The Bank for International Settlements (BIS) has released a working paper examining “crypto carry” — the differences between Bitcoin (BTC) and Ether (ETH) spot and futures prices — and its effect on crypto investment markets. The complex paper sheds light on the behavior of crypto investors, particularly smaller investors, in relation to boom and bust cycles.

“Carry” describes the results of “going long in the spot market, while selling forward the same amount forward via a futures contract.” The paper bases its findings on “stylized facts” based on a variety of exchanges over time.

Very little of the carry size — about 3% — resulted from differences between interest rates on crypto and fiat or variations among exchanges, which may be crypto-native, like Binance and OKX, or regulated like the Chicago Mercantile Exchange (CME). The major factor was the convenience yield of holding futures:

“Crypto carry is large (up to 60% p.a.), strongly time-varying, and is most compatible with the existence of a highly volatile crypto futures convenience yield, i.e. investors are willing to pay more for the convenience of a levered futures contract relative to buying spot crypto.”

Rising crypto carry was found, based on the evidence of traders on the CME, to be associated with “a rise in net long positions by ‘nonreportable’ traders,” such as “family offices, proprietary trading shops that run commodity trend-following strategies, and/or wealthy individuals.”

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Those buyers take levered futures positions “when there are strong price trends and heightened media attention.” Sellers experience risks from price volatility at the same time, the argument continued, making capital on the sell side “scarce and slow-moving.”

Smaller leveraged investors chasing the trend and the relative scarcity of arbitrage capital are the two main reasons for the large “crypto carry” of up to 60% in #Bitcoin and #Ethereum https://t.co/GVUOze61mc pic.twitter.com/fKpW55Rbhn

— Bank for International Settlements (@BIS_org) April 4, 2023

This situation has notable consequences. It causes a high carry rate. Furthermore, “The interplay between these forces […] Help[s] explain why severe price run-ups and market crashes are a frequent feature of crypto markets,” the authors wrote. Thus, the size of crypto carry can partly predict market crashes because of its correlation with convenience yield. In traditional markets, convenience yield describes the premium of holding an underlying asset rather than its derivative. The authors wrote:

“One of the most salient features of crypto markets over the past years, namely rapid price booms followed by large busts, seem to be linked to the drivers of the crypto convenience yields.”

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