Arbitrage

CME Bitcoin futures trade at a discount, but is that a good or a bad thing?

CME Bitcoin futures briefly traded at a 5% discount, alarming analysts, but what does it mean for BTC price?

CME Group’s Bitcoin (BTC) futures have been trading below Bitcoin’s spot price on regular exchanges since Nov. 9, a situation that is technically referred to as backwardation. While it does point to a bearish market structure, there are multiple factors that can cause momentary distortions.

Typically, these CME fixed-month contracts trade at a slight premium, indicating that sellers are requesting more money to withhold settlement for longer. As a result, futures should trade at a 0.5%-to-2% premium in healthy markets, a situation known as contango.

However, a prominent futures contract seller will cause a momentary distortion in the futures premium. Unlike perpetual contracts, these fixed-calendar futures do not have a funding rate, so their price may vastly differ from spot exchanges.

Aggressive sellers caused a 5% discount on BTC futures

Whenever there’s aggressive activity from shorts (sellers), the two-month futures contract will trade at a 2% or higher discount.

*CME Bitcoin 1-month futures premium vs. BTC index. Source: TradingView*

Notice how one-month CME futures had been trading near the fair value, either presenting a 0.5% discount or 0.5% premium versus spot exchanges. However, during the Nov. 9 Bitcoin price crash, aggressive futures contracts sellers caused the CME futures to trade 5% below the regular market price.

The present 1.5% discount remains atypical, but it can be explained by the contagion risks caused by the FTX and Alameda Research bankruptcy. The organizations were together supposedly one of the largest market makers in cryptocurrencies, so their downfall was bound to send shockwaves throughout all crypto-related markets.

The insolvency has severely impacted prominent over-the-counter desks, investment funds and lending services, including Genesis, BlockFi and Galois Capital. As a result, traders should expect less arbitrage activity between CME futures and the remaining spot market exchanges.

The lack of market makers exacerbated the negative impact

As market makers scramble to reduce their exposure and assess counterparty risks, the eventual excessive demand for longs and shorts at CME will naturally cause distortions in the futures premium indicator.

The backwardation in contracts is the primary indicator of a dysfunctional and bearish derivatives market. Such a movement can occur during liquidation orders or when large players decide to short the market using derivatives. This is especially true when open interest increases because new positions are being created under these unusual circumstances.

On the other hand, an excessive discount will create an arbitrage opportunity because one can buy the futures contract while simultaneously selling the same amount on spot (or margin) markets. This is a neutral market strategy, commonly known as “reverse cash and carry.”

Institutional investors’ interest in CME futures remains steady

Curiously, the open interest in CME Bitcoin futures reached its highest level in four months on Nov. 10. This data measures the aggregate size of buyers and sellers using CME’s derivatives contracts.

*CME Bitcoin futures open interest, USD. Source: Coinglass*

Notice that the $5.45 billion record high happened on Oct. 26, 2021, but Bitcoin’s price was near $60,000 then. Consequently, the $1.67 billion CME futures open interest on Nov. 10, 2022, remains relevant in the number of contracts.

Traders often use open interest as an indicator to confirm trends or, at least, institutional investors’ appetite. For instance, a rising number of outstanding futures contracts is usually interpreted as new money coming into the market, irrespective of the bias.

Although this data can’t be deemed bullish on a standalone basis, it does signal that professional investors’ interest in Bitcoin is not going away.

As further proof, notice that the open interest chart above shows that savvy investors did not reduce their positions using Bitcoin derivatives, regardless of what critics have said about cryptocurrencies.

Considering the uncertainty surrounding cryptocurrency markets, traders shouldn’t assume that a 1.5% discount on CME futures denotes long-term bearishness.

There’s undoubtedly a demand for shorts, but the lack of appetite from market makers is the primary factor leading to the current distortion.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.

The impact of the Wintermute hack could have been worse than 3AC, Voyager and Celsius — Here is why

Market makers are the backbone of every crypto exchange, ICO, DApp and many token listings, which is exactly why investors shouldn’t shrug off Wintermute’s hack.

Most crypto investors probably never heard of Wintermute Trading before the Sept. 20 $160 million hack, but that does not reduce their significance within the cryptocurrency ecosystem. The London-based algorithmic trading and crypto lending firm also provides liquidity to some of the largest exchanges and blockchain projects.

As a crypto-native trading firm, meaning digital assets have been its core since its inception in July 2017, Wintermute’s expertise in the sector is attested by $25 million in funding from global venture capital investors like Fidelity Investments, Pantera Capital and Blockchain.com Ventures.

Lending and venture capital firms have limited impact on day-to-day operations

An important distinction sets a market maker apart from bankrupt crypto venture capital firms like 3 Arrows Capital or insolvent lending and yield platforms like Voyager Digital and Celsius Network. Wintermute’s $160 million hack could have a much more profound impact on the crypto industry, considering how essential liquidity is.

The very nature of these businesses is vastly different. For example, a venture capitalist typically invests in pre-seed or seed capital by funding the projects ahead of their launch. There is a need for early-stage funding for tokens, nonfungible token (NFT) projects, decentralized applications (DApps) and infrastructure, but the money will eventually come up when a good team, idea and community are assembled.

Furthermore, the failure of a certain venture capitalist, whether it is or is not relevant to the industry, does not damage its competitors’ reputation. In fact, the opposite sentiment emerges because it proves that picking the right projects pays off, if the firm has been correctly managing its risk exposure. The same can be said for the yield and lending platforms, which basically compete for client deposits and scramble to offer the best returns.

