Efficient Price Discovery in the Bitcoin Markets

Introduction

• The findings of Wilshire Phoenix (hereinafter, “we” or “our”) indicate that CME Bitcoin Futures contribute more to price discovery than its related spot markets
• Our analysis was performed using similar methodology previously employed by the SEC’s Division of Economic and Risk Analysis to evaluate price formation
• CME Bitcoin Futures have grown to become significant, this is not only demonstrated through trading volume and open interest, but also by influence on spot price formation
• A leading futures market suggests the existence of a robust base of traders who may trade on such market for many reasons such as trust in the exchange venue and lower latency
• Studies on price formation between the spot and futures markets in other asset classes often find that the futures markets lead

Price discovery is a hotly contested topic amongst trading venues and participants on multiple sides of primary markets as well as policy makers and regulators. The concept even merits explanation on the CFTC agency website where it states that price discovery is “the process of determining the price level for a commodity through the interaction of buyers and sellers and based on supply and demand conditions.”¹ Effective price discovery facilitates best execution, the fulfillment of fiduciary responsibilities and the practicalities of pricing IPOs and secondary offerings.²

Efficient prices also form the bedrock underpinning the $448.97 trillion interest-rate derivatives and $6.87 trillion equity-linked derivatives industry (which includes exchange-traded products.)³ Obstacles to price discovery can increase trading costs, lead to sudden volatility, and diminish the efficient functioning of the global capital markets.

Given that price discovery in the traditional markets remains a contested topic, it is no surprise that the debate regarding the same in the bitcoin markets is that much more unsettled.⁴ Therefore, this paper seeks to evaluate the bitcoin price discovery process using proven, respected, and recognized academic methods that have been utilized for many other tradeable commodities and financial instruments over the past several decades. Another way our analysis differs is our usage of data at a higher frequency than previous papers, with ticks, grouped into one-minute intervals, as compared to 10 or 15 minutes. This allows a more precise estimation of the contribution of the spot and the futures markets to the process of price discovery.