New CME Bitcoin Futures And The Goldman Sachs Connection

Embedded into Bincoin’s genesis block by Satoshi Nakamoto on January 3, 2009, the day Bitcoin went live, was a message which is now well-known throughout the Bitcoin community. This message, taken from The Times newspaper of that day, read “Chancellor on brink of second bailout for banks”.

While there is ongoing debate as to its significance, the message was arguably a commentary on Satoshi’s less than favorable regard for the parasitic, unstable and inflationary nature of the contemporary banking system, as well as a statement on Bitcoin being able to provide a more equitable transfer system by cutting financial institutions out of the equation.

Elsewhere, Satoshi had elaborated on banks, again is a less than flattering way:

“Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.”

We can therefore conclude that the Bitcoin creator does not have a high opinion of banks in general, which probably also explains why Satoshi created Bitcoin in the first place, and why Satoshi’s white paper about Bitcoin was first published on a cypherpunks mailing list, and not, for example, within the pages of a Bank for International Settlements (BIS) research report.

Which is why it would be intriguing at this time to know what Satoshi thinks of the imminent launch of (US dollar cash-settled) Bitcoin futures by the CME Group. But even more interestingly, it would be intriguing to know what Satoshi would think of the fact that the settlement prices of these new CME Bitcoin futures are based on calculations by a private London-based company whose founder and sole director is from Goldman Sachs.

As a reminder, this is the same Goldman Sachs which Matt Taibbi described as follows, coincidentally also in 2009:

"The first thing you need to know about Goldman Sachs is that it"s everywhere. The world"s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."  

This is also the same Goldman Sachs, whose alumni currently occupy positions in the most powerful financial positions in the world, positions such as US Secretary of the Treasury (Steven Mnuchin), President of the European Central Bank (Mario Draghi), Governor of the Bank of England (Mark Carney), and President of the Federal Reserve Bank of New York (Bill Dudley).

The Fix is In: CME Bitcoin Futures

One key feature that stands out when glancing at the contract specs of these soon to be launched CME Bitcoin futures contracts is that they will be cash-settled based on a “CME CF Bitcoin Reference Rate (BRR)”

A recent CME press release elaborates:

“CME Group"s Bitcoin futures will be cash-settled, based on the CME CF Bitcoin Reference Rate (BRR) which serves as a once-a-day reference rate of the U.S. dollar price of bitcoin.  

 

Since November 2016, CME Group and Crypto Facilities Ltd. have calculated and published the BRR, which aggregates the trade flow of major bitcoin spot exchanges during a calculation window into the U.S. Dollar price of one bitcoin as of 4:00 p.m. London time.

 

The BRR is designed around the IOSCO Principles for Financial Benchmarks.

 

Bitstamp, GDAX, itBit and Kraken are the constituent exchanges that currently contribute the pricing data for calculating the BRR.”

A reference rate / benchmark calculated in the City of London that is used as a basis for the settlement of multi-billion dollar financial contracts. Wait, where have we heard that before?

The CME web site also helpfully hosts a methodology document for this Bitcoin Reference Rate (BRR), but which strangely has very little mention of CME, and a lot of citations to Crypto Facilities Ltd.

The document is even titled "Crypto Facilities - Digital Assets Unleashed" (dated March 6, 2017) and also copyrighted by Crypto Facilities Ltd. “© 2015 - 2017 CRYPTO FACILITIES LTD. ALL RIGHTS RESERVED. PATENT PENDING.”

In this methodology document, both the Administrator and Calculation Agent of the BRR are exclusively listed as "Crypto Facilities Ltd", based at an address in the City of London:

Contact Details: Crypto Facilities Ltd 4th Floor 25 Copthall Avenue London EC2R 7BP

 

Web: https://www.cryptofacilities.com Phone: +44 20 7655 6085 Email: contact@cryptofacilities.com

So who or what is “Crypto facilities Ltd”?  Looking at the UK Companies registration web site (Companies House), reveals that "Crypto Facilities Ltd" was incorporated on 12 August 2014 as a private limited company in the UK.

