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Market Manipulation 101: Bitcoin Futures



De Silva

This week, the Gemini auction price could get a little out of hand. Here’s one possible scenario for the settlement of the first bitcoin futures.

Tomorrow, the future of bitcoin will be determined. No, I'm not referring to another hard fork. Actually, on January 17, 2018, the first bitcoin futures contracts will settle.

Cash-settled bitcoin futures allow traders and institutions to place bets on whether the price of bitcoin will rise or fall – without holding bitcoin itself. The CBOE's bitcoin futures are the first cryptocurrency derivative listed on a traditional exchange. Unfortunately, because of the contract's unique design, there could be some complications.

To understand the nuances of the cash-settled contract, it might be worth revisiting previous coverage by ETHNews.

In the most basic terms, a person can agree to buy or sell a contract tied to the price of bitcoin at a future date (the benchmark price). Whether the contract's buyer receives or loses money is based on whether the benchmark price – determined by a 4 p.m. ET auction held by Gemini – is higher or lower than the price paid for the contract. (The contract's seller would also receive or lose a corresponding amount, less expenses).

Note: Each CBOE bitcoin futures contract relates to the underlying price of one bitcoin.

The benchmark price is the single most important factor in whether bettors win or lose money on their bitcoin futures. As such, CBOE's bitcoin futures contracts could be vulnerable to manipulation because the 4 p.m. ET Gemini auction is the sole determinant of the benchmark price. The auction is potentially a single point of failure.

Amplifying the problem is the auction's relatively low volume, which could make the ultimate settlement price susceptible to the undue influence of a rogue trader or group of traders.

Gemini Auction Data

During the first 10 days of January, an average of 35.34 bitcoin were sold during Gemini's 4 p.m. ET daily bitcoin auctions – but with a tremendous variance. 

On New Year's Day, just 0.0735 BTC was sold at auction for an approximate price of $985.50. Then, on January 8, 2018, the Gemini auction hosted a volume of 102 bitcoin, corresponding to an auction price of approximately $14,938 per bitcoin, and a total notional value of $1.52 million.

Browsing Gemini's historical data, it's clear that the amount of bitcoin auctioned each day varies significantly. And, like the global bitcoin price, the auction price itself has been fairly volatile. However, there appears to be a small but persistent premium for bitcoin sold via auctions, as the "absolute difference" is typically a small positive percentage.

Because the bitcoin auction volume is so low, it appears that a calculating trader could artificially influence the auction price to capitalize on futures positions. Although CBOE instituted position limits, it seems like the market doesn't have nearly enough liquidity to guard against the market-moving impact of even a mid-size trader.

Back-of-the-envelope calculations (described below) suggest that as little as a million dollars could be used to shore up futures positions and influence the auction market. But, even if manipulation appears possible, legal safeguards might dissuade malicious activity.

To learn more, ETHNews spoke with Andrew Verstein, an associate professor of law at Wake Forest University. Verstein is an expert in the area of commodities regulation, and he helped explain how the Commodity Exchange Act is designed to protect against price manipulation.

What it boils down to is that the manipulation of commodity prices is a crime. Verstein suggested that the Commodity Futures Trading Commission (CFTC) has a "somewhat timid reputation," but that might be due to its historically less-aggressive mandate.

While the Securities and Exchange Commission is explicitly tasked with investor protection, the CFTC's stated mission is to "protect market users and the public from fraud, manipulation, and abusive practices related to the sale of commodity futures and options and to foster open, competitive, and financially sound commodity futures and option markets."

However, proving that price manipulation occurred can be challenging in the commodities markets, said Professor Verstein, so the CFTC sometimes settles cases rather than letting them play out in the courts. Bitcoin futures, in particular, present an interesting case study because typical defenses might not hold up in front of a judge.

In physical markets, institutional traders might claim innocence based on the timely delivery of tangible commodities. However, bitcoin is not physical and it does not appear that institutions are purchasing troves of bitcoin on behalf of clients at regular intervals (think five-minute intervals).

