On May 17, starting at 10:28 AM Beijing Time, the price of Bitcoin on Bitstamp began a rapid decline. Within approximately 11 minutes, the price dropped by 11%, falling from above $7,600 to $6,178. Other exchanges followed with slight delays and smaller declines. Bitstamp later tweeted that the crash was triggered by a large sell order.
Dovey Wan, co-founder of Primitive Ventures, suggested in a tweet that no one would keep 5,000 Bitcoin (worth $40 million) on an exchange without a plan. She argued this was a deliberate market dump rather than an accident. According to Wan, the motivation was straightforward: someone had opened large short positions on BitMEX, a futures exchange, to profit from the crash. Approximately $250 million worth of long positions on BitMEX were liquidated.
BitMEX’s perpetual and futures contracts are based on the spot prices of Bitcoin on Bitstamp and Coinbase Pro. By manipulating the spot price on Bitstamp, a market actor could force a decline in the highly leveraged BitMEX market at a relatively low cost.
BitMEX uses a “cash settlement” model based on prices from Bitstamp and Coinbase Pro. In this model, derivatives like futures contracts are valued based on an index price. This index is typically calculated as an average or median of prices from other trading venues—which often have lower liquidity than the futures market itself. At settlement, buyers and sellers exchange cash based on this index price.
Understanding Cash Settlement in Futures Trading
In the world of derivatives trading, a common settlement method is “physical delivery.” In this model, the holder of a short futures position delivers the actual asset at expiration. Conversely, the long position must provide the corresponding asset (usually fiat currency) to purchase it.
Futures trading dates back to the early 18th century with the Dojima Rice Exchange in Osaka. Among existing exchanges, the Chicago Board of Trade—now part of the CME Group—was established in 1848.
Derivatives trading volume reached new highs in 2018 and 2019, far exceeding spot and cash-equivalent markets. The liquidity provided by derivatives remains a core component of the global financial system. In 2018, approximately 30 billion contracts were traded, with Asian exchanges accounting for the majority of volume.
The CME Group remains the world’s largest futures and options exchange. Last year, it reported a volume of 484 million contracts. Notably, CME introduced a cash-settled Bitcoin futures product in December 2017, which has grown steadily since.
As part of the price discovery process, Bitcoin futures are becoming increasingly important. Given the exaggerated volume reporting on some spot exchanges—as highlighted in the Bitwise report—the futures market may have been leading price action for some time.
How Traditional Exhouses Use Physical Delivery
The CME Group offers 1,977 contract products. Of these, 880 use physical delivery, and 1,097 use cash settlement. However, the vast majority of cash-settled products are derivatives based on other instruments, such as swaps, spreads, or basis trades. These products cannot be physically delivered by their nature.
Excluding these, 396 cash-settled products remain. Most are oil, equity indices, or regional electricity products. These are assets that are difficult to store or deliver physically. The cost of physical delivery is simply too high.
Benefits of Physical Delivery
Major physical delivery contracts tend to be traditional instruments that remain critical to the global economy. These include foreign exchange contracts, government bonds, key energy products like crude oil and natural gas, gold and silver, and agricultural products like corn, wheat, and cotton.
Financial innovation led by Chicago exchanges in the 1970s introduced new types of futures contracts. These were products that either could not be physically delivered or where delivery was too costly. The most liquid of these is likely the CME’s S&P 500 stock index futures contract.
Physical delivery would require buying or shorting all 500 stocks at expiration. Since the futures contract is often more liquid than the underlying stocks, the main concern is price manipulation.
Why Cash Settlement Dominates Bitcoin Futures
CME categorizes its Bitcoin futures product under “equity indices.” But Bitcoin is not a basket of assets. Instead, one of its key features is that, although digital, it behaves more like a commodity or metal. The only difference is that it is produced through an abstract process called “proof-of-work.”
So why did CME choose cash settlement, and what measures did they implement to prevent manipulation?
The most likely reason is that they could not find a custodian or clearinghouse they trusted to handle Bitcoin transactions. Instead, they adopted an index method from CryptoFacilities (now part of Kraken) to reduce the risk of manipulation near settlement.
The CME Bitcoin Reference Rate is calculated using a volume-weighted median price across 12 time intervals, each 5 minutes long. Data is taken from Bitstamp, Coinbase, itBit, and Kraken between 11:00 PM and 12:00 AM Beijing Time.
This complex mechanism aims to mitigate manipulation, suggesting that cash-settled Bitcoin index futures are inherently flawed. Given that a single large trader can influence Bitstamp’s price—and thereby affect prices on Coinbase, itBit, and Kraken—no amount of design can fully protect against manipulation while accurately reflecting market prices.
Advantages of Physical Delivery for Bitcoin
In a physical delivery futures market, the risk of price manipulation is low. Buyers holding long contracts must pay for the assets they purchase, and sellers must deliver the actual Bitcoin. The exchange or clearinghouse must ensure both parties have the necessary funds and assets.
Some literature on physical delivery points to risks like “short squeezes” or “cornering the market.” For example, if a trader builds a long position larger than the available supply of the asset, sellers may be unable to deliver. This could force contract prices above levels justified by supply and demand.
Similarly, control over the delivery process itself—such as controlling oil tankers—could manipulate prices.
But how likely is this for Bitcoin and other digital assets? Preventing one or more accounts from building a position larger than the available supply is a matter of margin and collateral management design.
As a physically settled exchange, we monitor these risk levels closely. Our “settlement period” or “deleveraging” mechanism ensures that longs have enough USDT to pay sellers and that sellers have enough BTC to deliver as expiration approaches. In the final days, over-collateralization may be required.
Regarding delivery control, digital assets are uniquely suited to physical settlement. They were designed to be censorship-resistant and manipulation-resistant. Miner fees, while variable, are transparent and can be simply factored into contract pricing.
For these reasons, physically settled futures contracts are clearly superior to the widely used cash-settlement method.
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Frequently Asked Questions
What is physical delivery in futures trading?
Physical delivery means that upon contract expiration, the seller must deliver the actual asset (e.g., Bitcoin) to the buyer, who pays the agreed price. This contrasts with cash settlement, where only the price difference is exchanged.
Why is physical delivery better for Bitcoin futures?
It reduces the risk of price manipulation near settlement because the contract is tied to actual asset delivery. This aligns the futures price more closely with the spot market and avoids reliance on index prices from potentially illiquid exchanges.
Can physical delivery be manipulated?
While possible in theory, it is much harder with digital assets like Bitcoin. Proper margin requirements and collateral management can prevent market corners. The transparent nature of blockchain also makes delivery verification straightforward.
What are the challenges of physical delivery?
The main challenges involve ensuring both buyers and sellers have the necessary assets and funds at expiration. This requires robust clearing mechanisms and sometimes over-collateralization as settlement approaches.
How does cash settlement work?
In cash-settled contracts, no asset changes hands. Instead, the difference between the contract price and the index price at expiration is paid in cash by the losing party to the winning party.
Which method is more common in traditional markets?
Physical delivery is common for commodities like gold, oil, and agricultural products. Cash settlement is often used for financial instruments like index futures or weather derivatives, where physical delivery is impractical.