According to Companies House, "Crypto Facilities Ltd" only has one director, a certain Timo Schlaefer.

Who is this Timo Schlaefer? According to LinkedIn, Timo Schlaefer was with the Vampire Squid Goldman Sachs between 2011 to 2015. Strangely though, the header of Schlaefer"s LinkedIn profile still says “Goldman Sachs”.

LinkedIn screenshot https://uk.linkedin.com/in/timoschlaefer/en

Then there is a Bitcoin Magazine article about Schlaefer dated February 2015 which describes him as “Executive Director in Credit Quantitative Modelling at Goldman Sachs.”

In summary, here we have a new Bitcoin futures contract, a derivative on the global phenomenon that is Bitcoin, whose settlement price is based on a reference rate calculated in London by an unknown company whose sole director is from Goldman Sachs.

But there is nothing to worry about, because CME also confirms that there is an Oversight Committee for this Bitcoin Reference Rate calculation. This committee has the impressive title of the “Bitcoin Pricing Products Oversight Committee”, and the Committee:

“has been established jointly by Crypto Facilities Ltd. (“CF”) and Chicago Mercantile Exchange Inc. (“CME”).

 

The initial members of the Oversight Committee and its Chairman shall be appointed jointly by CF and CME”

While we will leave you to ponder what all of this means, its difficult to imagine that US dollar cash-settled CME Bitcoin Futures were on Satoshi’s radar when he typed “Chancellor on brink of second bailout for banks” into his computer on January 3, 2009, hitting the enter key and kicking off Bitcoin’s genesis block and the creation of a new global system for disintermediating banks and sparking the emergence of an entire new universe of crypto currencies and blockchain platforms.

Financial Times: Sell Bitcoin Because The Market Is About To Become "Civilized"

On 31 October 2017, we discussed the announcement that the CME Group was responding to client interest and launching a Bitcoin Futures contract before the end of this year. CME stated that the contract would be cash settled based on the CME CF Bitcoin Reference rate, a once-a-day reference rate of the US dollar Bitcoin price at 4.00pm London time. In the run-up to the launch of the futures contract, the Financial Times has written a piece on the likely impact of futures trading on the Bitcoin price.

The title of the piece makes the FT’s view clear, “Prepare to bet against bitcoin as it becomes civilised”. We disagree with using the word “civilised” in this context (see below), but here is the FT’s take. 

In recent years, bitcoin has been the wild west of the financial world. Now, however, it is being civilised — a touch. In the coming weeks, the Chicago Mercantile Exchange plans to start listing bitcoin futures, with a centralised clearing mechanism. Cboe Global Markets may follow suit. That will enable investors to bet on the coin’s future value without actually holding it — just as investors can use the Chicago exchange to bet on hog prices, say, without ever handling a pig.

To its credit, the FT reflects the concerns from some CME participants that there is insufficient regulatory oversight and Bitcoin’s stratospheric vol could lead to significant losses for some traders.

Is this a good idea? Some of the CME’s members do not think so. This week Interactive Brokers, an important clearing firm in the exchange, took the extraordinary step of using a newspaper advertisement to ask for more regulatory oversight. It fears that bitcoin is potentially so volatile that these futures will create huge losses for traders, which might then undermine the health of the CME and hurt other brokers, given its part-mutualised structure. The CME — unsurprisingly — dismisses this as poppycock: it argues that any risks will be contained by rules that allow traders to charge more so as to generate fat margins (of about 30 per cent) and thus absorb losses, and by circuit breakers that would stop a trade in the event of wild price swings.

