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Thank you @Phyrex_Ni for the discussion. Here's an example of an arbitrage process:
Thank you @Phyrex_Ni for the discussion. Here’s an example of an arbitrage process:
The spot ETF IBIT experiences a fund liquidation, leading to a large sell-off of $IBIT, which is sold at a discount.
When there is a certain discrepancy between (the stock price of $IBIT) and (the net asset value of BTC per share of $IBIT), arbitrageurs buy discounted $IBIT and sell BTC in the spot/futures market to profit from this arbitrage.
Selling BTC does not require market makers/arbitrageurs to hold BTC; for example, they can borrow BTC to sell in the spot market or short BTC using US dollar-denominated contracts. As long as arbitrageurs have enough USD, they can sell enough BTC.
This completes the transmission from $IBIT sales to BTC sales. For example, if a fund liquidation causes a 5% discount, equivalent to 60k BTC worth of $IBIT, all of it is bought by arbitrageurs, who simultaneously sell 60k BTC in the spot/futures market.
Arbitrageurs wait for the $IBIT discount to recover, then sell $IBIT at the normal price and simultaneously close the same amount of short positions. During this process, no $IBIT redemption into BTC occurs.
If the $IBIT discount persists for a long time without recovery, or if arbitrageurs hold too much $IBIT, causing liquidity risks, they will redeem $IBIT for BTC and sell the spot BTC plus close the equivalent short positions.
5 is the main trading method for arbitrageurs; 6 is a special case. Suppose a fund liquidates 60k BTC; then about 54k BTC might be hedged away, leaving only 6k BTC to be redeemed through the spot redemption route.