JPMorgan Says Bitcoin ETF Could Shrink CME Futures Insurance
The introduction of a Bitcoin ETF in the US will be key to normalizing Bitcoin futures prices.
No fewer than nine Bitcoin Exchange Traded Fund (ETF) filings are pending with the U.S. Securities and Exchange Commission (SEC), including a new filing from Michael Novogratz’s Galaxy Digital.
At the most basic level, vehicles offer investors the option to bet on Bitcoin by simply buying stocks through a brokerage account.
But JPMorgan, the largest U.S. bank, has identified another potential benefit to the approval of Bitcoin ETFs: helping normalize Bitcoin futures premiums on the Chicago-based CME and other exchange rates. The premium represents the difference between the futures price for Bitcoin and the spot price, which is traded on the major cryptocurrency exchanges.
“We believe the launch of a Bitcoin ETF in the United States will be key to normalizing Bitcoin futures prices,” JPMorgan analysts wrote in a May 9 report, adding that the most recent at the CME listed June contract was trading at an annual premium of 25%.
The premium has increased since February when it was below 20%. A high-performing trader could have secured 25% of the annual premium as a profit by buying the cryptocurrency on the spot market and at the same time selling the June futures contract on the CME.
According to JPMorgan analysts, the premium gap may be due in part to the fact that many large investors have not yet set up an account or process to purchase cryptocurrencies, or that this is prohibited under their own regulations or requirements. You will be barred from access through CME or Grayscale Bitcoin Trust (GBTC) futures, which have their own restrictions on price anomalies.
So the existence of a physically settled ETF could help offset some of the price differences by bringing more liquidity into the market.
CME futures contracts are settled in cash at the Bitcoin reference rate (BRR) – the daily reference rate in US dollars as of 4:00 p.m. London time. BRR represents an hourly weighted average price on a number of major exchanges as of 4:00 p.m. and is not a single observed price. In this way, the exchange ensures that a large transaction or cluster of transactions has only a limited impact on the BRR.
However, Bitcoin’s volatility is relatively high compared to traditional assets. As a result, the BRR tends to deviate from the cash market price, which leads to tracking errors in the execution transaction.
“Over a longer period of time using only the prices on the Coinbase exchange, the monthly tracking error of the BRR was sometimes 2% or more compared to the average at 4 p.m. last year. Compared to the performance of the underlying transactions (realized transactions) versus the spot rate over the same period, there was a tracking error of more than 10% per year in the past year. The abundance of Bitcoin futures may in part reflect the inefficiency in restoring the BRR they are handling, especially without direct access to the spot market, ”JPMorgan analysts said.
Last year, Paul Tudor Jones’ investment firm made a bullish bet on Bitcoin using the futures market rather than the spot market. While the company’s funds have been converted into Bitcoin through Coinbase, many managed funds are not eligible to be invested through cryptocurrency exchanges.
“Funds can only access bitcoin through CME futures,” said Pankaj Balani, co-founder and CEO of the Singapore-based Delta Exchange. “This will ultimately drive up the premium for Bitcoin futures.”
Bitcoin Futures: Annual tracking error due to BRR | Source: JPMorgan
The tracking error can be much lower if the ETF is physically settled at the spot market price. The hedge can be priced.
Execution of so-called execution transactions
also known as basic trading – where investors use hedging to take advantage of futures premiums – is much easier and more efficient with ETFs, which can result in more players and lower premiums.
“Currently, the listed underlying trades require an initial margin of nearly 40% on the futures position along with the ever-changing margin and full funding of the opposing GBTC long positions, resulting in a significantly less attractive cash return. An ETF would make underlying trading at current prices more efficient and attractive, especially if these ETFs can be bought on margin.
A carry trade is a trading strategy that involves borrowing at a low interest rate and investing in an asset that offers a higher rate of return. A carry trade is usually based on taking out a loan in a currency with a low interest rate and converting the amount borrowed into another currency. Generally, the proceeds will be deposited in the second currency if it offers a higher interest rate. The proceeds can also be used for assets such as stocks, commodities, bonds, or real estate denominated in the second currency.
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