Bitcoin futures pricing kindles manipulation fears

CME and CBOE insist pricing methodology is robust; critics say contracts are ripe for manipulation


  • CME and CBOE’s cash-settled bitcoin futures reference only a portion of spot trading volumes.
  • US bitcoin exchanges are not subject to regulatory requirements on market surveillance and monitoring.
  • CME’s contracts reference trading activity at four bitcoin exchanges; CBOE relies on the auction price at a single exchange.
  • CBOE has implemented tighter position limits on bitcoin futures, which could deter manipulation.

The new bitcoin futures contracts that began trading on the Chicago Board Options Exchange and Chicago Mercantile Exchange earlier this month aim to give investors exposure to bitcoin without the perils of dealing directly with the fledgling exchanges where the cryptocurrency is traded.

But critics worry the settlement pricing methodologies for the contracts, which rely on only a portion of all bitcoin trading volume, makes them susceptible to manipulation.

The CF Bitcoin Reference Rate (BRR) used to price CME Group’s cash-settled bitcoin futures contract includes four bitcoin exchanges, which between them account for roughly 40% of bitcoin trading volumes. CBOE’s contract relies on pricing from a single exchange, Gemini, which holds a 7% market share.

“These markets are small, very illiquid and can be easily manipulated,” says a senior risk officer at a large derivatives clearing house.

Bitcoin exchanges have a short but checkered history. Mt Gox collapsed in 2014 after it inexplicably lost around 850,000 bitcoins belonging to customers. It was the world’s largest bitcoin exchange at the time, handling over 70% of all transactions. Bitfinex, which replaced Mt Gox as the largest bitcoin exchange by volume, was hacked in 2016. Clients of the exchange were also prevented from cashing out in US dollars earlier this year after Wells Fargo suspended outbound wire transfers to its correspondent accounts. Similar reports of hacking and trade manipulation have popped up on other bitcoin exchanges.

This is hardly surprising. While some bitcoin exchanges have been required by regulators to implement basic anti-money laundering and cybersecurity controls, no such rules exist regarding market surveillance. “No regulator is requiring the [bitcoin spot] exchanges to do anything as far as trade surveillance and monitoring for manipulation,” says Gary DeWaal, special counsel at the law firm Katten Muchin Rosenman.

The futures exchanges say they have taken the necessary steps to police activity in the underlying markets used to calculate settlement prices for their contracts. “We deploy appropriate protocols for ongoing monitoring of our futures market and the underlying activity in the BRR,” says a spokesperson for CME Group. “In the futures market, we also implement risk-mitigation tools such as margin, credit controls and price limits to appropriately manage the risk of listing and clearing bitcoin futures.”

CBOE spokesperson Suzanne Cosgrove says the settlement and surveillance procedures for its bitcoin contracts have been reviewed by the Commodity Futures Trading Commission. “This process included rigorous vetting and ongoing enhancements to the design, settlement, margining and surveillance process for XBT futures, including with the CFTC and our clearing house, the OCC [Options Clearing Corporation].”

No regulator is requiring the [bitcoin spot] exchanges to do anything as far as trade surveillance and monitoring for manipulation

Gary DeWaal, Katten Muchin Rosenman

The CFTC does not directly regulate bitcoin exchanges. However, it can pursue cases of manipulation in cryptocurrencies. “While its regulatory oversight authority over commodity cash markets is limited, the CFTC maintains general anti-fraud and manipulation enforcement authority over virtual currency cash markets as a commodity in interstate commerce,” reads a statement on the regulator’s virtual currency resource web page.

The CFTC declined to comment on its surveillance and monitoring of bitcoin exchanges.

Still, some worry the bitcoin futures market will attract its share of scofflaws. “The fact the CFTC let this go forward suggests their staff and the exchanges took a view that it was not readily susceptible to manipulation,” says Jeff Bandman, the former director of the CFTC’s division of clearing and risk. “But I think it’s a reasonable bet that bad actors out there are going to try.”

CME and CBOE have implemented various controls to prevent the manipulation of settlement prices. CME’s BRR is based on trading activity on four bitcoin exchanges – GDAX, Bitstamp, Kraken and itBit – over a one-hour window from 3–4pm, London time. The data is broken up into 12 five-minute segments, and a volume-weighted median is calculated for each segment to discount outliers. The 12 volume-weighted medians are averaged to create the final reference rate, which is published at 4.01pm on each trading day.

“If you wanted to influence this index, you would essentially have to trade substantial size on ideally all the exchanges, and you would have to do it for an entire hour,” says Timo Schlaefer, co-founder of Crypto Facilities, which calculates the BRR for CME. “We have back tested it to 2013–14 when the price differentials on the exchanges were really extreme in some cases, and it gives a good price even in those circumstances.”

The fact the CFTC let this go forward suggests their staff and the exchanges took a view that it was not readily susceptible to manipulation. But I think it’s a reasonable bet that bad actors out there are going to try

Jeff Bandman, former director of clearing and risk, CFTC

CBOE’s approach is much simpler: its contracts pay out the auction price for bitcoin on the Gemini exchange at 3pm eastern time on the settlement date of the contract. CBOE declined to share more details on the design of its pricing methodology.

