How Does an Illiquid Spot Market Affect Basis Risk for a Crypto Hedger?
An illiquid spot market increases basis risk because the spot price can be easily moved by small trades, leading to greater volatility and potential divergence from the futures reference rate. If the hedger's specific spot transaction occurs at a price significantly different from the reference rate's calculated average, the hedge will be imperfect, and basis risk will be high.
Glossar
Basis Risk
Exposure ⎊ The core of basis risk within cryptocurrency derivatives, particularly options, stems from the imperfect correlation between the price movements of the underlying asset and its derivative contract.
Illiquid
Valuation ⎊ Illiquidity in cryptocurrency, options, and derivatives manifests as a divergence between marked-to-market prices and intrinsic value, often amplified by limited arbitrage opportunities and information asymmetry.
Crypto Spot Market
Exchange ⎊ The crypto spot market represents a venue facilitating direct exchange of cryptocurrencies for other assets, typically fiat currency or other digital tokens, at the prevailing market price.
Spot Market
Definition ⎊ The Spot Market is the financial venue where cryptocurrencies or other underlying assets are traded for immediate settlement, meaning the exchange of the asset and cash occurs almost instantaneously at the prevailing market price.