Our suspicion is that CME Group has seen the volume of Bitcoin trading and is determined to get its “cut”, whether or not some of its members take some big hits or not. It can deal with those issues if or when they occur. Anyway, the FT moves on to the more interesting subject of the impact on Bitcoin’s price. We should note that when the futures contract was announced the price surged more than $100 to a then all-time high of $645.

But while the regulatory debate bubbles on, there is a more immediate question facing investors: bitcoin prices. Until now, it has been an article of faith among bitcoin evangelists that if — or when — the currency became more “civilised”, this will boost the price. After all, the argument goes, assimilating bitcoin into the mainstream investment world should boost its appeal and demand, making it more valuable.

As the FT alludes to in the articles title, it expects the Bitcoin price to fall.

It is highly likely there will be an opposite effect. Until now, investors have not had an easy way to bet against bitcoin — the only “short” was to sell coins. But the CME futures contract will let investors place those negative bets. You do not need to be a conspiracy theorist to imagine that some bitcoin cynics will be doing just that.

To support its case, the FT cites the example of Japan launching equity derivatives in 1989, just before the bubble burst.

Think, for example, about Japan. Before the mid-1980s, its stock market seemed to exist on a planet of its own, subject to its own valuation rules. But when Japanese equity derivative contracts were launched, and then integrated within the wider global market system as a result of financial reform, that sense of “otherness” broke down. The change in how Japan was seen through a comparative investment lens was not the only reason for the 1990 Nikkei crash, but it contributed.

We have a slight problem with using this as an analogy for Bitcoin. Firstly, an ultra-hawkish BOJ-governor was nominated in mid-1989 who announced his intention to crackdown on house price inflation and the shadow banking system which was facilitating much of the leverage. Secondly, all bubbles burst and Japan’s was extreme. For example, depending on whether you use the highest per square metre property deal in the Ginza district, or one in the Chiyoda district, the land underneath the Imperial Palace was valued between $852 billion and $5.1 trillion at the time. Futures trading, we would suggest, played a tiny role.

The FT cites the launch of trading in the ABX Index prior to the sub-prime crisis, as another example.

So too with US mortgages. Until 2005 or so, outsiders could not easily assess or price the risks of America’s subprime mortgages: mortgage-backed bond prices were opaque, and the only way to short the market was to sell bonds. But when mortgage derivatives, such as the ABX index, were launched, it suddenly became easy to make negative bets. Then, the ABX index was published in newspapers, such as the Financial Times, in 2007, creating a visible barometer of sentiment. That helped a sense of panic to feed on itself after 2008.

Once again, we would suggest the FT is confusing the impact of derivatives with an inevitable reversion of market price of an asset in a bubble as expectations regarding the outlook changed. In the case of sub-prime, housing prices in the US had never fallen, then they did, the AAA-ratings of the bonds were manifestly incorrect and the dramatically overpriced sub-prime bonds were pledged as collateral in all manner of other risky, leveraged trades.

From our perspective, the impact of the futures launch is difficult to gauge as it depends on the interaction of two opposing forces.

Firstly, as cryptocurrencies gradually become accepted as an asset class, more institutional money is likely to enter the sector and holding long futures positions is one way to do it.

 

Secondly, as the article notes, Bitcoin futures will be settled in cash, which means there is potential for the volume of futures trading to vastly outweigh the buying and selling of “actual” Bitcoins. If this occurs, then the “tail can wag the dog” as price discovery is dominated by futures trading. This permits all manner of market abuse via naked short selling by investors, major banks and any “official” players who deem it necessary to manipulate the Bitcoin price.

For this reason, we don’t agree that adding a futures contract will necessarily “civilise” Bitcoin, indeed, it might have the opposite effect.

