Contango and Backwardation in Bitcoin: How Miners take Advantage of Speculators
Contango is when the futures price is higher than the spot prices, i.e. the speculators are paying a higher price for the future. This is beneficial for miners who are able to lock higher prices to sell their produce.
On the contrary, Backwardation is the opposite, the speculators are perceiving lower prices in the future.
To understand the Contango and Backwardation in Bitcoin prices, this explanation by Veteran Trader. UglyOldGoat is pure gold.
Example of Backwardation (Coronavirus Drop)
Usually, Bitcoin’s market is in Contango due to the long-term bullish outlook. However, the markets had been thrown into Backwardation due to wild swing in price due to coronavirus scare.
In the table below, let us assume that the spot price of Bitcoin is $7100. Hence, the futures curve is in backwardation for the month of April.
Also, one can notice how the price is falling as we move forward in timelines from May to June. Hence, until June 2020, this is representing a downward sloping curve at the moment. This is essentially what one implies by a futures contango curve.
The Supply Side Story
Bitcoin Basis is the difference between the futures and spot prices. When the basis is positive, it implies that speculators are paying more against the present spot prices. During the recent bull market, the Basis was substantially positive. The last few times when the market was thrown into backwardation was from June-December 2018, and then briefly at times during 2019.
Markets can be thrown from Contango (or positive basis for perpetual contracts) to Backwardwation (or negative basis) in a very short span of time. Moreover, when it spikes on either side, we generally see a quick or slow reversal towards the opposite side (contrarian trading).
This is exactly what happened during the last week when the futures and derivatives market went haywire. The speculators exhibited strength in the rise from $3850 to $5600 on Friday. However. it is unlikely that we break considerably higher, as the spikes in this chart will look to play on the other side.
Miners would have likely locked the $10,500 price before the halving to account for the reduction in miners rewards. However, the one’s who waiting for better pricing was probably hacked by the virus.
In all likelihood, one can assume that large miners are hedged against a downfall in price and a momentary fall to even $1000 would not affect the industry in the long term. It will definitely affect small and medium scale miners, who will look to shut off their system. However, if the price goes back up, they will again contribute to the rise in hash rates.
That said, if the markets continue to be in backwardation there will be less incentive to short the market, and tables would start turning in favour of longs.