The Threat of Bitcoin Futures

Noelle Acheson is a 10-year veteran of company analysis and corporate finance, and a member of CoinDesk’s product team.

The financial press has bot te a flutter overheen the launch of bitcoin futures trading on not one but two reputable, regulated and liquid exchanges: CME and CBOE.

CME Group, the largest derivatives exchange ter the world, spil well spil one of the oldest, will launch bitcoin futures trading on Dec. 18th, while CBOE Global Markets, which wields the Chicago Houtvezelplaat Options Exchange (the largest U.S. options exchange) and BATS Global Markets, plans to ritme CME to the punch by opening its own trading on Dec. 10th.

Te theory, this opens the doors to institutional and retail investors who want exposure to bitcoin but for some reason (internal rules, or an aversion to risky and ingewikkeld exchanges and wallets) can’t trade actual bitcoin.

And that expected flood of rente is, from what I hear, part of the reason that bitcoin’s price recently slok past $11,000 (which, considering it began the year at $1,000, is phenomenal).

But if that’s true, I’m missing something: I don’t understand why the market thinks there will be a ample request for bitcoin itself spil a result.

A primer

Very first, a geschreven overview on how futures work: Let’s say that I think that the price of XYZ which is presently trading at $50, will go up to $100 ter two months.

Someone offers mij the chance to commit to paying $80 for XYZ te two months’ time. I accept, which means that I’ve just “bought” a futures contract. If I’m right, I’ll be paying $80 for something that’s worth $100. If I’m wrong, and the price is lower, then I’ll be paying more than it’s worth te the market, and I will not be blessed.

Alternatively, if I think that XYZ is going to go down ter price, I can “sell” a futures contract: I commit to delivering an XYZ te two months’ time for a set price, say $80. When the contract is up, I buy an XYZ at the market price, and produce it to the contract holder te come back for the promised amount.

If I’m right and the market price is lower than $80, I’ve made a profit.

Beyond this basic premise, there are all sorts of hybrid strategies that involve holding the underlying asset and hedging: for example, I hold XYZ and sell a futures contract (I commit to selling) at a higher price.

If the price goes up, I make money on the underlying asset but lose on the futures contract, and if it goes down the situation is reversed. Another common strategy involves at the same time buying and selling futures contracts to “lock ter” a price.

Futures contracts presently exist for a vast range of commodities and financial instruments, with different terms and conditions.

It’s a ingewikkeld field that moves a loterijlot of money. The futures market for gold is almost 10x the size (measuring the underlying asset of the contracts) of the physical gold market.

How can this be? How can you have more futures contracts for gold than actual gold? Because you don’t have to supply a tapkast of gold when the contract matures. Many futures contracts lodge on a “metselspecie” fundament – instead of physical delivery for the sale, the buyer receives the difference inbetween the futures price (= the agreed-upon price) and the spot (= market) price.

If the aforementioned XYZ contract were on a metselspecie settlement poot and the market price wasgoed $100 at the end of two months (spil I had predicted), instead of an XYZ, I would receive $20 (the difference inbetween the $100 market price and the $80 that I committed to pay).

Both the CME and the CBOE futures lodge ter metselspecie, not ter actual bitcoin. Just imagine the legal and logistical hassle if two reputable and regulated exchanges had to set up custodial wallets, with all the security that would entail.

So, it’s likely that the bitcoin futures market will end up being even larger than the actual bitcoin market.

Side effects

That’s significant. Why? Because institutional investors will like that. Size and liquidity make fund managers feel less stressed than usual.

The bitcoin market seems to be excited at all the institutional money that will come pouring into bitcoin spil a result of futures trading. That’s the part I don’t understand.

It’s true that the possibility of getting exposure to this mysterious asset that is producing outstanding comebacks on a regulated and liquid exchange will no doubt entice serious money to take a bitcoin punt. Many funds that are by chartervliegtuig prohibited from dealing ter “alternative assets” on unregulated exchanges will now be able to participate.

And the chance to leverage positions (get even more exposure than the money you’re putting te would normally warrant) to magnify the already shocking comebacks will almost certainly attract funds that need the reserve edge.

But here’s the thing: the money will not be pouring into the bitcoin market. It will be buying synthetic derivatives that don’t directly influence bitcoin at all.

For every $100 million (or whatever) that SupermegahedgefundX puts into bitcoin futures, no toegevoegd money goes into bitcoin itself. Thesis futures do not require ownership of actual bitcoins, not even on contract maturity.

Sure, many will argue that more funds will be interested te holding actual bitcoins now that they can hedge those positions.

If SupermegahedgefundX can offset any potential losses with futures trading, then maybe it will be more willing to buy bitcoin – albeit why it would permit its potential gains to be diminished with the same futures trade is beyond mij. And, why hold the bitcoin when you can get similar profits with less initial outlay just by trading the synthetic derivatives?

That’s the part that most worries mij. Why buy bitcoin when you can go long a futures contract? Or a combination of futures contracts that either exaggerates your potential gains or boundaries your potential loss?

Te other words, I’m worried that institutional investors that would have purchased bitcoin for its potential gains will now just head to the futures market. Cleaner, cheaper, safer and more regulated.

Look out

What worries mij even more is the possibility that the institutional funds that have already bought bitcoin (and shoved the price up to current levels) will determine that the official futures market is safer. And they will sell.

Now, it’s possible that the request for bitcoin futures and the general optimism that seems prevalent ter the sector will shove up futures prices (ter other words, there will be more request for contracts that commit to buying bitcoin at $20,000 ter a year’s time than those that commit to buying at $12,000 – I know, but the market is strange).

This will most likely influence the actual market price (“Hey, the futures market knows something wij don’t, right?”).

And the launch of liquid futures exchanges increases the likelihood of a bitcoin ETF being approved by the SEC te the near future. That would bring a lotsbestemming of money into an already crowded space.

But. it’s also possible that the institutional investors that are negative on bitcoin’s prospects (and there’s no shortage of those) may use the futures markets to waterput money behind their conviction. It’s much lighter to sell a futures contract with a lower-than-market price than it is to actually brief bitcoin. Thesis investors may well send signals to the actual bitcoin market that sends prices tumbling.

And the leverage inherent te futures contracts, especially those that lodge for contant, could increase the volatility te a downturn.

That’s pretty scary.

Let’s not even go into the paradigm shift that this development implies. The growth of a bitcoin futures market positions it even more spil a commodity than a currency (te the US, the Commodity Futures Trading Commission regulates futures markets). And even more spil an investment asset than a technology that has the potential to switch the plumbing of finance.

So, while the market emerges to be saluting the launch of not one but two bitcoin futures exchanges ter the next two weeks (with two more potentially significant ones on the near horizon) with ebullience, wij indeed should be regarding this development spil the end of the beginning.

And the beginning of a fresh path.

The leader te blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a stringent set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests te cryptocurrencies and blockchain startups.

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