The second scenario precisely describes the state of the “gold” market today. According to the Reserve Bank of India’s estimate, the ratio of “paper gold” trading to physical gold trading is 92:1, meaning that the price of gold on the screens has almost nothing to do with the buying and selling of physical gold. This makes the gold market and, therefore, the gold price something of a mockery. As Zero Hedge has highlighted time after time, the gold price has frequently been subject to waterfall declines, as huge volumes of gold futures are dumped on the market with no regard for price. See "Gold Slammed After Someone Pukes $4bn Notional In Gold Futures" on 10 November 2017. Perhaps the FT journalist, Gillian Tett, could write an article on gold, instead of Bitcoin, explaining how the price of the former – a widely viewed indicator of financial risk – is being suppressed by derivative trading. Indeed, Tett was present at a private dinner in Scott’s of Mayfair several years ago when the Gold Anti-Trust Action Committee gave a presentation on exactly the same process which she expects to lower the Bitcoin price.

CME Stays Silent on Cause of COMEX Silver Flash Crash

Submitted by Ronan Manly, BullionStar.com

Silver futures prices on the COMEX futures trading platform briefly plummeted at approximately 7:06am Singapore time yesterday, with the price for the front month (most active) September silver contract falling from a US$16.06 quote down to a low of US$14.34 all within  a 1 minute interval. The futures price then recovered nearly all of its losses in the subsequent 2-3 minute period. High to low, this COMEX silver futures contract saw its price fall by just over 10.7%, before rebounding nearly 11%.

During this time when the COMEX price crashed, there was nothing fundamentally happening in the wider financial markets, or indeed in the physical silver market, to justify these price gyrations in COMEX silver futures prices. Which all goes to show that the COMEX ‘paper’ futures silver prices is completely detached from the physical silver market, and that COMEX silver futures prices have no anchoring in the real silver market.

This price movement in the September 2017 silver futures contract (contract code SIU7 aka SIU17) can be seen in the below 1-minute tick candlestick chart from CME. Times in the chart are New York Time (NYT), which is 12 hours behind Singapore.

During this one minute period between 19:06 NYT and 19:07 NYT, the SIU7 contract saw trading volume of 4954 contracts (the 4.954K in the chart below), with the price falling from a high of 16.065 to a low of 14.34, before ending that minute period at US$ 14.68.

The COMEX SI silver futures contract, which is a deliverable contract but which in practice is rarely delivered; is a futures contract for 5000 troy ounces of silver. The 4954 contracts traded during the 1 minute period in theory represent 24.77 million ounces (770 tonnes) of silver and would be valued at $397.8 million at the opening price of US$ 16.06 at 19:06 NYT.

Overall within these 4 minutes, more than 8,300 September silver contracts were traded.

COMEX September Silver futures (SIU7): Flash crash at 19:06 NYT 6th July

Following this 1 minute flash crash, in the subsequent minute between 19:07 NYT and 19:08 NYT,  the SIU7 contract price rebounded sharply, rising from US$ 14.67 to US$ 15.62 on a trading volume of 1495 contracts. This rebound reflected in the below chart which also shows the opening and closing prices of each minute period. The price continue to rebound between 19:08 and 19:09 on volume of 936 contracts to close the minute at US$ 15.07, and then between 19:09 and 19:10, the price again closed higher at US$ 15.90 on volume of 932 contracts.

Overall, from the low quote of US$ 14.34, the price had rebound within the next 3 minutes to US$ 15.90, a rebound of 10.95%, and just 1% lower than the price had been (US$ 16.06) 4 minutes earlier.

COMEX Sept Silver futures (SIU7): Rebound between 19:07 – 19:10 NYT 6th July

Note that the same price flash crash also affected the next most actively traded COMEX silver contract for December 2017 (code SIZ7). See COMEX silver futures summary table below, and notice the lows for the September 2017 and December 2017 contracts at US$ 14.34 and US$ 14.44, respectively.

