In crypto, although assets trade 24 hours a day, the introduction of the Bitcoin (BTC) Futures contract on the Chicago Mercantile Exchange (CME) has meant that not only has there been a regular price gap between the closing price on the CME and spot trading in crypto markets, but the CME price has been seen as a proxy for institutional valuation of BTC.
Indeed, an increasing number of traders are looking to design their trading strategy around these price differentials by speculating if, how, and when these gaps will be filled. For instance, if they deem a weekend fluctuation to be too optimistic or pessimistic, they will often anticipate any gap between the CME price and the 24-hour price to be closed, and will trade accordingly.
Bitcoin price gaps occur on the CME as a result of Bitcoin being traded on cryptocurrency exchanges while it is closed. CME Bitcoin futures markets observes weekends, trading hours, and holidays including Christmas and Thanksgiving. When the market reopens the following day, after the weekend or a holiday, the CME resumes trading Bitcoin at the market’s current prices.
The History of Bitcoin Futures Contracts
In December 2017, Bitcoin (BTC) futures contracts were officially launched by the Chicago Mercantile Exchange (CME) as part of its futures market. This was a huge milestone for the whole crypto industry as the CME is the largest financial derivatives exchange in the world. The launch occurred around the height of, what was at the time, the greatest bull run in Bitcoin’s history in 2017. This famous market rally was of course trumped by that which began in November 2020 and continued on into early January of this year. Futures are considered a keystone of the institutional crypto market, as they offer investors a cost-effective tool for hedging core Bitcoin holdings and regulated access to the digital asset class without the added burden of setting up new processes to manage risks involved in holding physical securities.
As a traditional, regulated venue, the CME physically delivered futures contracts are only available during trading hours to accredited investors, whereas perpetual and spot contracts on crypto exchanges can be traded 24/7 by anyone. Price gaps, which are denoted as an empty space on BTC price charts, are therefore often attributed as a reflection of the differential between pricing for institutional and retail Bitcoin investors. In reality however, from what we at EQUOS.io have witnessed in the market, Institutional investors are increasingly actively engaged in the spot and perpetual market on crypto exchanges, and this activity is coming to represent a far greater driver of Bitcoin’s price. As institutional participation in this side of the market expands, in line with the growth in institutional-grade infrastructure, this gap will likely become less influential in price oscillation.
Bitcoin gaps can often take hours, days, weeks and even months to fill after they have originally been formed, and in many cases do not get filled at all - the market simply just continues to trade at the spot level without any reconciliation.
Futures contracts, such as those traded across the CME, are only settled at the end of a set time period which is specified when the trade is entered into. All profits and losses are realized at the contract expiry date. Perpetual contracts operate in a similar fashion, however, do not have an expiry date so they can be ‘perpetually rolled over’, and then settled at any given time, giving the trader more control over their positions.
Recent price Gaps
While often these gaps will be inconsequential, if the price of Bitcoin spikes or drops significantly after the closing price on Friday and into the weekend, a wide gap will arise and can result in scope for arbitrage amongst experienced market participants. These traders will know that historically, these gaps tend often to be filled, meaning that prices tend to reconcile via a retracement, drawing prices back into their fair value price range. Therefore, Bitcoin bulls are typically eager to see an overhead CME gap closed so as to pave the way for a rebound in momentum on the proverbial trading floor.
With Bitcoin’s strong rally running through the end of 2020 and coinciding with the three day CME Christmas holiday closure, one of the largest CME bitcoin futures gaps was recorded - driving a divergence between $23,660 (CME close on December 24th) and $26,525 (Spot on December 28th);. This gap was never fully closed as the momentum of the bull-run took hold and continued to push prices upward.
A successive historic gap then formed over the four-day New Year’s CME closure. Bitcoin’s price on the CME closed at $29,300 on December 31st. In the following days Bitcoin’s spot price scaled dramatically, breaching the pivotal $30k threshold and reaching an all-time high (ATH) almost $34k by the time the CME market opened on Jan 4th - leading to a price gap of almost $5,000. This gap induced some rapid retracement, the pullback slumped Bitcoin to its lowest price of the new year at $27,734 early on Monday morning, and this drop filled the gap.
Next wave of opportunity
The maturity of the crypto derivatives market plays an important role in attracting more institutional investors. One of the primary concerns of institutional players is the need for proper financial tools to run risk management. A functional, robust derivatives market alongside regulation and compliant providers is key to this. As the next wave of more sophisticated participants enter the crypto space, volume will inevitably shift towards safer, more trustworthy venues. Bitcoin futures and other perpetual swap instruments are now trading at multiples times more volume than the underlying bitcoin spot market according to recent data. Anyone interested in investing in the cryptocurrency or simply thinking about sharpening their trading strategy would benefit from noting all of the different factors that impact its price, including the effect of price gaps. That said, basing trades on speculation around CME gaps alone is still a considerably risky strategy.
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