Is Basis Risk Generally Higher or Lower for a Cryptocurrency Futures Contract Compared to a Traditional Commodity Future?
Basis risk is often considered higher for cryptocurrency futures. This is due to the higher volatility of crypto assets, the fragmentation of the spot market across many exchanges, and the varying methodologies used to calculate the crypto index price for settlement.
Traditional commodities have more standardized spot markets and often have a physical delivery mechanism that forces convergence more strictly, leading to a generally more predictable basis.
Glossar
Physical Delivery Mechanism
Settlement ⎊ Physical Delivery Mechanisms within cryptocurrency derivatives, options, and financial derivatives represent the concrete transfer of an underlying asset ⎊ be it a digital token, commodity, or financial instrument ⎊ from seller to buyer upon contract exercise or expiration.
Traditional Commodities
Asset ⎊ Traditional commodities are tangible, physical goods, such as crude oil, gold, agricultural products, and base metals, that are interchangeable with other goods of the same type and are fundamental to global commerce.
Spot Market Fragmentation
Liquidity ⎊ Spot market fragmentation in cryptocurrency derivatives, particularly options, manifests as dispersed order flow across multiple exchanges and venues, diminishing aggregate liquidity.
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.
Cryptocurrency Futures
Leverage ⎊ Cryptocurrency futures contracts represent agreements to buy or sell a specified quantity of a cryptocurrency at a predetermined price on a future date, functioning as a derivative instrument.