CME Summary table of COMEX Silver Futures contract prices showing Highs and Lows

What caused this momentary price plummet in the COMEX silver futures is not clear. This is because the CME Group, operator of the COMEX futures platform, has provided no explanation for these price gyrations. Possible causes could include market illiquidity, deliberate manipulation, a trading error or errors, or algorithmic trading programs triggering stop losses or inducing abnormal trading patterns. The flash crash in silver at 19:06 NYT also rippled into COMEX gold trading during the same minute (19:06 NYT), causing the COMEX August 2017 gold futures (contract code GCQ7), which had been minding its own business trading in a tight band around US$1224, to stage its own sharp drop from which it didn"t recover through the remainder of the Asian day. Perhaps this was the intention, to get gold lower via its sidekick silver. 

   

COMEX August Gold futures (GCQ7): 19:06 NYT on July 6

Until the CME Group releases a statement on this (which it probably won’t as it never does), the exact cause of this futures price flash crash remains unclear. What the CME did do yesterday however was as follows: At 19:06:38, the CME systems implemented a 10 second halt in the COMEX silver futures contracts. Within 20 minutes, CME made an announcement in a messaging broadcast that it was reviewing all SIU7 (September futures) trades that had taken place under US$ 15.84 and all SIZ7 (December futures) trades that had taken place under US$ 15.94. After another 20 minutes, CME announced in a messaging broadcast that for SIU7, any trades executed below US$ 15.54 would be adjusted up to US$ 15.54, while for SIZ7, all trades executed below 15.64 would be adjusted up to US$ 15.64.

These speedily introduced price adjustments would appear to suggest that the CME Group quickly determined that whatever caused the sharp price falls in the COMEX silver futures prices was not part of normal COMEX futures market trading, and that the CME made the call to back out and cancel at least some of the effects of this abnormal market trading. This would also seem to suggest the CME found evidence of something untoward, either price manipulation, or unfair algorithmic trading, or unjustified stop-loss triggering etc.

While these ‘paper’ trading markets in the form of the OTC London silver market and the COMEX futures market unfortunately do have a real impact on the international silver price that is inherited by physical silver markets, this latest pricing fiasco on the COMEX again demonstrates that COMEX trading of precious metals futures and London trading of fractionally-backed unallocated precious metals spot and forwards contracts are becoming more and more detached from the underlying reality of the physical gold and silver markets. In time, this may also have an adverse effect on investor sentiment in the paper markets which could a trigger a shift in gold and silver price discovery away from paper and towards physical.

A "Mysterious Antenna" Emerges In An Empty Chicago Field; Billions Depend On It

Readers are familiar with the various microwave and laser arrays located at the real New York Stock Exchange in Mahwah, New Jersey, both of which we have written about in the past.

Microwave tower located next to the NYSE in Mahwah, NJ.

This article, however, is not about the familiar antennas off Route 17 in New Jersey. Instead, demonstrating to what lengths the high frequency traders will go for just a few millisecond advantage - which makes in the HFT world makes all the different between billions in profits and losses - Bloomberg reports that a mysterious antenna has emerged in an empty field in Aurora, near Chicago, and a trading fortune depends on it.

Strange? Of course: as BBG"s Brian Louis admits "it was an odd transaction from the outset: $14 million, double the going rate, for a 31-acre plot of flat, undeveloped land just west of Chicago. In the nine months since, the curious use of the space has only added to the intrigue. A single, nondescript pole with two antennas was erected by a row of shrubs. Some supporting equipment was rolled in. That’s it."

As it turns out, those antennas - as readers may imagine - were anything but ordinary. Same goes for the buyer of the property: anything but your typical land investor, although the name will be all too familiar to those who have followed our reporting on HFT over the years: it was Jump Trading LLC, "a legendary and secretive trading firm that’s a major player in some of the most important financial markets."

Equipment on land purchased by an affiliate of Jump Trading

Jump Trading affiliate World Class Wireless purchased the 31-acre lot for $14 million, according to county records. “They paid probably twice as much as it’s worth,” said David Friedlandof Cushman & Wakefield. “I don’t see anyone else paying close to that price.”

