Bitcoin Futures – Wall Street’s Big Short?

The first Bitcoin futures market is open for business, the CBOE (Chicago Board Options Exchange) opened Bitcoin futures for trading on the 10th of December. It was a clever move by CBOE, the exchange is small compared to CME and they scored a massive publicity coup by front-running CME. By using a self-certification scheme for the contracts, both exchanges have bypassed too much regulatory scrutiny, although the move raised some eyebrows amongst financial institutions.

It’s big news for a three main reasons:

1 – A stamp of approval

For the cryptocommunity it feels like a stamp of approval from the major financial institutions. It’s true that Bitcoin was first created in response to the biggest financial crisis in modern history – it’s a facility that could replace banks, and replace money. But the fact is that it needs legitimacy to become a fully functioning asset that could be considered a store of wealth, the futures market contributes to that legitimacy.

2 – Leverage up by trading on margin

Futures is about betting on the future price of a financial security – I believe that X will be worth Y on this future date. Historically it was a way for farmers to secure a price for their produce in the future to ensure they would a certain price for their produce.

The benefits of futures is that you trade on margin, this means you don’t have to pay the entire amount up-front and so you can leverage your investment (with the caveat “you could lose more money than you put in”). Typically margins are around 10%, although with Bitcoin futures it’s over 40% due to volatility.

3 – Speculate on Bitcoin without owning bitcoins

In futures commodities, settlement is often in that commodity. So if you’re not careful, you could end up with several thousand bushels or wheat or barrels of oil .. this is unlikely to happen, but the fact is that you are trading on deliverable assets. With Bitcoin futures, settlement is in cash, which means that you can bet on the value of Bitcoin without ever touching a private key, a hardware wallet and no danger of being hacked and all the other risks of owning Bitcoin.

The next Big Short

The Big Short is a favourite film of mine about a group of traders betting against the housing market and the CDOs which were propping it up. There’s a similar narrative around Bitcoin at the moment that has been popularised by many media publications – “Wall Street prepares to short bitcoin” they say.

A catchy headline, especially after the likes of Jamie Dimon – CEO of JP Morgan – calling bitcoin “a fraud”. Surely Wall Street traders will leap at the chance to short this Ponzi scheme? Perhaps not.

Traders have been able to short bitcoin for years, however they have not been able to naked short bitcoin. It would take a brave trader to speculatively bet against bitcoin though, it’s an asset that’s growing on the back of market hype, and this isn’t diminishing any time soon.  I think the main group who will want to short Bitcoin are the miners, it would be a sensible option for the big miners to hedge against a collapse in price as their massive banks of mining machines are essentially useless for doing anything except mine Bitcoin.

Low volumes

Regardless, in the first 24 hours the CBOE market traded just over 3,000 BTC, which is a small fraction of overall Bitcoin trading. CME is a much bigger market, it will be interesting to watch the launch of the CME futures on the 18th and see what happens.

One outcome may well be that by being able to effectively hedge Bitcoin, more risk-averse groups will start mining operations, potentially decentralising the concentration of mining in China. If you have access to cheap Electricity or the byproduct of cheap heat is useful to you (or both), Bitcoin mining may be attractive.

It also opens the doors for an Ethereum futures market or even a crypto index. A liquid bitcoin futures market were to develop it will certainly herald a new chapter in Bitcoin’s history and further legitimise its place in the modern economy.

Either way, it’s never a dull day in cryptocurrencies!