The Bitcoin ETF Trojan Horse
The Gold Analogy
The spot price of gold is a crucial benchmark for pricing gold-related financial instruments, including Gold Exchange-Traded Funds (ETFs) that are settled in spot gold. These ETFs are designed to track the price of gold and offer investors exposure to the gold market without the need to hold physical gold.
When traders manipulate the spot price of gold through tactics like spoofing, as seen with the Justice Department victory against JP Morgan traders, it can directly affect the valuation of spot-settled Gold ETFs. If the spot price of gold is artificially inflated or deflated due to manipulation, the value of the ETFs would also be inaccurately represented. This could lead to investors buying at inflated prices or selling at deflated prices, not reflective of the true market supply and demand.
Moreover, the integrity of the ETFs and the broader financial market is compromised, as investors rely on the assumption that prices are determined by legitimate market forces. It is my assumption that the incoming Bitcoin ETF will be susceptible to the same type of Gold price manipulation via sophisticated derivative strategies.
JP Morgan vs The United States
The former JP Morgan precious metals traders Gregg Smith and Michael Nowak were sentenced to prison for engaging in a sophisticated scheme known as “spoofing” to manipulate the price of spot gold. Spoofing involves placing fake orders that are intended to give the false impression of market interest in a security, commodity, or currency, which in turn influences the price. These traders placed large buy or sell orders with no intention of executing them, to create an artificial sense of supply or demand. Once the market reacted to these fake orders by moving in the desired direction, the traders would quickly cancel the spoof orders and execute real trades to capitalize on the artificially inflated or deflated prices, securing profits or mitigating losses in the process. Their actions were deceptive to other market participants and disrupted the fair and transparent functioning of the precious metals market.
Bitcoin Manipulation Hypothetical Scenario:
Let’s assume a large investment bank called ‘OrangeRock’ decides to open a Bitcoin ETF, which over a number years makes them the largest custodian of spot Bitcoin. This scenario reveals how OrangeRock could move, suppress, or maintain the spot price of Bitcoin using their ETF and derivative instruments.
- Strategic Futures Positioning: OrangeRock could start by taking large positions in BTC futures contracts. These contracts might be spread across multiple expiration dates to maintain a sustained influence on the futures curve.
- Physical BTC Holdings and ETF Shares: OrangeRock’s BTC ETF, which holds 1 million BTC, represents the largest single holding of spot Bitcoin. They could use their ETF to either withhold BTC from the market (creating the appearance of scarcity) or sell BTC into the market (suggesting a surplus), depending on whether they wish to push the spot price up or down.
- Price Targeting Through Market Actions: As futures expiration dates near, OrangeRock might begin to execute trades that would aim to align the futures prices with their desired spot price level. They could do this by either signaling their intention to deliver BTC on the futures contracts (pushing the price up) or indicating that they will be taking delivery of BTC (pushing the price down).
- Closing Futures Positions to Realize Gains or Losses: In the days before the expiration of the futures contracts, they could start closing positions in a manner that pushes the spot market towards their targeted price level, thus benefiting from the futures positions they have held.
- Influencing the Settlement Price: On the final trading day, OrangeRock might attempt to influence the settlement price by executing a series of trades in the spot market during the settlement period. This would be an attempt to make the final settlement price of the futures contracts align with the targeted BTC price.
The Counter-Narrative
Critics of this hypothetical scenario would likely rebut with some variation of the following:
“In a real-world context, such actions would likely be quickly identified by regulatory authorities as market manipulation. Entities like the Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC), and other financial regulators have sophisticated monitoring systems to detect and investigate suspicious trading patterns and price movements. Additionally, given OrangeRock’s size and influence, any abnormal market behavior would be even more conspicuous and subject to immediate scrutiny.
Moreover, OrangeRock, like all investment firms, must comply with a range of legal and regulatory requirements designed to maintain fair and efficient markets. They are expected to follow strict internal controls, risk management procedures, and compliance protocols to prevent any form of market manipulation or other types of misconduct.”
Conclusion
While the counter narrative is technically true, it well known how long it can take the justice system to stop, or even marginally degrade illegal activity in financial markets. There are many reasons for this such as lack of effective deterrence, where even when illegal activity is caught, the penalties do not outweigh the profits of the activity itself. While I believe a spot settled ETF for sale in US securities markets will be accretive to Bitcoin’s price, I also believe that as more spot flows into these ETF custodians, the more likely the hypothetical manipulation I outlined will come to pass.
