Structural Issues May Be Causing BitMEX’s Low Bitcoin 'Cash and Carry' Returns

BitMEX may be one of the largest crypto derivatives platforms, but it offers the lowest return on bitcoin "cash and carry" trades.

Currently, the return offered by Seychelles-based BitMEX on a three-month basis is 2.71% annualized, half of what rival exchanges like Binance, FTX and Deribit are offering, according to data source Skew.

Cash and carry arbitrage involves buying an asset in the spot market against a sell position in the futures market when the latter is trading at a premium to the spot price. Essentially, carry strategies profit from futures basis – the spread between prices in futures and spot markets – which evaporates on the day of the expiry.

Bitcoin as BitMEX's sole collateral

BItMEX's policies and recent history appear to have affected traders’ behavior, thus keeping rates low on BitMEX relative to other platforms.

"We believe that the difference in the BitMEX premium relates to their single collateral offering," Patrick Heusser, senior cryptocurrency trader at Zurich-based Crypto Broker AG, told CoinDesk in a Twitter chat.

BitMEX only accepts bitcoin as collateral, meaning traders can pay or receive margin, profit and loss solely in bitcoin. As such, when the market drops, the collateral loses value, forcing longs to exit by taking offsetting positions. That, in turn, leads to bigger price decline and more "long liquidations," a forced unwinding of buy positions akin to what can happen in a margin call on traditional futures exchanges.

"During the March sell-off, the network was clogged up, and the liquidation cascade drove prices lower at a faster pace. Assuming it was a closed ecosystem, the danger was that bitcoin's price on the BitMEX platform could have gone to zero, resulting in a complete wipeout of collateral value and all open positions," Heusser said.

On March 12, bitcoin fell by nearly 40% to levels below $4,000. The sudden decline, which began from around $7,800, triggered record buy-sell liquidations worth $876 million on BitMEX. These forced closures likely aggravated the price drop.

Hence, traders are less aggressive in building long on BitMEX as compared to other exchanges like FTX, where they can pledge stablecoins and cryptocurrencies as collateral. That helps mitigate risk arising from sudden price collapse.

"There is a residual risk market makers have if they get 'too long' on BitMEX. Therefore, the general pricing of those futures is slightly lower compared to the multi-collateral platforms," said Heusser.

Other platforms

Binance, the leading global cryptocurrency exchange by trading volume, launched a cross-collateral program on its futures platform earlier this year. The feature allows users to trade futures using crypto assets from their Binance Exchange Wallet as collateral, without having to sell any coins.

Deribit, the biggest exchange by options volume, also offers a single collateral mechanism like BitMEX. Even so, the futures' basis on Deribit is significantly higher compared to BitMEX.

That's possibly due to differences in liquidation mechanisms.

On Deribit, positions are liquidated incrementally. "The position will be liquidated in fractional steps to avoid unnecessary reductions, on condition that partial liquidation ensures the margin balance is above the required maintenance margin level,” according to the official blog. A full liquidation occurs as the trader's margin balance is below the maintenance margin.

That incremental liquidation allows traders to express their bullish view more aggressively, causing futures premium to widen. BitMEX does not offer a partial or incremental liquidation mechanism.

BitMEX's large market share

Further, BitMEX's high trading volume and order book depth could be responsible for the low basis compared to Deribit.

As of Tuesday, BitMEX accounted for 14% of the global bitcoin futures trading volume of $16 billion, while Deribit contributed just 2%, according to data source Skew. Further, at BitMEX, the average daily spread between buy and sell orders on bitcoin futures for $10 million quote size is currently 0.4% versus 2.94% on Deribit.

That said, the low basis on BitMEX does not represent low credit risk. If anything, it indicates the opposite due to the single-collateral structure.