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JPMorgan has released a report on the futures and derivatives market around the world in a report titled “Why Is The Bitcoin Futures Curve So Steep?” JPMorgan Chase analysts examined the growing futures and derivatives market surrounding bitcoin, provided insights as to why the contango is so steep and explored what the future holds for the monetary asset as it becomes increasingly financialized.
Here are some of the highlights from the report.“As has often been the case in the past, the growth and gradual maturation of cryptocurrency markets has naturally generated interest in derivatives and other sources of leverage. Though futures trade against a range of pairs, Bitcoin unsurprisingly dominates this nascent marketplace. Similarly to the spot market, these products trade within a highly fragmented ecosystem, with nearly 30 active venues.
The vast majority is traded offshore as well, with less than 15% of the total open interest listed on major, regulated domestic venues like the CME. Normalized depth in futures has also kept pace with the deepening of the cash market, suggesting it too is benefiting from institutional inflows and improved liquidity provision in spot.”
With the launch of CME bitcoin futures contracts in late 2017, institutional investors in the United States began to have access to bitcoin derivatives exposure, but access to “spot bitcoin” has been harder to come by, even as the bitcoin market cap has increased more than 200 percent above the 2017 peak.
The analysts offered up potential reasons for why the contango has remained so large. Among the possible explanations provided by JPMorgan is counterparty and repatriation risk in offshore markets, complications with obtaining spot BTC exposure in the legacy system and, subsequently, the Grayscale Bitcoin Trust (GBTC) being a main source of BTC exposure on the street (and all of the premium/discount problems that come along with the investment vehicle).
“Why has such attractive pricing not simply been arbitraged away? One could perhaps blame counterparty and repatriation risk in unrelated offshore markets, but certainly not the CME. In a market with rampant bullish sentiment and heavy retail involvement it is tempting to simply blame demand for leverage. And that is certainly true to some extent. However, there are also some more idiosyncratic but equally important aspects of how these contracts are designed in the context of market segmentation that are specific to Bitcoin and likely explain a substantial fraction of this richness.”
JPMorgan believes that the introduction of a bitcoin exchange-traded fund (ETF) will compress the yields offered by the trade, as a liquid investment vehicle that trades at net asset value (NAV) will give investors the access to “spot BTC” that they need in order to execute the arbitrage trade.
As shown in the chart below, net positions in the CME bitcoin futures market shows that hedge funds have continued to increase their short positions into 2021, totaling about $1.45 billion at the time of writing. Are hedge funds naked short bitcoin? Absolutely not, they are simply executing the cash and carry trade, and capturing the large spread in the process.
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