In-depth Study: The Subtle Relationship Between BTC Spot ETF and CME's Massive Short Positions

Author: Crypto_Painter

Recently, there has been a sense of panic in the entire market, largely due to the massive short positions at CME. As an old player in the crypto space, I vaguely remember that when CME officially launched BTC futures trading, it coincidentally marked the end of the epic bull market of 2017!

Therefore, studying these massive short positions at CME is of great significance!

First, let me introduce the background:

CME refers to the Chicago Mercantile Exchange, which launched BTC futures trading at the end of 2017, with the commodity code: [BTC1!]. Subsequently, a large amount of Wall Street institutional capital and professional traders entered the BTC market, delivering a heavy blow to the ongoing bull run and causing BTC to enter a bear market that lasted for four years;

As traditional capital increasingly entered the BTC market, the institutional traders (hedge funds) and professional traders that CME primarily serves began to participate more and more in BTC futures trading;

During this period, CME's futures open interest grew larger and successfully surpassed Binance last year, becoming the leader in the BTC futures market. As of now, CME's total open interest in BTC futures has reached 150,800 BTC, approximately $10 billion, accounting for 28.75% of the entire BTC futures trading market;

Therefore, it is not an exaggeration to say that the current BTC futures market is not controlled by traditional crypto exchanges and retail investors, but has already fallen into the hands of professional institutional traders in the U.S.

With more and more people recently discovering that CME's short positions have not only increased significantly but have also recently broken historical highs and continue to rise, as of the moment I am writing this article, CME's short position has reached $5.8 billion, and the trend shows no obvious signs of slowing down;

Does this indicate that elite capital on Wall Street is heavily shorting BTC and has no confidence in the future performance of this bull market?

Looking purely at the data, it indeed seems so. Moreover, BTC has never experienced a situation where it maintained fluctuations for more than three months after breaking historical highs during a bull market. All signs indicate that this large capital may be betting that this BTC bull market will far underperform expectations.

Is reality really like this?

Next, let me explain where these massive short positions come from, whether we should feel fear, and what impact this has on the bull market.

First, if you often check CME prices, you will notice an interesting characteristic: the price of the BTC1! futures trading pair is almost always at least a few hundred dollars higher than the Coinbase spot price. This is easy to understand because CME's BTC futures are settled monthly, equivalent to the monthly swap contracts in traditional crypto exchanges;

Therefore, when market sentiment is bullish, we can often see that swap contracts exhibit varying degrees of premiums, such as the premiums for quarterly contracts during a bull market being very high.

If we subtract the Coinbase spot price from the CME BTC futures price (both are USD trading pairs), we can obtain the following chart:

The orange curve represents the BTC price trend on a 4-hour level, while the gray curve represents the premium of CME futures prices relative to CB spot prices;

It is clear that the CME futures premium fluctuates regularly with each month's contract roll-over (automatically moving to the next month's contract), similar to the premium of swap contracts in traditional crypto exchanges, which tend to have higher premiums when contracts are generated and gradually smooth out as contracts approach expiration;

It is this regularity that allows us to engage in a certain degree of cash-and-carry arbitrage. For example, when a quarterly contract is generated on a CEX exchange after a significant bull run, if its premium has reached 2-3%, we can take out $2 million, buy $1 million in spot, and simultaneously open a $1 million short position on the quarterly contract;

During this period, regardless of how the price fluctuates, the short position will almost never be liquidated. As long as we wait until the quarterly contract expires and the premium is gradually smoothed out, we can achieve a risk-free stable return of 2% on the $1 million, which is $20,000.

Do not underestimate this return; for large funds, this is almost a risk-free high return!

To do a simple calculation, CME generates a new contract on average once a month. Since 2023, its average premium has been 1.2%. Considering the transaction fees for this operation, let’s assume it’s 1%, which means there is a fixed risk-free arbitrage opportunity of 1% each month.

