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The FBI revealed that it assisted Colonial Pipeline in recovering a portion of its BTC ransom payment, but can the government truly seize Bitcoin and the network?
On June 7, a federal task team in the United States confiscated more than $2 million in Bitcoin (BTC) to pay a ransom following an attack on the Colonial Pipeline system. Authorities found 63.7 BTC, according to a warrant issued with the United States District Court for the Northern District of California.
As news of the recovery spread through mainstream media, some outlets suggested that the U.S. government somehow hacked the Bitcoin address in order to extract the funds. For example, University of Michigan professor and New York Times contributor Justin Wolfers tweeted:
News that the government has figured out how to snatch bitcoin from the online wallets of cyber criminals surely reduces the use cases for Bitcoin even further.
— Justin Wolfers (@JustinWolfers) June 8, 2021
This triggered a discussion on whether an entity could break through SHA-256 encryption, and if so, why waste this ability on unlocking a Bitcoin wallet that only contains $2 million?
The same type of cryptography is used by the National Security Agency, banks, foreign agencies, cloud storage systems, and most electronic devices like smartphones and communication apps.
If governments wanted to create short-term havoc in the cryptocurrency market, they would need to make large sales to negatively impact the price. However, there would probably be at least 3 telling signs that would hint that this type of scenario was unfolding.
Open interest at CME BTC futures would spike
The most likely vehicle for government entities to short (sell) is by trading CME Bitcoin futures. In addition to the price pressure, analysts would need to confirm a large increase in open interest, which is the number of contracts in play. Unfortunately, CME does not provide real-time data for this indicator.
As shown above, each CME Bitcoin futures contract represents 5 BTC, so the 7,572 open interest totals 37,860 BTC. These contracts are financially settled, meaning that the winner is paid in dollars.
While the current $1.25 billion open interest does not seem significant enough to create shockwaves, the figure did reach $3.3 billion in February as Bitcoin traded at $58,000. Therefore, a substantial and rapid increase in the open interest is a potential indicator of government-related activity.
The futures premium should flip negative
A large futures contract seller will cause a momentary distortion in the futures premium. Unlike perpetual contracts, these fixed-calendar futures do not have a funding rate, so their price will vastly differ from regular spot exchanges.
By measuring the price gap between futures and the regular spot market, a trader can gauge the level of bullishness in the market. Whenever there’s an aggressive activity from shorts (sellers), the two-month futures contract will trade at a 1% or higher discount.
Notice how the July CME futures usually trade between a 0.5% discount and a 1.5% premium versus regular spot exchanges. However, during the May 19 crash, aggressive futures contracts selling caused the price to trade 2.5% below Coinbase.
This movement can either occur during liquidation orders or when large players decide to short the market using derivatives.
Exchange infrastructure would come under attack
Despite the fact that most bitcoin exchanges have set up servers in foreign regions, governments may attempt to confiscate physical servers or web domains.
Investors who have been following the crypto industry since 2017 will recall that in July 2017, Alex Vinnik, the founder of BTC-e, was detained and the website was hijacked by the US government.
In November 2020, Cointelegraph published an excellent article explaining how, according to a framework developed by the United States Department of Justice, it may be sufficient for a crypto transaction to “touch financial, data storage, or other computer systems within the United States” to trigger enforcement action.
Any coordinated effort by governments to suppress cryptocurrencies will likely involve a massive “anti-money laundering” effort against exchanges, especially those offering derivatives products to retail investors.
Thus, unless these 3 signs are in place, there is little reason to believe that a massive government-led campaign to disrupt the industry is underway.