BTC/USD Pair Trade — A deep-ish dive

I was never on the forex desk but we sat close enough to them and hung out with them enough to pick up a few helpful ideas.

Forex traders speak in strange tongues amongst themselves. Some of it appears to be Greek, or at least Greek letters. Much of it is acronyms and shorthand. They even port some of this language into regular life and personal relationships (which is weird). But for us poor bond and equity folk, they were willing to give us some “rules of thumb” to help us.

In a pair trade, they looked at two factors: inflation and risk free rates of return.

Now like all “rules of thumb”, they serve as simplifications for a myriad of data points and analyses that contributed to those factors. Did overall indebtedness matter? Absolutely. Did trade deficits and their rate of change matter? Of course. Underlying financial strength or weakness? Yup. The structure of a country’s indebtedness? (long term vs. medium term vs, short term) Now we are talking. Changes in Basel rules, ECB policy, swap lines and MFIID? By now, most of us had wandered off to find lunch.

So, allowing that there are many important factors boiling vigorously underneath our “rule of thumb” analysis which we are going to largely ignore, let’s look at a big change that has happened recently in a very popular pair trade: Bitcoin vs. the US dollar.

The first thing to note is that not much has changed on the Bitcoin side of the trade. The inflation rate of Bitcoin right now is 1.76%. Since Bitcoin fractional reserve banking is still a glimmer in some FinTech developers’ eyes (despite the heresy that implies), we can probably leave out any financialization impact on that number and accept it as is. The risk free rate of return is somewhere between zero (my keys, my coins) and -50 basis points (for “institutional grade” custody). Let’s assume that competition will drive that down to -25 basis points. What about offers of 8% to lend my Bitcoin? Sorry, I was referring to risk free rates of return.

The change has all been on the US dollar side. The Federal Reserve has blown out its balance sheet, which would normally be very inflationary, in its epic battle against deflation.


Basically, the FED has seen Japan since 1989 and thinks it can do better.

However, that is not the metric that we are going to lay against our BTC:USD trade because there is a global economy to consider. While the FED may be an outsized player in the US dollar, there is a large and complex domestic and international appetite for US dollars just to keep current economic activity flowing on a non-inflationary growth trajectory. And many of the dollars that have been whipped up out of thin air onto the FED balance sheet have actually not found their way into economically useful applications. The average dollar does not get around the economy as quickly as it used to.


So, for our pair trade consideration, we will fall back on the much maligned and often manipulated CPI measurement. The FED Board of Governors have signalled clearly and often that anything between 2% and 4% inflation is acceptable. 4% and above Governors are considered “dovish”, 2% Governors are considered “hawkish”.


OK, so far so good. They miss pretty frequently but it seems to average out.

But now the FED is starting to warn of higher, albeit “transitory”, inflation to come. In an article from NBC News, you will note two interesting factors that we can use for our “rule of thumb” analysis. The first is that the FED is raising their inflation expectation to 3.4% from 2.4% when they last mentioned it in March. Also, a few paragraphs down you will see that money center banks (ie. shareholders of the FED) can borrow short term at 0–0.25%, for now.

If you are a money center bank, you are probably not reading this. For the rest of us, the special deal does not represent a realistic risk free rate of return. Let’s use the rate that banks use when pricing mortgages, the 10 year Treasury Bond Yield. So, a bit over 1.5%.


Now it is time to do some math. Since we are using “rule of thumb” analysis, we can limit ourselves to grade school level math.

For Bitcoin, the inflation rate is 1.76% and the risk free rate of return is -0.25%. Since both inflation and the risk free rate are costs of holding Bitcoin, we can add them together and come up with a holding cost, in Bitcoin, of 2.01%.

For the US dollar, the inflation rate is at least 3.4% and the risk free rate of return is 1.5%. The inflation rate is a cost, the interest rate is a positive return so the cost of holding a dollar is 1.9%.

So, if you believe that these numbers are representative of reality and will stay the same for your investment horizon, it looks like the pair is fairly balanced, today.

And that has been the story of this pair for the last month or so. This may be a coincidence, so don’t stop here. There are many other factors, so keep an eye out for them. But, for now, the pair has been moving sideways recently.


But pair trading is all about figuring out what happens if any of the factors change. And to borrow the FEDs language, how “transitory” those changes are likely to be.

For Bitcoin, the next big change is in 2024 when the inflation rate is scheduled to half as defined by the software that runs Bitcoin. So we can safely set BTC as a constant. Significant financialization leading to positive risk free rates of return would improve BTC’s footing but we will leave that aside for now.

For the US dollar, it wouldn’t take much to change the cost of holding, especially since the FED has signalled that it will resist rate hikes as much as possible.

It is not unreasonable to look for a CPI of 8%-12% by the end of the year (prospective) and a risk free rate of return that has been dragged up to say 4% on the 10 Year Treasury. If you are curious as to why pension funds are hoovering up real estate recently (long hard assets, short dollar), perhaps you will notice that this “rule of thumb” can be applied, in part or in whole, to almost any two asset classes.

But for the BTC:USD pair trade, that difference starts to look significant. The real cost of holding dollars could rise to 4% or even 8% while the cost of Bitcoin would remain stable at 2.01%.

The trade is not a slam dunk today because predicting future inflation and risk free rates of return involves predicting the future, which is difficult. Traders quantify this difficulty by assigning weights to different outcomes and averaging the results to see if the risk is worth taking. This is subjective and risky, which is one of the reasons markets exist in the first place.

If you think US dollar inflation rates will fall back to 2% and interest rates will hover around 1.5%, then the cost of holding USD will drop 0.5% and it may be a better place to hold cash than Bitcoin. What percentage will you put against that? 10% (very unlikely), 50% (could happen), 90% (pretty certain). How about my scenario above where inflation gets away from the FED for a year or two while they expand their balance sheet to hold interest rate rises, resulting in a 4%, 6% or 8% real cost of holding dollars? Again, assign a weight according to the likelihood that you perceive. When you are finished (and you can add as many scenarios and weights as you please), multiply the weights by the expected outcomes and add them all up. If your weights do not exceed 100% (always check your math), then you get a benchmark. That doesn’t mean we will end up there. But now you have a framing mechanism into which you can feed new information as it becomes available.

One more rule of thumb which is why I wrote this in the first place: when everything has to work out almost perfectly for things to stay the same, it is time to evaluate how things will change.

Hopefully these “rules of thumb” will help you position yourself for the upcoming turmoil.

Full Disclosure: I am biased. My company is building an app that will allow regular people to go long Bitcoin and short Dollars on a long term, flexible and sustainable basis. You can find out more at



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