Calculating for a year with 12 occurrences, that’s approximately a 12.7% risk-free annualized return, which already outperforms most money market funds in the U.S., not to mention putting that money in a bank for interest.

Therefore, from the current perspective, CME's futures contracts are a natural arbitrage venue. However, there is another question: where do we buy the spot?

CME serves professional institutions or large funds, and these clients cannot trade like us by simply opening an account on a CEX exchange. Most of their money is also from LPs, so they must find a compliant and legal channel to purchase BTC spot.

Ding ding! Coincidentally, the BTC spot ETF has come through!

Thus, a closed loop is completed: hedge funds or institutions buy heavily in the U.S. stock ETF while opening equivalent short positions at CME, making risk-free fixed arbitrage every month to achieve a stable return of at least 12.7% annualized.

This argument sounds very natural and reasonable, but we cannot rely solely on words; we need to verify it with data. Have U.S. institutional investors really been arbitraging through ETFs and CME?

As shown in the chart below:

I have marked the periods of extremely low CME futures premiums since the ETF was approved, while the lower sub-chart indicates the net inflow of BTC spot ETF that I wrote myself.

You can clearly see that whenever the CME futures premium starts to shrink significantly, falling below $200, the net inflow of the ETF also decreases. When CME generates a new monthly contract, a large net inflow into the ETF occurs on the first Monday of trading for the new contract.

This can indicate that a considerable proportion of the funds in the ETF net inflow is not simply for purchasing BTC but is used to hedge against the high premium short positions that will be opened at CME;

At this point, you can refer back to the earlier chart that shows the data on CME's short positions, and you will find that the time when CME's short positions truly began to surge by 50% coincides exactly with January 2024.

And the BTC spot ETF also officially started trading after January 2024!

Therefore, based on the above not-so-complete data argument, we can draw the following research conclusions:

1. The massive short positions at CME likely include many shorts that are used to hedge the spot ETF, so the actual net short position should be far less than the current $5.8 billion, and we need not feel panic because of this data;

2. The ETF's net inflow of $15.1 billion to date likely includes a considerable portion of funds that are in a hedged state, which explains why the historical second-highest single-day net inflow into the ETF (of $886 million) in early June and the entire week of ETF net inflow did not lead to a significant breakthrough in BTC's price;

3. Although CME's short positions have a lot of fluff, they had already shown a significant increase before the ETF was approved, and during the subsequent bull market from $40,000 to $70,000, there was no significant liquidation, indicating that there are likely still firm bearish funds among U.S. institutional investors, so we cannot let our guard down;

4. There needs to be a new understanding of the daily net inflow data of the ETF; the impact of net inflow funds on market prices may not necessarily be positively correlated and could even be negatively correlated (large ETF purchases leading to BTC price declines);

5. Considering a special situation, when one day in the future the CME futures premium is completely consumed by this group of arbitrage systems and there is no potential arbitrage space left, we will see a significant reduction in CME's short positions, which will correspond to a large net outflow from the ETF. If this situation occurs, do not panic too much; this is simply a withdrawal of liquidity from the BTC market to seek new arbitrage opportunities.

6. Finally, a thought: where does the premium in the futures market come from? Is the wool really coming from the sheep? I may conduct further research on this later.

Alright, that concludes this research summary. This content leans towards market research and does not provide very clear directional guidance, so it may not be of much help for trading. However, it is quite helpful for understanding market logic. After all, when I see the massive short positions at CME, I also feel a bit scared and even recall the long bear market from 2017 to 2018…

That bear market was much more nauseating than today's fluctuating market. However, fortunately, from the current perspective, BTC is indeed favored by traditional capital. To put it bluntly, the willingness of hedge funds to come to this market for arbitrage is essentially a form of recognition, even though the money comes from us retail investors, haha.

Finally, if you have doubts about the uniqueness of this bull market, you can also check the discussion in the quote below "Is this bull market more complex than previous bull markets?," which works better when combined with this article!

Thank you for reading!