CME Bitcoin Futures Growth Support Sustained Rally
What began as ten commercial traders buying bitcoin futures in large quantities at the Chicago-based CME Group is starting to look like a trend. A Forbes analysis of Commitments of Traders (COT) and CME Group data starting from about two weeks ago suggests that the rise in investor capital tied up in bitcoin futures open interest (OI) contracts held at the CME exchange and the number of participating large traders is now broader.
The number of large traders required to disclose their futures activity to the Commodity Futures Trade Commission (CFTC) - those with an exposure equivalent to five or more bitcoins - increased 29% in two weeks to 94. Compared to two weeks ago, the number of COT big traders now includes twenty more hedge funds, four more banks, and two more commercial traders. This could provide pivotal support to the rising bitcoin trend now that the April 2021 record of $64,900 is merely 4% away.
Over the same period, bitcoin OI rose 55% to 10,918 contracts, according to the CFTC’s COT weekly report ending on October 12. By Friday’s close, before it was confirmed that the Securities and Exchange Commission (SEC) had approved its first bitcoin exchange traded fund (ETF), BTC futures OI had risen an additional 7% intraweek to 11,682 contracts.
Retail investors trading at the CME have sold modestly into the ongoing bitcoin rally, in a sign they haven’t yet caught on what institutional traders are doing. Retail investors will likely come around in due time, as it becomes clear that the current rally can sustain gains above last April’s high.
One of the major changes this past week was the news that eight major banks had for a second week added 500 short bitcoin futures contracts to their collective OI holdings, according to the COT data. Breaking the 1,000 contract barrier in two weeks after having an average of 138 short contracts for more than seven months suggests that large banks are starting to assume a sell-side liquidity role for bitcoin, like they do for other futures instruments. Up until now, only hedge funds had served in that capacity. With more liquidity, the market operates more smoothly and price gaps in a security become less frequent and smaller in size.
No matter which way one looks at the SEC approval of the ProShares Bitcoin Strategy ETF, it is a major wink from SEC Chairman Gary Gensler to US-regulated cash and futures exchanges. It would not be at all surprising to see a major boost in CME Group stock price as a result of the SEC bitcoin futures ETF decision. The dollar value of CME crypto futures reached an all-time record high of $4.16 billion on Tuesday, up 679% from a year prior. The double-digit OI growth referenced earlier is highly correlated with future transactional earnings for the CME. It should be noted, however, that crypto futures remain a small but fast-growing source of revenue for CME Group.
To be sure, the sharp rise in the number of futures OI contracts is in part related to the fact that the bitcoin futures ETF now approved in the United States will require the issuing entities (e.g., ProShares initially, later other firms like Invesco and Valkyrie Digital Assets) to acquire bitcoin futures as collateral for the ETF shares that investors will purchase. The ProShares bitcoin ETF shares are expected to make their trading debut at the NYSE exchange tomorrow. With the ProShares precedent approved, other bitcoin ETF applications based on bitcoin futures should be approved and begin trading at Nasdaq and Cboe in short order.
So what will ProShares Bitcoin Strategy ETF investors own? It might be easier to say that they will not own bitcoin. ETF shares are a familiar, cost efficient instrument for individuals or institutions to own, but clinically speaking they derive their value from something else, in this case from a bitcoin futures, which is a derivative of bitcoin. Thus, bitcoin is the cash asset, the bitcoin futures is the first derivatives product, and the ETF holding bitcoin futures is the second derivatives product. For now, the SEC does not want ETFs to hold physical bitcoin, and for an understandable reason. If the SEC gave carte blanche to asset managers to divert even a small portion of the tens of trillions in US investor capital to buy bitcoin directly, it would create a massive distortion in the supply-demand curve of bitcoin, an asset with a fixed issuance.
So the current SEC experiment underway could be that the use of double derivatives will somehow absorb much of the popular demand for bitcoin without causing the cryptocurrency to skyrocket overnight. Another possible explanation is that when the CFTC initially approved traditional bitcoin futures (as opposed to an ETF) in 2017, it was widely blamed for popping the bitcoin bubble of 2017.
Be that as it may, for each bitcoin ETF share to be issued, a certain number of bitcoin futures would need to be held in reserve. The convertibility of CME bitcoin futures is such that investors are able to settle in bitcoin if a bitcoin holder wants to exchange them for a futures contract exposure. But in practice, more than 99% of all bitcoin futures settlement is cash-settled when a futures exposure ends, meaning that bitcoin futures investors exchange cash for the difference between the price when they entered into the contract and the price when they closed the transaction. CME bitcoin futures, however, can exist without contractual or regulatory obligations that they hold the equivalent of five bitcoins.
The price of bitcoin at or above $60,000 despite heavy headwinds from China trouble (Evergrande, energy woes, slow GDP) and supply-chain troubles points to greater confidence in the most popular cryptocurrency. The massive U.S. institutional door - that of bitcoin ETFs - that has just opened has more chances of boosting bitcoin into record territory than a drop below $60,000. It remains to be seen, however, how much of a boost the SEC’s double-derivative demand shock absorber will have on the bitcoin cash market. For now, the U.S. market is the only jurisdiction that keeps approved ETF vehicles from holding actual bitcoins and nothing suggests other countries will follow the U.S. model.
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