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The Chicago Mercantile Exchange (CME) Bitcoin (BTC) futures contracts have been trading below the spot price of Bitcoin on regular exchanges since November 9, a situation technically known as backwardation. Although this indicates a bearish market structure, several factors can cause momentary distortions.

Typically, these CME fixed month contracts trade at a slight premium, indicating that sellers are asking for more money to hold settlement longer. As a result, futures should trade at a premium of 0.5% to 2% in healthy markets, a situation known as contango.

However, a prominent future contracts seller will cause a momentary distortion of the futures premium. Unlike perpetual contracts, these fixed-timeframe futures do not have a funding rate, so their price can be quite different from spot exchanges.

Aggressive sellers prompted a 5% discount on BTC futures

Whenever there is aggressive activity from the shorts (sellers), the two-month futures contract will trade at a discount of 2% or more.

CME Bitcoin 1-month futures premium against the BTC index. Source: Trading View

Notice how CME 1-month futures were trading close to fair value, exhibiting either a 0.5% discount or a 0.5% premium to spot trades. However, when Bitcoin prices fell on November 9, aggressive futures sellers caused CME futures to trade 5% below the normal market price.

The current discount of 1.5% remains atypical but it is explained by the risks of contagion induced by the Bankruptcy of FTX and Alameda Research. The group was supposed to be one of the biggest market makers in cryptocurrencies, so their downfall was bound to send shockwaves through all crypto-related markets.

Insolvency has seriously impacted over-the-counter counters, investment funds and leading lending services, including Genesis, BlockFi and Galois Capital. As a result, traders should expect less arbitrage activity between CME futures and other spot market exchanges.

The lack of market makers has exacerbated the negative impact

As market makers work to reduce their exposure and assess counterparty risk, the potential excess demand for long and short positions at CME will naturally lead to distortions in the futures premium indicator.

Forward contracting is the main indicator of a dysfunctional and bearish derivatives market. Such movement can occur during liquidation orders or when large players decide to short the market using derivatives. This is especially true when open interest increases because new positions are created under these unusual circumstances.

On the other hand, an excessive discount will create an arbitrage opportunity as one can buy the futures contract while simultaneously selling the same amount in the spot (or margin) markets. This is a neutral market strategy, commonly called “reverse cash and carry”.

Institutional Investor Interest in CME Futures Remains Steady

Curiously, open interest on CME Bitcoin futures hit a four-month high on Nov. 10. This data measures the aggregate size of buyers and sellers using CME derivatives contracts.

CME Bitcoin Futures Open Interest, USD. Source: Coinglass

Note that the all-time high of $5.45 billion occurred on October 26, 2021, but Bitcoin’s price was close to $60,000 then. Therefore, the open interest of $1.67 billion on CME futures contracts on November 10, 2022 remains relevant in the number of contracts.

Related: US Crypto Exchanges Lead to Bitcoin Exodus: Over $1.5 Billion in BTC Withdrawn in One Week

Traders often use open interest as an indicator to confirm trends or at least the appetite of institutional investors. For example, an increasing number of open futures contracts is generally interpreted as new money entering the market, regardless of the bias.

While this data cannot be considered bullish on a stand-alone basis, it does indicate that professional investor interest in Bitcoin is not going away.

As further evidence, note that the open interest chart above shows that savvy investors have not reduced their positions using Bitcoin derivatives, regardless of what critics have said about cryptocurrencies.

Given the uncertainty surrounding the cryptocurrency markets, traders should not assume that a 1.5% CME futures discount denotes a long-term decline.

There is undoubtedly a demand for shorts, but market makers’ lack of appetite is the main factor behind the current distortion.