Perhaps you have wet your toes by speculating with bitcoin or its smaller brother on the CME, XBT. After all, the Chicago Mercantile Exchange (CME) offers very legitimate and highly regulated derivatives from energy and interests rates to agriculture. These markets allow producers the ability to hedge their underlying positions on products, such as cotton or a stock portfolio.
I haven’t read a lot about these more mainstream markets ever being manipulated. Now, new research has warned of a “striking systematic trend” in bitcoin price movements, with bitcoin falling far further than average ahead of the CME’s bitcoin futures contracts being settled each month. This, along with a disappointing launch of the Bakkt crypto platform, caused bitcoin and its rivals to lose anywhere from 15% to 25% this week.
Is the cryptocurrency market being manipulated? You tell me. The anecdotal fact that these markets are used by speculators on laptops in their bedrooms is somewhat disturbing. There is no legitimate hedging of an underlying product going on here. Hackers all across the world have access to these platforms and work 24/7 to find the Achilles heel.
Bitcoin has dropped on average 2.27% towards settlement each month, compared to an average fall of just 0.06% on a random day over the same period, bitcoin and cryptocurrency analysts at Arcane Research found. According to Arcane’s Bendik Norheim Schei, “Statistically, it is highly unlikely that the price falls in advance of CME settlement should be caused by mere coincidence.”
The inherent problem is that the bitcoin futures on the CME are settled in cash. The price for the settlement is determined by the bitcoin price in the underlying market. Bakkt, however, will settle in bitcoin itself, as opposed to cash, with the auspice of eliminating manipulation. Traders are hoping Bakkt’s bitcoin futures will gain popularity and steer investors away from cash settled contracts. At this point there is quite a way to go. Only 72 bitcoins traded on Bakkt on its first day, compared to several thousand traded daily on the CME.
The chart above depicts settlement prices on bitcoin futures at the CME for the last four months. As you will notice, the price at settlement was roughly down 2.5% before each futures expiry. So how does this happen? Hypothetically, one possible strategy is that trader’s buy (go long) “physical” bitcoin in the spot market and sell (go short) bitcoin futures contracts. This way, they secure the position against price fluctuations.
If the price of bitcoin goes up, the trader loses on the short position, but this is counteracted by the long position rising in value. Okay, so how do they make money? Towards the settlement date of the contracts, traders can sell off their “physical” bitcoin and potentially trigger a price drop in the spot market. If that happens, the value of their short position will rise and they can earn a simple profit on futures contracts upon settlement. Regardless, additional quantitative and qualitative research needs to be done by the exchange. Saber rattling in the bitcoin market is the last thing investors want.