There was a reason why Jump overpaid so much: it was an investment into guaranteed future returns.

Because ultimately the purchase was all about the location: just across the street lies the data center for CME Group, the world’s biggest futures exchange. By placing its antennas so close to CME’s servers, Jump hopes to shave maybe a microsecond off its reaction time, enough to separate a winning from a losing bid in trading that takes place at almost the speed of light. Enough to make billions in profits if done successfully millions of times every minute for year.

As Bloomberg describes the land grab, "it was the latest, and perhaps boldest, salvo in an escalating war that’s being waged to stay competitive in the high-speed trading business."

The war is one of proximity -- to see who can get data in and out of CME the quickest. A company called McKay Brothers LLC recently won approval to build the tallest microwave tower in the area while another, Webline Holdings LLC, has installed microwave dishes on a utility pole just outside the data center.

“It tells you how valuable being just a little bit faster is,” said Michael Goldstein, a finance professor at Babson College in Babson Park, Massachusetts. “People say seconds matter. This is microseconds matter.”

It also tells you something else: at its core, modern trading is simply about being faster than your competition: no thinking goes into the trade, only reaction times matter. That, and frontrunning your competition. Some more details about this literal land grab:

In October 2015, McKay Brothers, a company that sells access to its microwave network to high-speed traders, leased land diagonal to the CME data center, under the name Pierce Broadband LLC, according to DuPage County property records.

Last month, the county gave McKay approval to erect a 350-foot high microwave tower that could be 600 feet closer to the data center than its current location, records show. Two trading firms, IMC BV and Tower Research Capital LLC, own minority stakes in McKay. Co-founder Stephane Tyc said his firm may never build the tower but it would be part of the firm’s continual efforts to speed transmission time.

Then there’s Webline Holdings. In November 2015, it was granted a license to operate microwave equipment on a utility pole just outside the data center, according to Federal Communications Commission records. Webline has licenses for a microwave network stretching from Aurora to Carteret, New Jersey, where Nasdaq Inc.’s data center is located. Messages left for Webline were not returned.

Back to the mysterious antenna: according to Bloomberg, the license for the transmission dishes is held by a joint venture between World Class and a unit of KCG Holdings, another HFT trading firm that was recently acquired by Virtu Financial. In other words, the "who is who" of HFT has been unleashed on an empty field near Chicago, and to the builder will go the spoils.

It could be billions in revenues.

* * *

After all this frentic building of microwave tower, who is closest to the CME servers? It is unclear. Trading data first leaves CME computers via fiber cable, and then to nearby antennas that send it by microwave to other towers until it reaches New Jersey, where all the major U.S. stock exchanges house their computers. The moves in Aurora are intended to reduce the time that the data is conveyed through cable; the practical impact is shaving off a millisecond or maybe even a few nanoseconds.

At its core, the race is about latency arbitrage, and not being the slowest firm on the block - a recipe for financial ruin. Sending data back and forth between the U.S. Midwest and East Coast allows high-frequency traders to profit from price differences for related assets, including S&P 500 Index futures in Illinois and stock prices in New Jersey. Those arbitrage opportunities often last only tiny fractions of a second.

Ironically, all the land grab and overpriced land purchases could be made obsolete with one simple decision: a microwave tower could be installed on the roof of the CME data center to eliminate the need for jockeying around the site, the same way the NYSE has a microwave tower next to its NJ headquarters. The exchange is indeed looking at allowing roof access, along with CyrusOne, the company that bought the data center last year, CME said in a statement. Traders being traders, however, they may continue to battle, this time for the most advantageous position on the microwave tower itself.

“We are confident the CME can provide an alternate and better solution which offers a level playing field to all participants," said McKay’s Tyc.

Which is ironic because at its core, modern High Frequency Trade is about everything but a level playing field: after all there are millions of traders to be frontrun, take that away, and the HFT parasites of the world have no advantage whatsoever.