Closing the gap: The effect of CME Bitcoin futures on Bitcoin price

The price of one actual Bitcoin on the open crypto market, known as spot BTC, fluctuates based on a countless number of factors, such as trading volume, usage and adoption. However, other catalysts affect the asset in a roundabout manner. Cash-settled Bitcoin futures trading products from the Chicago Mercantile Exchange stand as one arguable highly referenced indirect element contributing to Bitcoin’s (BTC) price direction. 

“The Bitcoin derivative products offered by CME are simply a vehicle for accredited investors to place sophisticated and risk-offsetting trades that would otherwise be inaccessible to them,” Shawn Dexter, a decentralized finance analyst at Quantum Economics — a markets analysis firm — told Cointelegraph on Oct. 8. “This leads to both, short-term and long-term impact on price.”

CME Bitcoin futures trading at its simplest

At the height of Bitcoin’s largest bull run to date, the CME launched cash-settled Bitcoin futures trading, on Dec. 17, 2017. Cash-settled futures, however, involve no actual spot BTC. They simply let traders bet on the future price of Bitcoin without utilizing the underlying asset.

For example, let’s say Bitcoin’s spot price sits at $10,000 per BTC at the beginning of a month and ends that month at $11,000. Buying one CME Bitcoin futures contract (equivalent to the price of five Bitcoin) when BTC’s price is at $10,000 and holding through expiration at the end of the month means the trader will receive $55,000 in cash at the end of the month, not actual Bitcoin.

Since trades involve no actual Bitcoin sales or purchases, these futures products logically may not seem like they should impact Bitcoin’s spot price. In reality, however, these futures do weigh on Bitcoin’s price, according to Dexter:

“In the short term, any price impact caused by a hefty purchase in the futures market will be quickly arbitraged away in the spot market, causing prices to converge. But this could just as well happen if the hefty purchase were to occur in the spot market first.”

At times, Bitcoin trades at varying prices on different exchanges based on events, order book demand and other factors. If a large enough price discrepancy exists, a trader might buy BTC for a lower price on one exchange and sell it at a higher price on a different exchange. This activity is called arbitrage.

Bitcoin’s price on CME futures would likely rise noticeably if someone bought a large number of Bitcoin futures contracts on CME. This does not directly move Bitcoin’s spot price, although eager traders would then go buy or sell spot Bitcoin at a cheaper price as an arbitrage opportunity, driving up the spot price in tandem, according to Dexter. This concept works for a number of scenarios between CME and spot BTC.

On a larger time horizon, the CME’s Bitcoin futures trading products affect Bitcoin’s spot price more significantly, Dexter explained, adding: “The CME products allow for increased price stability and decreased risk. This is bullish for Bitcoin since it allows larger investors to get involved in the market with less hesitation. Thus increasing liquidity and stability.” Essentially, CME’s BTC futures add money to the market from large mainstream traders and other participants while also allowing them to hedge their trades.

An explanation from a regulator

Derivatives trading markets for commodities can affect their respective underlying spot markets, according to Heath Tarbert, chairman of the United States Commodity Futures Trading Commission. Derivatives include futures trading products. “Sometimes, the price of cattle is actually set in the derivatives markets,” Tarbert told interviewer Anthony Pompliano on Oct. 7 as part of a segment during the LA Blockchain Summit. Cattle and Bitcoin are both considered commodities. Tarbert added: “People say, ‘Well the futures contract on cattle says it should be x amount per head, and, therefore, this is what the price should be in the real market.’”

Some commodity futures are physically settled, however, involving the transfer of the underlying asset after expiration, thus, differing from CME’s Bitcoin futures trading products. Including similar findings, investment firm Wilshire Phoenix released a lengthy report on the CME BTC futures topic on Oct. 14, 2020, citing the conclusion: “CME Bitcoin Futures contribute more to price discovery than its related spot markets.”

What about the CME gaps?

The crypto space gives significant weight to CME gaps. A gap occurs on the CME Bitcoin futures chart when Bitcoin’s spot price moves while the CME Bitcoin futures markets are closed for the weekend or the holidays. If CME’s Bitcoin futures open for trading after a big move from Bitcoin, a gap is left on the chart between the listed price when the CME closed and the price of BTC when it opens.

The crypto space often expects Bitcoin’s price to return to such levels, “filling” any gaps on the chart. “Price does not need to trade in both directions through a gap to be considered filled,” Dexter explained. “A gap is considered filled as long as it meets the previously traded price before the gap.”

Trading is largely about probabilities. Probability favors gaps fills, according to Dexter, although he added, “It is important to note that gaps don’t necessarily have to be filled,” as gaps exist in the same category as other chart patterns:

“The previously traded price on CME prior to any gap could be construed as Bitcoin’s fair market price. Furthermore, depending on the type of gap, market participants are likely to open and/or close positions at the previously traded price, hence causing the gap fill.”

Contrary to the market’s sentiment favoring gap fills, however, Melvis Langyintuo, a client solutions strategist at OKCoin, told Cointelegraph on Oct. 6 that CME Bitcoin gap fills are unlikely due to the CME’s lack of Bitcoin futures trading volume in comparison to crypto-native derivatives exchanges.

In the last 30 days, the CME’s Bitcoin futures have yielded roughly $433 million in average daily volume, according to Langyintuo. In contrast, popular crypto derivatives exchange BitMEX often hosts over $1 billion in 24-hour trading volume. Over the last 24-hours, BitMEX’s Bitcoin perpetual swap futures product has hosted almost $1.4 billion in volume, based on numbers posted on the exchange. Several other high-volume crypto-native derivatives exchanges also exist, and these exchanges trade throughout the weekend while the CME Bitcoin futures do not, which adds to the equation.

“This makes the CME gap non-consequential compared to the BTC potentially filling the gap,” Langyintuo said. “The CME BTC prices are either trailing the BTC price moves or they are a bet on where the CME BTC market may reopen on Monday,” he added. “Trading CME futures into the weekend is akin to essentially placing a weekend ‘put’ or ‘call’ on gap to capture that spread,” he explained, referencing a similarity to Bitcoin options trading — another type of derivative seen on the CME and in the crypto space. Langyintuo concluded:

“For price to fill the gap, there would need to be a lot of volume on both the bids and offer side of the futures contract before the weekend, and on Sunday, once the market resumes trading, the same levels of volumes would need to be maintained in order to normalize the gap in a smooth fashion.”

A vast number of forces impact Bitcoin. A conclusion can be difficult when it comes to how much impact any specific driver has, although in this case, it seems as though the CME’s Bitcoin futures may affect Bitcoin’s spot price on a number of levels.