A common criticism of the settlement pricing methodologies for bitcoin futures is that they account for only a portion of the trading in the underlying cash markets. Neither CME or CBOE incorporate pricing from Bitfinex, which accounts for nearly half of all trading in bitcoin.

Bitfinex was included within the BRR when it was first rolled out in 2016, but it was removed along with OKCoin in April this year after losing access to US dollar outbound wires. One of Crypto Facilities’ criteria for inclusion in the BRR is that client funds must be able to flow in and out of the exchange freely.

Schlaefer says including every bitcoin venue in the BRR would be counterproductive. Many bitcoin exchanges account for only a nominal amount of trading volume and including them in the index would only make it less transparent and more difficult for traders to replicate, he argues. He estimates that 90–95% of bitcoin trading volume is concentrated on six exchanges: Bitfinex, GDAX, Bitstamp, Gemini, Kraken and itBit.

According to, the four exchanges included in the BRR represented around 40% of total bitcoin trading volume over the 30 days to December 19. GDAX and Bitstamp accounted for 22% and 10% of volumes, respectively, while Kraken and itBit had market shares of 3% and 2% respectively.

Schlaefer says Crypto Facilities is constantly monitoring and talking with exchanges that might qualify for inclusion in the BRR index. As market share among bitcoin exchanges tends to shift rapidly, he says it’s better to track a handful of top exchanges rather than focusing on just one: “If you only have one exchange, it might become immaterial. Obviously, it is less liquid than having four, but there are also the exchange issues. It happens quite frequently that exchanges are victims of denial-of-service attacks or the application programming interfaces don’t work as they should.”

CBOE’s reliance on a single exchange – Gemini, which accounted for only 7% of trading volume over the same 30-day period – had raised alarm in some circles. However, a regulatory source says the exchange has effectively addressed those concerns by limiting the number of expiring contracts that a single entity can hold in the five business days prior to settlement to 1,000 contracts, down from an original limit of 5,000. “By throttling down the number of futures contracts you can hold you are basically limiting the multiplier that would cause you to try to do it in the first place,” he says.

However, the head of a second derivatives clearing house says it is too early to say whether either exchange’s pricing methodology is fit for purpose. “I don’t think there is a best settlement price mechanism because we haven’t seen a shakeout in the price-discovery community that we have gotten in other marketplaces,” he says. “It is just too much unknown in this market right now for hyper-regulated global institutions to be moving along this fast.”

John Griffin, a professor of finance at the University of Texas at Austin, who co-authored a paper on the manipulation of the settlement prices for CBOE Volatility Index (VIX) futures contracts, says he sees similarities with bitcoin futures, which could make them susceptible to manipulation.

First, like VIX futures, the bitcoin contracts are cash-settled, which makes them more vulnerable to manipulation than if they were physically settled, he says. Second, Griffin sees potential for the bitcoin futures market to be larger and more liquid than the spot market. If that occurs, as it did with VIX futures, the spot market can be easily moved to benefit larger positions held in futures, Griffin says.

It is very dangerous for futures exchanges to have a settlement volume that is greater than the settlement volume in the lower level

John Griffin, University of Texas at Austin

As CME and CBOE only include a portion of overall bitcoin trading volume in the calculation of settlement prices, futures trading on both exchanges could eventually surpass the liquidity in the underlying markets. “Exchanges need to look carefully in the volume going on in the lower level relative to the volume they have trading through their exchange. It is very dangerous for futures exchanges to have a settlement volume that is greater than the settlement volume in the lower level,” he says.

Some market participants say CME and CBOE moved too quickly to launch bitcoin futures and have highlighted flaws in the self-certification process for registering the contracts with the CFTC. Prior to listing a new contract, an exchange must either self-certify in writing that the new contract complies with the Commodity Exchange Act, or submit the contract for CFTC approval. A contract can be listed one full business day after self-certification, unless the CFTC finds it would violate the CEA or the commission’s regulations.

The CFTC found no such issues to the self-certifications submitted by the two exchanges on December 1. However, the Futures Industry Association said the self-certification process failed to allow for “proper public transparency and input” – especially with respect to clearing arrangements – in a letter sent to the CFTC on December 6.

DeWaal admits he expected the industry be given a chance to offer feedback on the contracts before they went live. “I was surprised the public wasn’t given an opportunity to give its views,” he says. “There must be more people interested in this contract and the impact of this contract other than just the members of the exchanges and the exchanges themselves.”

CME and CBOE Futures Exchange have shown a willingness to adjust the contracts in response to industry feedback. CME set initial margin requirements at 27% of the notional value of the contract, according to the CFTC, but increased it to 35% following a discussion with the regulator prior to its self-certification. It increased initial margin requirements again, this time to 47%, in the week leading up to the launch of the contract.

CFE’s initial margin for the new contracts also moved from 33% to 44% less than a week before the contract went live.

Still, concerns remain that the futures exchanges are trying to do too much, too soon, and too fast. “It feels rushed,” the risk officer at the clearing house says. “It feels rushed in the context given the hyper volatility we have had recently. Layering on top of that, this is a new market dynamic. That is where I think you could get uncomfortable.”

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