company doesn't want to be in the business of verifying ownership of bitcoin, or operating a big collections department to chase down account holders with negative equity. I can't blame it.
The net result is that bitcoin futures will likely trade at a premium until other bitcoin products, such as a true bitcoin ETF, appear on regulated exchanges. Notably, the Bitcoin Investment Trust, which acts as a closed-end fund for bitcoin, trades at roughly 18% more than the underlying value of its bitcoin holdings, a premium that doesn't seem so absurd given bitcoin futures trade at 10% more than the spot value of bitcoin.