Fraud! What Fraud?
With SEC’s qualified approval of Ethereum Exchange Trade Products (ETPs) the crypto endgame has begun and the Chicago Mercantile Exchange (CME) is the patsy.
The key question facing the SEC in approving crypto-ETPs is, "how do we know that the rampant fraud in the underlying instruments (Ethereum in this case but also Bitcoin) will not impact retail consumers?".
Like all commodity markets, it boils down to a regulated Exchange (in this case the CME) having processes in place to detect manipulation of asset prices ON the exchange.
Exchanges indeed do have extensive surveillance systems in place to try to detect on-exchange frauds but as the SEC notes
“But if the would-be manipulator is not transacting on the CME itself, the impacts of its misconduct would not necessarily be surveilled by the CME unless the misconduct also impacts the CME ether futures market”
So just how will the CME detect fraud in the underlying crypto markets, here Ethereum? Such as for example, https://www.justice.gov/opa/pr/two-brothers-arrested-attacking-ethereum-blockchain-and-stealing-25m-cryptocurrency
At this point, the SEC chose to rely on information gleaned from the recent approval of Bitcoin spot ETFs. Their analysis is based on ‘correlations’ between the Bitcoin futures price and the prices reported by Bitcoin exchanges. Ether ETP would, when implemented, use Ether prices from the same crypto exchanges,
Proposers (i.e. the firms issuing the ETPs) provided the SEC with evidence of high correlations between Ether spot exchange prices and CME futures prices, up to 99.89%. (No conflict-of-interest there?)
“Specifically, given the consistently high correlation between the CME bitcoin futures market and a sample of spot bitcoin markets—confirmed through robust correlation analysis using data at hourly, five-minute, and one-minute intervals—the Commission [SEC!] was able to conclude that fraud or manipulation that impacts prices in spot bitcoin markets would likely similarly impact CME bitcoin futures prices.”
Slam dunk, eh?
But hold on a moment!
There is NO real futures market in BTC.
This is because there is no supply/demand dynamic that would drive future prices since the supply of BTC is always well-known, now and in the foreseeable future.
So, just what is the CME BTC futures price? IT IS THE SPOT PRICE!
Since its inception in 2017, the CME BTC futures price has been used as a way of trading on the BTC spot price on a regulated market – i.e. to bet on the BTC spot price without the jiggery-pokery of using dodgy crypto exchanges and rapacious miners.
No wonder the futures price is highly correlated to the exchanges' spot prices!
So can the CME detect misconduct on proposers’ systems (e.g. Fidelity) – No!
Do proposers have surveillance systems in place to detect fraud on crypto exchange trading platforms, NO!
Do crypto exchange trading systems, have surveillance systems in place to detect fraud on underlying blockchains, especially Ethereum - NO!
Everyone is trusting everyone else to do the right thing! (Not very crypto, eh?)
So, who is protecting consumers? No one?
I am looking forward to the future senate hearings where an array of ETF proposers and crypto exchange heads are quizzed by senators (just like the tobacco or big pharma CEOs) about who was protecting retail investors in crypto ETFs.
I predict early 2026!
Structured Solutions Architect at Causal Capital
2moPatrick, thanks for sharing your post. CME Launched their cash settled Bitcoin Futures & Options back in Dec 2017 https://bit.ly/4bTXPGM. The contract specs can be found here https://bit.ly/3Vf1uZZ. Bitcoin futures are a beast with their 5:25 Outright Leverage on a +- 20 tick move. You need to know what you’re doing as a trader before getting involved in this instrument, so most retail traders would probably go for the Micro Contract MBTK if they had any interest in doing so. On Ethereum, the CME launched ETH Futures & Options https://bit.ly/4bxRVer back in Feb 2021. There’s also a micro contract https://bit.ly/3QWBnVq which is equally scatty on liquidity as the ETH Mini but not beasty enough to capture my interest. The point is, BTH and ETH have been knocking around for a while. There are people that claim a basis arbitrage differential between the spot / futures contracts of BTC can momentarily exist. Given Bitcoin trades across the weekend while the CME is closed, maybe there is an edge here. I haven’t investigated this dynamic because crypto isn’t my thing as a trader. That said, after browsing through this regulatory document you shared in line with the CME reference rate processes, may be a policy gap exists after all.
DeepTech innovation, identity, security, decision, HAIT, MD PhD SMIEEE MSCS
2moThe market just doesn’t exist…waitaminute…let’s fabricate it!
Professor at Faculty of Law, The University of Hong Kong
2moI guess the possibility that the correlation between spot and futures markets being the result of fraudulent prices in the former affecting the latter never crossed their minds eh, Patrick McConnell? 🤷🏻 After all, crypto is not a normal commodity for which there is actual utility from which investors can estimate value. The only valuation one can rely on is the spot price and the prevailing narrative.