Author: Crypto_Painter Source: X, @CryptoPainter_X
Lately, the entire market has shown a hint of panic, largely due to the massive short positions held by CME. As a veteran in the cryptocurrency market, I vividly remember the epic bull run of 2017 coming to an end when CME officially launched BTC futures trading. Therefore, studying CME’s enormous short positions is of extraordinary significance.
First, let’s introduce some background:
CME refers to the Chicago Mercantile Exchange, which launched BTC futures trading at the end of 2017. The commodity code is: [BTC1!]. Subsequently, a large number of Wall Street institutional capital and professional traders entered the BTC market, dealing a heavy blow to the ongoing bull market, leading BTC into a bear market that lasted for 4 years.
With an increasing number of traditional funds entering the BTC market, institutional traders (hedge funds) and professional traders serviced by CME began to participate more actively in BTC futures trading.
During this period, CME’s futures positions continued to grow, and last year it successfully surpassed Binance, becoming the dominant player in the BTC futures market. As of now, CME’s total BTC futures positions have reached 150,800 BTC, approximately $10 billion, accounting for 28.75% of the entire BTC futures market share.
Therefore, it is no exaggeration to say that the current BTC futures market is not controlled by traditional cryptocurrency exchanges and retail investors, but has fallen into the hands of American institutional traders.
As more and more people have noticed, CME’s short positions have not only increased significantly, but have also recently reached a new all-time high and continue to rise. As of the time of writing this article, CME’s short positions have reached $5.8 billion, with no apparent signs of slowing down.
Does this mean 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 the data, it certainly seems so, especially since BTC has never maintained a steady trend after breaking historical highs during a bull market for over 3 months. All signs indicate that these large funds may be betting that this round of the BTC bull market will not perform as expected.
Is the reality really as it seems?
Next, I will explain where these enormous short positions come from and whether we should be fearful. Furthermore, I will examine the impact it has on the bull market.
Firstly, if you frequently check CME’s prices, you will notice an interesting pattern. The price of the BTC1! futures contract is almost always several hundred dollars higher than the spot price on Coinbase. This is understandable because CME’s BTC futures are settled monthly, similar to the current month’s forward contract on traditional cryptocurrency exchanges.
Therefore, when the market sentiment is bullish, we often see forward contracts with varying degrees of premiums, with the premium for the second quarter being particularly high during a bull market.
If we subtract CME’s BTC futures price from Coinbase’s spot price (both USD trading pairs), we get the following chart:
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The orange line represents the BTC price on a 4-hour timeframe, while the gray line represents the premium of CME futures prices relative to CB spot prices.
We can clearly see that CME’s futures premium level exhibits a regular fluctuation with each monthly contract extension (automatic rollover to the next month’s contract). This is similar to the premium of forward contracts on traditional cryptocurrency exchanges, which tend to have high premiums at the time of contract generation, gradually flattening out as the contract approaches expiry.
It is this regularity that allows us to engage in a certain degree of spot-futures arbitrage. For example, when a CEX exchange’s quarterly contract is generated after a period of significant bullish market activity, and the premium has risen to 2-3%, we can invest $2 million, buying $1 million in spot and opening a $1 million short position on the quarterly contract.
During this period, regardless of price fluctuations, the short position is unlikely to be liquidated. As long as the premium is gradually eroded before the quarterly contract expires, we can secure a risk-free 2% stable return on the $1 million investment, which is $20,000.
Do not underestimate this return. For large funds, this is almost a risk-free high return!
If we do a simple calculation, CME generates a new contract on average every month, and since 2023, the average premium has been 1.2%. Taking into account transaction fees, let’s assume 1%. This means that over the course of a year, there is a fixed 1% risk-free arbitrage opportunity every month.
With 12 occurrences in a year, this translates to an annualized risk-free return of approximately 12.7%, which outperforms most of the returns offered by U.S. money market funds, let alone bank interest rates.
Therefore, at present, CME’s futures contracts are a natural arbitrage platform. However, there is still a problem: while futures can be traded on CME, where can we buy spot?
CME serves professional institutions or large funds, and these clients cannot simply open a CEX exchange account like we can. Most of their money is also with LPs, so they need to find a compliant and legal channel to purchase BTC spot.
Voila! Enter BTC’s spot ETF!
With this, the loop is complete. Hedge funds or institutions can make significant purchases on the U.S. stock market ETF while simultaneously opening an equivalent amount of short positions on CME. By engaging in a risk-free fixed arbitrage once a month, they can achieve a stable return of at least 12.7% per annum.
This reasoning seems natural and reasonable, but it requires validation through data. Have U.S. institutional investors actually engaged in arbitrage through ETFs and CME?
As shown in the figure below:
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I have marked the periods of extremely low CME futures premiums since the ETF’s inception on the chart, while the subgraph indicator below is my own BTC spot ETF net inflow bar chart.
You can clearly see that whenever CME’s futures premium begins to significantly decrease, to less than $200, the net inflow of the ETF also decreases. However, when CME generates a new monthly contract, the ETF will experience a substantial net inflow on the first Monday of trading for the new contract.
This to some extent indicates that a considerable proportion of the net inflows into the ETF are not purely for purchasing BTC, but rather for hedging the high premium short positions to be opened on CME.
Now, go back and take another look at the data chart showing CME’s short positions. You will notice that CME’s short positions began to surge exactly after January 2024. Coincidentally, BTC’s spot ETF also began trading officially after January 2024!
Therefore, based on this incomplete data analysis, we can draw the following research conclusions:
1. CME’s massive short positions are likely to be used to hedge spot ETFs. Therefore, the actual net short positions should be far from the current $5.8 billion, and we should not be fearful because of this data.
2. The net inflow of the ETF, amounting to $15.1 billion, is likely to have a considerable portion of funds being in a hedging state. This explains why the historical second-highest daily net inflow of the ETF in early June (amounting to $886 million) and the entire week’s net inflow did not lead to a significant breakthrough in BTC’s price.
3. Although CME’s short positions have a lot of leverage, there was already a significant increase before the ETF was approved. Despite the subsequent bull market rise from $40,000 to $70,000, there were no major liquidations, indicating that there are likely to be firm bearish funds among U.S. institutional investors. We cannot afford to take this lightly.
4. Daily net inflow data for ETFs may need to be reevaluated. The impact of net inflows on market prices may not necessarily be positively correlated but may also exhibit a negative correlation (large ETF purchases leading to a decline in BTC prices).
5. Consider a special situation: when, in the future, the premium of CME’s futures contracts is completely eradicated by these arbitrage systems, and there is no potential arbitrage space, we will see a significant reduction in CME’s short positions, corresponding to a large net outflow from the ETF. If this situation arises, there is no need for excessive panic; it is simply a case of liquidity exiting the BTC market to seek new arbitrage opportunities elsewhere.
6. Lastly, a point of consideration: where does the premium in the futures market come from? Is the wool truly pulled over the sheep’s eyes? I may conduct further research on this in the future.
Well, that concludes this research summary. This issue leans towards market research and does not provide clear directional guidance for trading. However, it is very helpful for understanding the logic of the market. After all, when I saw CME’s massive short positions, I was a little scared too, and it brought back memories of the prolonged bear market from 2017 to 2018.
That bear market was way more nauseating than the choppy market we’re experiencing today. But fortunately, as things stand, BTC is indeed favored by traditional capital. Put bluntly, the willingness of hedge funds to arbitrage in this market is a form of recognition, even though it’s our retail money they are using.
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