Title: The Impact of CME’s Massive Short Positions on the Bitcoin Market
Author: Crypto_Painter Source: X, @CryptoPainter_X
Recently, the market has been tinged with a sense of panic, largely due to the massive short positions held by CME. As a veteran in the crypto world, I vividly recall the epic bull run of 2017 coming to an end when CME officially launched BTC futures trading. Therefore, studying CME’s enormous short positions holds significant meaning.
First, let’s provide some background information:
CME refers to the Chicago Mercantile Exchange, which launched BTC futures trading at the end of 2017 with the product code: [BTC1!]. Subsequently, a large number of Wall Street institutional capital and professional traders entered the BTC market, dealing a blow to the ongoing bull market and leading BTC into a 4-year bear market.
With traditional funds increasingly entering the BTC market, institutional traders (hedge funds) and professional traders serviced by CME began participating more in BTC futures trading.
During this period, CME’s futures open interest grew significantly and last year surpassed Binance, becoming the leader in the BTC futures market. Currently, CME’s total BTC futures open interest stands at 150,800 BTC, equivalent to $10 billion, capturing a 28.75% share of the entire BTC futures market.
In essence, the current BTC futures market is no longer controlled by traditional crypto exchanges and retail investors but has fallen into the hands of American institutional traders.
As more people have noticed recently, CME’s short positions have not only significantly increased but have also recently reached a historical high, continuing to rise. As I write this article, CME’s short position has reached $5.8 billion, showing no signs of slowing down.
Does this indicate that Wall Street’s elite capital is heavily shorting BTC and has no confidence in the future performance of this bull market?
Purely based on data, it does seem so. Moreover, BTC has never maintained a prolonged consolidation period of over 3 months after breaking historical highs in a bull market. All signs point to the fact that these large funds may be betting that this BTC bull market will fall short of expectations.
Is this really the case?
Let me explain where these massive short positions at CME come from, whether we should feel fearful, and what impact this has on the bull market.
If you frequently check CME prices, you will notice an interesting feature. The price of the BTC1! futures trading pair is consistently several hundred dollars higher than the Coinbase spot price. This is understandable because CME’s BTC futures settle monthly, similar to the monthly forward contracts on traditional crypto exchanges.
Therefore, during bullish market sentiment, we often see forward contracts with varying degrees of premiums, with the next quarter’s contract premium typically being very high during bull markets.
By subtracting CME’s BTC futures price from Coinbase’s spot price (both USD trading pairs), we get the following chart:
The orange curve represents BTC price trends on the 4-hour timeframe, while the gray curve represents the premium of CME futures price relative to CB spot price.
It is clear that CME’s futures premium shows a regular fluctuation pattern with each contract rollover (automatic transfer to the next month’s contract). This is similar to the premium seen on traditional crypto exchange forward contracts, where they exhibit high premiums at contract inception and gradually flatten out as the contract nears expiry.
It is this pattern that allows for some degree of futures arbitrage. For example, when a CEX exchange’s quarterly contract is generated after a significant bull market, and the premium has reached 2-3%, one can invest $2 million, buying $1 million worth of spot and opening a $1 million short position on the quarterly contract.
During this period, the price fluctuations will not lead to liquidation of the short position. As long as the premium gradually flattens out before the quarterly contract expires, one can earn a stable profit of 2% on $1 million, which amounts to $20,000.
Do not underestimate this profit. For large funds, this represents almost risk-free high returns!
Doing a simple calculation, with CME generating an average of one new contract per month since 2023, and an average premium of 1.2%, considering transaction fees, this equates to a fixed 1% risk-free arbitrage opportunity every month.
With approximately 12 opportunities per year, this translates to an annualized return of about 12.7%, surpassing the returns of most US money market funds, not to mention interest earned by depositing this money in banks.
Currently, CME’s futures contracts serve as a natural arbitrage venue. However, a question remains: where can one buy spot BTC if futures are traded on CME?
CME caters to professional institutions or large funds, who cannot simply open a CEX exchange account like us individuals and start trading. Most of their funds are LPs, so they need to find a compliant, legal channel to purchase BTC spot.
Voila! Enter the BTC spot ETF!
With this, a complete cycle is formed. Hedge funds or institutions make significant purchases on the US stock ETF while simultaneously opening equivalent short positions on CME. This allows for a monthly risk-free fixed arbitrage, achieving a minimum stable return of 12.7% annually.
This argument may sound natural and reasonable, but it requires validation through data. Have US institutional investors truly engaged in arbitrage through ETFs and CME?
As shown in the following graph:
I have marked the periods of extremely low CME futures premium since the ETF was approved, with the sub-graph indicating the net inflow of BTC spot ETF that I compiled.
You can clearly see that whenever the CME futures premium significantly shrinks to less than $200, the net inflow of the ETF also decreases. Conversely, when a new monthly contract is generated at CME, the ETF experiences a significant net inflow on the first Monday of trading.
To a certain extent, this indicates that a considerable portion of the net inflows in ETF funds are not solely for BTC purchases but are used for hedging the high premium short positions to be opened on CME.
By revisiting the data on CME’s futures short positions, you will notice that the substantial increase in short positions, by 50%, coincides precisely after January 2024.
Interestingly, the BTC spot ETF officially began trading after January 2024!
Based on the somewhat incomplete data analysis above, we can draw the following research conclusions:
1. The massive short positions at CME are likely used for hedging against the BTC spot ETF, meaning the actual net short position is likely far less than the current $5.8 billion. There is no need to panic because of this data.
2. The net inflow of $15.1 billion in the ETF, most likely includes a significant portion of funds in hedging positions. This explains why the historical second-highest single-day net inflow of $886 million in early June and the entire week’s net inflow did not lead to a significant breakthrough in BTC prices.
3. Although there is a significant amount of speculation in CME’s short positions, there was already a noticeable increase before the ETF approval. Additionally, there was no major liquidation during the subsequent bull market, indicating the presence of funds within US institutional investors that are still bearish on BTC. One should not take this lightly.
4. The impact of net inflows from ETFs on market prices may not necessarily be positively correlated. There may be instances of negative correlation (large ETF purchases leading to a drop in BTC prices).
5. Consider a specific scenario: when the future premium at CME is exhausted by these arbitrage systems, and there is no potential arbitrage space, we may witness a significant decrease in CME’s short positions. Correspondingly, there will be a large net outflow from the ETF. Should this happen, do not panic; it simply signifies the exit of liquid funds from the BTC market, seeking new arbitrage opportunities.
6. Lastly, contemplate where the premium in the futures market originates from. Does the wool truly come from the sheep? I may delve into this further in future research.
In conclusion, this research summary leans towards market analysis without clear directional guidance for trading. However, it aids in understanding market logic. When I see the massive short positions at CME, I feel a twinge of fear and reminisce about the prolonged bear market from 2017 to 2018.
That bear market was much more nauseating than today’s volatile market. Fortunately, at present, BTC is indeed attracting the favor of traditional capital. Harsh as it may sound, the fact that hedge funds are willing to arbitrage in this market essentially signifies recognition, even though the funds come from us retail investors.
