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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 suffers a fund liquidation: massive amounts of $IBIT are sold, and they are sold at a discount.
When there is a certain spread between (the $IBIT stock price) and (the BTC net asset value contained per share of $IBIT), arbitrageurs buy the discounted $IBIT and sell BTC on the BTC spot/futures market to perform the arbitrage.
Selling BTC does not require the market maker/arbitrageur to hold BTC. For example, they can borrow BTC from the spot market to sell, or short BTC using a U-margined futures contract. As long as the arbitrageur has enough USD, they can sell a sufficient amount of BTC.
This completes the transmission from $IBIT selling to BTC selling. For instance, due to a fund liquidation, a total 95% discount wipes out $IBIT equivalent to 60,000 BTC. All of it is bought by arbitrageurs, who simultaneously sell 60,000 BTC in the BTC 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 redemption of $IBIT into BTC occurs.
If the $IBIT discount does not recover for a long time, or if arbitrageurs take on too much $IBIT and generate risk by crowding out liquidity, then the arbitrageurs will redeem $IBIT for BTC, sell the spot BTC, and close an equivalent amount of short positions.
5 is the main trading method for arbitrageurs, and 6 is a special case. Suppose a fund liquidates BTC equivalent to 60,000 BTC. Then as much as 54,000 BTC may be hedged away, and only 6,000 BTC will go through the redemption-into-spot (redeem into spot) path.