BTC futures - A Trojan Horse
BTC Futures were heralded increasing exposure and thus buying power to the BTC market. But in essence it has only brought manipulation and a bear market in December and January, with 2 huge dips in the BTC price as a result.
But how was this market manipulated? And what's next?
Between the 19th and 26th of January we experienced 2 different BTC future expirations. Both occurred on a Friday at around 4PM (GMT). The first one (on the 19th) was on CBOE which is world's largest options exchange, while the second one (26th) was on the CME which has the widest array of derivatives products and is considered the more liquid of the two in terms of BTC futures.
The first and most blatant price manipulation is considered to occur during auctions, which is when the settlement price is determined for the futures contracts (both on CBOE and CME). Once the settlement price is generated, all open and expiring contracts will be settled against that price, regardless when an how much you bought previously. Therefore, the auction is massively important for your profit and loss outcomes and thus attracts a lot of dodgy tactics. A well known tactic, also known as 'banging the close,' occurs when (groups of) large investors (whales) try to push the settlement price of the futures markets into the direction most beneficial to their open positions. Theoretically this type of manipulation is easier to pull off in the CBOE futures market than it is in the CME futures market due lower volume in the CBOE market (especially during auctions) and due to the different nature of the auction itself.
Let's consider a example of this on the CBOE. The settlement price here is a result of an auction in which all interested parties submit their limit (or even market) orders. After a certain period, the price is determined against which most trades can be executed, which is then broadcasted as the settlement price.
Imagine if you were a whale looking to profit from the way this market is organised and you think the market is largely bearish (likely to go down). Suppose you short (sell) 50,000 BTC over the months of December and January all the way from $15,000 to $10.000 (with an average a sell price of $12,500). January 19th arrives, expiration date, and you decide to participate in the auction too to drive the price down further. Before the auction starts the price is $10,000 per BTC in the futures market and in the spot market (regular BTC market, e.g. Coinbase or Kraken). You could participate in the low volume auction, driving the price down further with say another 1,000 futures to a settlements price of $9,500.
The results of this lower settlement price would result in your 1000 futures being sold $500 lower than market price, effectively a $500,000 loss. However, your short futures position of 10,000 futures is massively profiting from this lower settlement price: $5,000,000. This is on top of the $2,500 per future sold in December and January, which totals another $25,000,000. So the total profit of this exercise is $29,500,000.
An insane amount of profit, without even having touched the spot market. However if you would have had any position starting in January and sold that as well to increase selling pressure, even more money would have been made as now you could buy back a lot cheaper.
For the CME, the process is more complex as the auction cannot just be influenced by putting selling orders in the future market. This is because the CME derives the settlement price in the future market from the average price traded on 4 spot exchanges from 4 to 5 PM (GMT). As the WSJ explained already before the expiry took place:
"So to bang the close at CME, you would need to do intense buying or selling at several of those bitcoin exchanges during the 60-minute window as the futures are expiring. That would be Jan. 26 for the first contract CME plans to list."
To be successful, the effort would have to have access to a considerable amount of BTC, which could mean the strategy is less fruitful.
In the example above, we also discussed the second and less overt type of manipulation. This is the part where you are setting up huge short positions (remember the 10,000 futures shorted against an average of $12,500), driving the price down in the process, while enjoying the eventual low settlement price. Even when not influencing the settlement price during the auction, the market is still being manipulated as the selling pressure is coming from one particular (group of) whale(s) while they never have to buy back but just enjoy the settlement to occur. This means buying pressure is never created from the whale that has to buy back.
In my view this is the main reason why we had a major downturn with a lot of FUD being spread into the market, to support the negative sentiment and therefore selling pressure. With the expirations completed now, I am expecting another bull run to occur. With a lot of whales (including banks and hedgefunds) who have bought the precious BTC from the average Joe who had 'weak hands' during the bear market.
Do you agree or do you have a different idea on what is happening now?
Images
https://www.google.nl/search?q=futures+manipulation&safe=strict&dcr=0&source=lnms&tbm=isch&sa=X&ved=0ahUKEwiV66DIyvjYAhXIJewKHb9FDbkQ_AUICigB&biw=1279&bih=572
https://www.google.nl/search?safe=strict&rlz=1C1GGRV_enGB751GB751&biw=1279&bih=523&tbm=isch&sa=1&ei=8K5sWo-RLom00gWllaJA&q=cme+futures+bitcoin&oq=cme+future&gs_l=psy-ab.1.1.0l7j0i24k1l3.7742.8765.0.10685.7.4.0.3.3.0.71.215.4.4.0....0...1c.1.64.psy-ab..0.7.232...0i67k1.0.X1H2clIRl00#imgrc=bfcCjKhMV1eRYM:
https://www.google.nl/search?safe=strict&rlz=1C1GGRV_enGB751GB751&biw=1279&bih=523&tbm=isch&sa=1&ei=OK1sWtHlKoLewAKpmob4DA&q=cboe&oq=cboe&gs_l=psy-ab.1.0.0l10.97413.98397.0.99971.4.4.0.0.0.0.58.162.3.3.0....0...1c.1.64.psy-ab..1.3.162...0i67k1.0.xC6px6_VzTg#imgrc=ya9v0wcJrDUMQM:
References
www.cboe.com
www.cmegroup.com
https://www.wsj.com/articles/bitcoin-futures-manipulation-101-how-banging-the-close-works-1513425600