Can Wall Street manipulate the Bitcoin futures market?

Analysts from Norwegian research firm Arcane Crypto revealed that between January 2018 and August 2019, Bitcoin fell 75 percent of the time in the lead up to CME settlement dates, which usually occur on the last Friday of the month.

As the first Bitcoin derivative offered by a major Wall Street exchange, CME Bitcoin Futures exploded on launch at the peak of the Bitcoin bull run in December 2017. Since then, the exchange has reported growing demand from professional traders.

A statistical probability

Bitcoin bull Thomas Lee first linked falling Bitcoin prices to the expiration dates of Cboe Futures contracts in June 2018.

“Bitcoin sees dramatic price changes around Cboe futures expirations," claimed Lee in a note to CNBC. "This was something flagged by Justin Saslaw at Raptor Group. We compiled some of the data and this indeed seems to be true. Overall, Bitcoin has fallen 18 percent in the 10 days prior to Cboe contract expiration.”

At the time, the idea was dismissed by the president of Cboe Global Markets, who suggested that "recent regulatory scrutiny," "the rise of other cryptocurrencies, and declining media interest in the asset” could be blamed for bearish price action prior to settlement dates.

Since then, Cboe has exited the Bitcoin market, and other analysts including Coinist Podcast host Luke Martin have observed Bitcoin’s tendency to fall as the settlement date of CME’s Bitcoin Futures contracts approaches.

Brave New Coin’s technical analyst Josh Olszewicz has also noted that CME Futures settlements appear to be a catalyst for moves in the Bitcoin market.

Arcane has attempted to quantify the relationship and found that on average, Bitcoin falls 2.27 percent towards each settlement, compared to an average fall of 0.06 percent on a random day over the same period.

This fall in prices conclude Arcane analysts, happens too often to be a coincidence:

"Statistically, it is highly unlikely that the price falls in advance of the CME settlement should be caused by mere coincidence," explains analyst Bendik Schei. "With approximately the same number of positive and negative days over the period, there is less than 2% probability of observing 15 (or more) days of price drops out of 20 possible."

Unlike other analysts, Arcane has also assessed the effect of market sentiment on this relationship, finding that the price falls hardest towards settlement when prior price action is bullish.

The underlying reason for this relationship is not clear, but Arcane suggests that it stems from professional traders’ use of CME futures as a hedging tool.

Banging the close

As Schei explains, one possible cause of the falling prices is professional traders hedging against the price of their spot Bitcoin with CME futures:

"One possible strategy for Wall Street traders is to 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."

But the movement could also be explained by something more sinister — a classic futures manipulation tactic straight out the Wall Street playbook.

‘Banging the close’ involves a trader selling a large amount of an asset on a spot exchange, in order to profit from an even larger short position on a derivative futures exchange, like CME Bitcoin Futures which is settled in cash rather than Bitcoin.

Big Wall Street players like Goldman Sachs and HSBC have previously faced legal action from institutional investors for ‘banging the close’ on assets like crude oil, but as Arcane CEO Torbjørn Bull Jenssen told Brave New Coin, the practice "is often related to high-frequency trading minutes before the settlement, and that is not what we evaluated."

Ultimately, whether the monthly price drop is due to traders ‘banging the close’ or hedging is not clear. As Jenssen said, "it is difficult to pinpoint this trend to a specific cause, whether it is manipulation or just a simple hedging strategy."

Arcane plan to continue investigating the correlation, but are optimistic that the "trend may be in for a change."

The arrival of physically-delivered Bitcoin futures, and the constant growth of the market make it unlikely that the relationship will remain steady. As Jenssen says, "In the long term, the general Bitcoin liquidity is likely to continue to grow, making it more difficult for individual traders to move the price, be it on purpose or not."