When market markers fail, liquidity dries up and there is nothing worse for tradable assets than spreads growing wider. Most DApps users and exchanges aren’t aware of these intermediaries because their work is hidden within the order books and price arbitrage across intermediaries whether or not they are centralized. The real secret lies in algorithmic trading.

By applying sophisticated modeling and trading software, algorithmic firms like Wintermute resort to diverse strategies to find a competitive advantage over regular traders, including arbitrage, derivatives and colocation servers for high-frequency market access.

In addition to traditional proprietary desk trading, Wintermute provides market-making services by facilitating transactions on intermediaries using their own resources. These services can be hired by exchanges, brokers, token issuers or third-party entities such as foundations and supporting companies.

Specialized trading firms usually handle this process, but the activity can also be carried out independently. Currently, Wintermute, Alameda Research, DRW, Jump Trading and Cumberland are some of the leading prop trading firms that provide liquidity for centralized exchanges and decentralized finance (DeFi) platforms.

This week’s hack was not Wintermute’s first million-dollar mistake

Wintermute was hired by the Optimism Foundation to provide liquidity for its token listing in June 2022 but completely messed up by losing 20 million OP tokens. Wintermute’s team disclosed the incident to the Optimism community and posted 50 million USD Coin (USDC) as collateral to ensure the protocol was fully reimbursed.

Think about that for a moment. Exchanges, blockchain projects, venture capitalists and DApps all need some form of liquidity to ensure that the secondary market works seamlessly for end users. Without thin spreads and some depth to the order book, there is barely a chance for any project to succeed.

Whether one considers liquidity providers to be villains or heroes, their importance to the crypto industry cannot be underestimated. The current hack could have been due to mistakes exclusive to Wintermute, and for this reason, they haven’t turned manifest as an additional risk for other market makers.

Traders should not compare the failure of 3AC, Voyager and Celsus to the threat of a liquidity vacuum that is driven by the exodus of the remaining arbitrage desks. There is no indication that widespread risk has emerged at the moment, but until a detailed post-mortem is issued and similar risks eliminated, traders should keep a close eye on the markets.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.

Tired of losing money? Here are 2 reasons why retail investors always lose

A majority of “traders” end up being losers with empty portfolios. Here is exactly why.

A quick flick through Twitter, any social media investing club, or investing-themed Reddit will quickly allow one to find handfuls of traders who have vastly excelled throughout a month, semester, or even a year. Believe it or not, most successful traders cherry-pick periods or use different accounts simultaneously to ensure there’s always a winning position to display.

On the other hand, millions of traders blow up their portfolios and turn out empty-handed, especially when using leverage. Take, for example, the United Kingdom’s Financial Conduct Authority (FCA) which requires that brokers disclose the percentage of their accounts in the region that are unprofitably trading derivatives. According to the data, 69% to 84% of retail investors lose money.

Similarly, a study by the U.S. Securities and Exchange Commission found that 70% of foreign exchange traders lose money every quarter, and eToro, a multinational broker with 27 million users, reported that nearly 80% of retail investors lost money over 12 months.

The same pattern emerges in every market across different continents and decades: retail traders seldom sustain profitable operations. Still, novice and experienced investors think they can overcome that bias due to ingenuity or mass marketing campaigns from influencers, exchanges and algorithmic trading systems.

Below are the 4 culprits behind the inevitable failure of retail traders. There is no easy solution aside from a long-term mentality and dollar-cost average-based strategy of buying a fixed amount every week or month.

Exchange servers have downtime and there are trade rollbacks

In June 2021, the U.S. Financial Industry Regulatory Authority fined Robinhood $70 million, alleging “widespread and significant harm” and “misleading information to millions of its customers” starting in September 2016. Specifically, the regulator cited the platform’s outages between 2018 and 2018, affecting clients’ ability to execute buy and sell orders during significant market volatility periods.

On 8 March 2022, London Metal Exchange (LME), the largest commodities trading venue in Europe, canceled all the trades in nickel futures and deferred the delivery of all physically settled contracts. The reason cited by Bloomberg was “unprofitable short positions, in a massive squeeze that has embroiled the largest nickel producer as well as a major Chinese bank.”

Notice that such a decision is vastly worse for a broker that decides to deliberately halt their platform. In those cases, at least the client can choose another intermediary. A rollback, or trade cancellation, is far more problematic because users had already expected the profits, or maybe even hedged, meaning the trade was part of a broader strategy.

High-frequency trading and unlimited funding

Professional traders use colocation servers, placing a server as close as possible close to an exchange’s data center because this significantly reduces transmission delays. These exchanges offer premium services to high-end clients, including the private housing servers on-site.

Besides requiring a significant amount of volume to cover the costs, colocation servers provide high-frequency traders the benefit of running strategies such as pinging, which uses a series of smaller orders to scope whales trying to enter or exit the market.

In addition to being heavily funded, these arbitrage traders usually have additional funding from exchanges. These benefits basically mean they can post trades with no collateral, similar to having credits, providing them with a huge advantage over retail investors.

The evidence? Three Arrows Capital’s (3AC) insolvency negatively impacted Deribit exchange, which was forced to cover the loss themselves. Moreover, prominent Bitcoin Cash (BCH) figure, Roger Ver, is being sued by the exchange CoinFLEX for $84 million allegedly owed due to liquidations.

Retail traders need to understand that there is no room for amateurs and realize the intricate relationship between exchanges, venture capitalists, market makers and whales. Whether or not a partnership is on paper, a mutual benefit ensures that these players have preferential access to pre-seed funding rounds, listings and market access.

The only way for investors to opt out of losing money is to give up on trading, and avoid leverage trading like the plague. In reality, investors with six months or longer timeframe stand a chance of being profitable in each of their positions.