As such, an extraordinary purchase or sale of bitcoin during Gemini's 4 p.m. ET bitcoin auction on January 17 could invite scrutiny from the CFTC. Manipulators could be slapped with fines, or trading bans – and the strategy might not even be successful (CBOE and Gemini have baked a provision into the bitcoin futures contract specifications to account for such extenuating circumstances).

Furthermore, Verstein reasoned, various auction participants might have incentives to push the settlement price higher or lower. If ever there was an example of game theory in action, this is it. To actually move the price, a trader would need to accurately surmise the behavior of the competition in order to take advantage of it.

All of this is to say that price manipulation could land a person in a heap of trouble.

Regardless of what happens next week, bitcoin futures are under the microscope, as the CFTC recently announced that it will revisit the self-certification process, which was used by the CBOE and CME Group among others to list bitcoin derivatives.


The hypothetical manipulation detailed below would be illegal. Nothing contained in this article is financial advice.

Back-of-the-Envelope Calculations

Buy 50 CBOE bitcoin futures contracts at $13,600 per contract (settlement date: January 17, 2018)*

*$13,600 was the low price for the contract listed on January 10, 2018, according to the CBOE XBT Bitcoin Futures Trading Data. Also note, you do not need to hold a future for the full duration of its existence. You may enter or exit your position before the contract's settlement.

Buy 20 bitcoin during Gemini's 4 p.m. auction on January 17, 2018. Assume that this pushes the settlement price up to $18,000 per bitcoin.
If things go as planned, your futures (and everyone else's) settle at $18,000 per bitcoin based on the Gemini auction (the global bitcoin price doesn't matter). So, for each contract you hold, you net $4,400.

Futures Settlement:

$18,000 - $13,600 = $4,400
$4,400 per contract x 50 contracts = $220,000

This equates to a gain of $220,000 on your bitcoin futures.

After the auction, you're left with 20 bitcoin, which you could sell at market price (to be fair, it could be a few thousand dollars higher or lower – and your own activity might have an impact on the prevailing price). For the sake of simplicity, let's assume that the market price returns to $13,600.

Bitcoin Auction Proceeds:

Sale of BTC Acquired from Auction – Cost of BTC Bought At Auction = Profit or Loss
(20 BTC * $13,600) – (20 BTC * $18,000) = ?
$272,000 – $360,000 = -$88,000
This equates to a loss of $88,000 on the bitcoin you bought through Gemini auction.

Net Gain/Loss:

Net Gain or Loss = Settlement Value of Futures Contracts – Cost Of Manipulating Auction Price
$220,000 – $88,000 = $132,000

If things go as planned, your project nets $132,000.

Capital Requirements:

$13,600 * 50 bitcoin futures contracts = $680,000
$18,000 * 20 bitcoin bought in Gemini Auction = $360,000
$680,000 + $360,000 = $1,040,000
Total Project Cost: $1,040,000

Estimated Return:

(132,000 / 1,040,000) * 100 = 12.69% return
Estimated Return: $132,000

It's critical to note that there is a provision in the XBT futures contract, stipulating that the Final Settlement Value might not be the Gemini Exchange Auction price if it falls outside of Gemini's parameters or "the normal settlement procedure cannot be utilized due to a trading disruption or other unusual circumstance."

In that case, contingencies explain that "the Final Settlement Value will be determined in accordance with the By-Laws and Rules of The Options Clearing Corporation ('OCC')." Essentially, the OCC would determine the final settlement price "based on its judgment of what is appropriate for the protection of investors and the public interest, taking into account such factors as fairness to buyers and sellers, the maintenance of a fair and orderly market, consistency of interpretation and practice, and consistency with actions taken in related futures or other markets."

Note: Calculations based on 100% initial position requirements. In reality, significantly less than 1 million dollars would be needed to influence market activity.

Matthew De Silva

Matthew has a passion for law and technology. He graduated from Georgetown University, where he studied international economics and music. Matthew enjoys biking and listening to tech podcasts. He lives in Los Angeles.

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