Are bitcoin futures dragging down prices? It’s not that simple

There are way too many factors to cleanly interpret the impact of CME and CBOE bitcoin futures.

The Federal Reserve Bank of San Francisco (FRBSF) has recently published its research finding that CME bitcoin futures trading likely led to a decline in bitcoin prices.

It did this, it argues, by putting a lid on the amount of money entering the market and giving bitcoin pessimists an easier way to profit from price declines. CME futures contracts are not physically settled, so it's essentially just placing bets on price movements without actually purchasing any bitcoin. This resulted in reduced demand which led to a decline in spot price.

It traces the path of bitcoin prices up to their all-time high of around US$20,000, which coincided with the introduction of CME bitcoin futures contracts, to their plummeting in February and their ongoing decline in the following months.

"We suggest that the rapid rise of the price of bitcoin and its decline following issuance of futures on the CME is consistent with pricing dynamics suggested elsewhere in financial theory and with previously observed trading behavior," it concluded. "Namely, optimists bid up the price before financial instruments are available to short the market. Once derivatives markets become sufficiently deep, short-selling pressure from pessimists leads to a sharp decline in value."

Similar effects have been observed in other markets, such as mortgage-backed securities which tanked once the market was able to short them, the analysts note. Or the tulip bulb market of the 1600s which also crashed after the introduction of tulip bulb futures.

It's a compelling point, but it might not fit quite so neatly.

Does it add up?

One of the unaccounted for factors might be that CME and CBOE weren't the first to introduce cryptocurrency futures trading. In fact, they were extremely late to the party, with exchanges like ICBIT offering bitcoin futures trading as early as 2013.

It grew rapidly from there, and the crypotcurrency futures market was thriving for over a year before CME touched it. Almost exactly a year ago, as bitcoin prices were pushing to a new all-time high at $1,300 and Ether to over $50, eToro was marvelling at a four-fold increase in bitcoin and Ether futures traders over the last 12 months and a 4,500% increase in volume traded.

BitMex was founded in 2015, and by early 2017, it was already trading crypto futures contracts worth over a billion dollars a month. And today, its BTC/USD derivatives alone are doing about $3 billion worth a day.

By comparison, CBOE arrived with bitcoin futures only, and hit the market with relatively small volumes.

"The total volume of transactions in the CME futures market started very low, with an average trading volume of contracts promising to deliver approximately 12,000 bitcoins during the first week of trading, relative to the estimated spot market turnover of 200,000 bitcoins," the FRBSF notes.

CBOE bitcoin futures saw their biggest day on 17 January 2018, when 15,500 bitcoin futures contracts changed hands. That record wasn't broken until 27 April, when 19,000 bitcoin futures contracts were traded, almost all of which were for May expiry dates.

According to CBOE Options Institute senior instructor Kevin Davitt, this influx reflected an overall bullish sentiment.

It's also worth noting that cryptocurrency futures trading, even when not physically settled, still results in a net increase of "physical" bitcoin demand. This is because futures markets like BitMex require traders to use it as collateral. As crypto, it dodges some heavy regulatory burdens, and as purely digital currency, it can be programmed and automated to drastically reduce the time and cost of onboarding customers.

What does it all mean?

Maybe nothing. It's hard to say. One might tentatively reach some conclusions though.

One might be that the impact of CME futures trading is being widely overstated. It's just one fish in a growing pond, and it might be more a prominent fish than an actual big fish.

The contracts would need to be extraordinarily large to dent the market by themselves next to all other futures trading options. This is certainly possible though.

One might also broadly assume that CME and CBOE cater more to institutional money and traditionally inclined speculators, compared to other cryptocurrency futures platforms. Its users might be more inclined to see cryptocurrency as a bubbly asset to profit from, rather than a platform for decentralised applications and transactions. Put them together and one might assume that those futures traders are more inclined to put big money towards crypto pessimism than traders on other platforms.

This doesn't quite square with the bullish sentiment for May that Davitt mentions.

One of the more adventurous suggestions, being put forward by Binary District, is that shady things are afoot, and that big players are using futures markets to shift prices for the purpose of making eye-watering profits. The gold and oil markets, it notes, may have been previously massaged in similar ways to produce a disconnect between supply and demand.

"In commodities markets such as oil and gold, futures contracts are known to have been used for price manipulation on a staggering scale. Interestingly, bitcoin has also been classified as a commodity by financial regulators in the US... Astonishingly, the imaginary quantities of oil being traded as futures surpasses the amount of actual oil changing hands in physical oil deals by a measure of 100:1... most of the market activity in crude oil futures can be attributed to the speculation of hedge funds and institutional investors.

"It was not that long ago that physical oil trading was turned into a futures market. Strangely, the all-time high of $150 for a barrel of oil around 2008 coincided with a never-before-seen supply glut. Because of the over-supply of physical oil, tankers were chartered and anchored to store the oil because all the on-land storage capacity had been used up. How can the price of a good reach a record high at a time when there is an oversupply of that good? The laws of supply and demand would dictate the exact opposite to be true."

It also points out that CME has previously come under fire on several occasions with accusations of wash trading and suggests that this could not have gone on without CME's knowledge. This brings it in line with the cryptocurrency exchanges which have been accused of doing the exact same thing.

It may also be worth noting that CBOE and CME started offering bitcoin futures under a self-regulating framework. This raised eyebrows at the Futures Industry Association, which argued that self-regulation was inappropriate for such a risky area.

If there's one takeaway, it's that the argument of CME futures dragging down bitcoin prices is probably a drastic oversimplification. If it is impacting prices, it's probably doing so in a much more complicated and multi-faceted way than simply dropping bitcoin spot trade demand and giving crypto sceptics a place to vent with their money.

Simple cryptocurrency futures trading guide

Disclosure: At the time of writing, the author holds ETH, IOTA, ICX, VEN, XLM, BTC and NANO.

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