Bitcoin Futures, what are they, and what is the potential impact for Bitcoin?

in bitcoin •  2 years ago  (edited)

Background

The listing of bitcoin futures on CBOE and CME is a major recognition for crypto-assets coming from the traditional markets. Bubble or not a bubble, traditional traders were feeling left-behind in the incredible gains that crypto-investors were recently realizing with ease. Driven by the distinguishing Wall Street greed, they demanded an easy and familiar way to bet on bitcoin price movements, and CBOE and CME answered their call, with others to follow.

Futures

A futures contract is a derivative, which derives its price from an underlying asset – particularly Bitcoin. This allows traditional traders to make cash profits from the movement of the price of Bitcoin, without actually having to go through the trouble to buy/sell actual Bitcoin from the crypto-exchanges. A futures contract between two parties basically means that the seller of the contract agrees to sell the underlying asset to the buyer at a predefined price (that of the contract) at a moment in the future. Cash-settled futures such as the Bitcoin ones, do not require actual buy/sale of the underlying asset; but only to settle the price difference from the contract and the underlying at the predefined moment in cash. Thus no actual bitcoins should be really bought or sold (although some may do that for hedging). People who are making their first steps in derivatives, wrongly assume that this means that the futures prices will not affect the price of the underlying or the other way around. It is beyond of the scope of this article to explain the exact relation between the two prices (I will release a simple tool, which can be used to calculate this theoretical price of the Futures, based on the Bitcoin price in real time, which could be used to profit from temporary deviations), but in simplest words the prices of the Futures contract and Bitcoin will be almost perfectly correlated. Remember, the futures contract derives its price from the underlying so the underlying is the “main” price. Despite this, sometimes crypto-traders of the underlying might decide to follow the price of the futures if it deviates up or down, as it could be seen as an indicator for investor expectations about the future.
That being said, the price of the CBOE contract will be almost equal (slightly higher for longer maturity futures due to time value of money) to the price of 1 Bitcoin, while the price of the CME will be slightly higher than 5 times the price of Bitcoin. For those interested there is an integrated formula in excel, the FV function, and you can find the specifics of the futures contracts on CBOE and SME’s websites.

Institutional trading, and the erroneous opinion about short selling leading to Bitcoin crash

There is a common opinion among the less experienced crypto-investors, that because institutional traders don’t believe in Bitcoin, they will heavily short-sell the futures, which will eventually lead to a crash for the Bitcoin price – WRONG! First of all, for a lot of public institutions, like pension funds for example it is completely forbidden to touch such risky assets so those are out of the picture. Don’t worry, your bank will not speculate with your savings deposit in Bitcoin Futures (short or long) – that’s illegal. Bitcoin futures will be mostly traded by risk-loving private investment companies, prop-traders, or institutions who trade on the account for their clients, which have specifically requested such exposure.

So will they short-sell the futures so massively to result in a Bitcoin price crash? The short answer (pun intended) is – no! Most of the non-believers in Bitcoin will simply refrain from touching the futures, for one simple reason. Mass short-positions in such a risky asset, which has proven many times it can grow by unprecedented amounts very quickly, would eventually result in a so-called short-squeeze, and drive all of the short-sellers out of the market and possibly out of business, if they were careless enough. Explaining all of the mechanisms of short-selling a futures contract, margin requirements and margin calls is again out of the scope of this article, but I may publish a more detailed description, if I see there is enough demand.

Summary

Opinions are like assholes. Everybody's got one and everyone thinks everyone else's stinks. In this article, I have not shared an opinion, but facts about how markets operate and what are the likelihoods of the impact of the Bitcoin Futures on the price of Bitcoin. The summary is that although some risk-loving private investors may short-sell futures, a mass short is extremely improbable, thus the futures won’t lead to a crash. Keep calm, traditional exchanges are not going to destroy your precious Bitcoins with the Futures contracts, and with this listing, they have unwillingly acknowledged that Bitcoin is here to stay and they just want a piece of it.

Veso, 11 Dec 2017

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Hey Veso! Cheers! Great article. Thank you for sharing. This was very helpful in getting a better understanding of the situation and seeing through all the noise. Really appreciate you. Welcome and keep fightin' the FUD!

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