What Is “Basis Risk” When Using Futures Contracts to Hedge Cryptocurrency Revenue?
Basis risk is the risk that the price of the asset being hedged (the mined coin) and the price of the hedging instrument (the futures contract) do not move perfectly in tandem. The "basis" is the difference between the spot price and the futures price.
If the basis narrows or widens unexpectedly, the hedge will not be perfectly effective, potentially resulting in a loss on the combined position.
Glossar
Hedging Instrument
Mitigation ⎊ A hedging instrument, within cryptocurrency and derivatives markets, functions as a strategic offset to adverse price movements in an underlying asset, effectively reducing portfolio risk exposure.
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.
Using Futures Contracts
Leverage ⎊ Futures contracts, within cryptocurrency, options, and financial derivatives, represent agreements to buy or sell an asset at a predetermined price on a future date, functioning as a mechanism to amplify potential returns ⎊ or losses ⎊ relative to the initial capital outlay.
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.