Institutional demand for stablecoins may cool because yield on “carry trades” has been cut in half since Monday.
The annualized rolling one-month futures basis shot as high as 28% at the start of the week on the Malta-based cryptocurrency exchange OKEx, the biggest in terms of open interest. That was the highest premium since February, according to data provided by the crypto derivatives research firm Skew.
That premium, however, dropped to 14% in under 48 hours. In other words, the carry strategy, if initiated now and held until next Friday, will yield an annualized return of 14%, down from 28% on Monday.
Carry trading, or cash and carry arbitrage, is a market-neutral strategy, one that seeks to profit from both increasing and decreasing prices in one or more markets. It involves buying the asset in the spot market and simultaneously selling a futures contract against it when the futures contract is trading at a premium to the spot price.
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The premium, however, evaporates as the futures contract nears expiration and on the day of the settlement, the futures price converges with the spot price. Should futures draw high premiums, savvy traders initiate a carry strategy and lock in fixed returns.
Futures markets usually trade at a premium to the spot market and the spread tends to widen during price rallies. The annualized premium rose roughly from 9% to 27% in the last two weeks of July as bitcoin’s price rose from $9,000 to $12,000 and it remained near that level going into August.
Traders could have locked in an annualized profit of 28% on Monday by buying bitcoin in the spot market and selling the front month futures contract on OKEx. Doing that trade now would still profit, but by only half as much.
The decline in the carry strategy yield could also mean a cut in demand for dollar-backed stablecoins like tether (USDT).
“Stablecoins are widely used as funding currencies and there has been a high demand for these dollar-backed cryptocurrencies from institutions,” Skew CEO Emmanuel Goh told CoinDesk in a Telegram chat. Indeed, the carry trade has been one of the main reasons for the surge in stablecoin issuance seen this year.
On Monday, the annualized cost of borrowing tether on the decentralized finance protocol Compound was 6.94%. Assuming carry traders borrowed USDT from Compound on Monday, holding the carry strategy until the August expiry, due next Friday, would generate a net yield of about 21% in annualized terms. (return of 28% from cash and carry adjusted for tether’s borrowing cost of 6.94%).
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If the same strategy were executed at press time by borrowing USDT, the net yield would be 6.3%. That’s because the cost of borrowing USDT is now 7.68% and the OKEx futures are trading at a premium of 14%. Put simply, carry trades have become far less attractive. As such, institutional demand for stablecoins could soften, as noted by Skew.
The premium has declined sharply in the past 48 hours, possibly due to bitcoin’s failed breakout above $12,000 and resulting concern of deeper price pullbacks. The decline in premium may have been compounded by increased selling in futures as more traders piled into the cash and carry trade.
Whenever futures trade at discount to spot prices, traders execute reverse cash and carry trade by buying futures and taking a short position in the spot market.