Complex Made Simple

Watch out! Bitcoin’s ‘Futures Trading’ may not be too bright

It’s not enough that Bitcoin is pretty erratic on its own, yo-yoing between $19,000 a coin and $14,500 literally overnight, by this Sunday 10, 2017, institutional investors will be able to hedge, and trade Bitcoin futures on perfectly legitimate and regulated platforms.

But Bitcoin is not a physical commodity like gold, sugar or wheat.

Is this part of why the price almost broke the $20,000 barrier Thursday, December 7?

Read: Bitcoin: A fraud or an ultimate game-changer?

$10,000 to $19,000 in 9 days!

CNBC reported that Bitcoin reached as low as $14,566 last Friday, quoting industry site CoinDesk, a price which was 14% less from earlier highs on the same day of $17,154, which itself dropped from $19,340 on Thursday, according to the Coinbase exchange.

Around November 28, depending which time zone you’re in, the crypto currency hit the $10,000 ceiling, which then made a splash, having risen from $1000 at the start of the year.

CNBC republished a note by Mark Newton, managing member at Newton Advisors, to his clients: “I truly don’t think people are involved on a mass scale yet. We’ve heard the (Bitcoin) fraud claims. Now we need people profiting immensely all around us and making forecasts for $1 million, etc., for it to truly have reached a euphoric peak,” Newton said.

JPMorgan Chase CEO Jamie Dimon has called Bitcoin a “fraud.” And digital currency investor Michael Novogratz also said last week that crypto currencies like Bitcoin are “going to be the biggest bubble of our lifetimes.”, and predicting that Bitcoin could reach $40,000 by end 2017.

Will the crypto price boom be followed by a major Bitcoin bust?

Bitcoin Futures

Chicago-based CBOE Global Markets is planning to launch Bitcoin futures this Sunday, before the world’s largest futures exchange, CME, is set for the week that follows, December 18, 2017, in an aim to establish digital cash as a legitimate asset class.

Reuters reports that Goldman Sachs Group Inc. is planning to clear Bitcoin futures for some clients.

“The bank, is evaluating the specifications and risk attributes for the Bitcoin futures contracts as part of our standard due diligence process,” Tiffany Galvin, the Goldman Sachs spokeswoman told Reuters.

CoinDesk is sceptical about Bitcoin futures trading.

It opines that futures trading, where one bets a price of a commodity or other financial instruments will be priced higher or lower and then commits to a transaction based on that, does not logically apply to Bitcoin.

When that ‘Future Date’ arrives, the transaction is usually settled in cash instead of a delivery of the commodity itself which allows for the future market to be much bigger in size that the physical commodity.

“Both the CME and the CBOE futures settle in cash, not in actual Bitcoin, but it’s likely that the Bitcoin futures market will end up being even larger than the actual Bitcoin market,” said CoinDesk.

So what’s the problem?

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so far so good but…

It’s true that a regulated and liquid exchange will also allow funds prohibited from dealing in alternative assets on unregulated exchanges to now join in the action with opportunity to leverage positions in already huge Bitcoin growth and returns.

“The Bitcoin market seems to be excited at all the institutional money that will come pouring into Bitcoin as a result of futures trading,” said CoinDesk.

And that’s exactly the part the industry platform said it didn’t understand.

“The money will not be pouring into the bitcoin market. It will be buying synthetic derivatives that don’t directly impact bitcoin at all,” CoinDesk said.

“For every $100 million (or whatever) that supermegahedgefundX puts into Bitcoin futures, no extra money goes into Bitcoin itself. These futures do not require ownership of actual Bitcoins, not even on contract maturity.”

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But what’s wrong with that picture if one can hold more Bitcoins that can be later hedged?

“Why buy Bitcoin when you can go long a futures contract? Or a combination of futures contracts that either exaggerates your potential gains or limits your potential loss?” asks CoinDesk.

“The concern is 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.”

If this happens they will simply sell, and a crash from those heights can really hurt.

Bitcoin’s amazing growth pattern

Table by Quartz, a digitally native news outlet