Bitcoin made another major step towards legitimacy with its entry to the CBOE futures market on December 10. A week later CME also followed suit with their launch of its futures to be settled in US dollars. Traders can now speculate and bet on the future bitcoin price without owning it. Buyers now bargain and pay for a contract that they will receive at a later date from the sellers just as with commodities and stocks. The development has been received with a lot of anxiety as traders ponder what the future holds for bitcoin and other digital currencies. Prices spiked sharply following this move pushing the crypto currency market cap to over $500 billion.
So, what exactly does the launch of Bitcoin futures portend for the markets?
Bitcoin Surges to an all-time High
Bitcoin futures trading started at $15,460 for the one-month contract, surging a remarkable 21 per cent before settling at $18,850. Bitcoin futures are just as unique as the digital currency movement now sweeping across the world. One will be forgiven for finding the concept confusing. People are used to speculating on the price on physical commodities not digital assets.
In itself, the launch was expected to put a stop to the wild upswings in prices that have characterised the cryptocurrency market in the past year. Quite the opposite happened with the contract closing at over $18,000. Bitcoin price, it seems, cannot be tamed just yet. It must however be noted that Bitcoin value has somewhat been steady over the past one week. We cannot at this point make any inference as to whether it is related with the launch, but we cannot rule out all connection either.
Huge difference between bitcoin futures and spot markets
There is still a big difference between bitcoin futures and spot markets, meaning that there’s still some common ground to be found. But, the difference also presents an opportunity to traders for arbitrage. The range has swayed between 5% and 15% since trading started representing as much as $1000. The huge volatility that now characterises cryptocurrencies is now a cause of concern among investors. At the least, it shows that prices will not always be shooting up.
Warnings that Bitcoin, the blockchain based technology is a bubble about to burst are now at an all-time high making betting on the value of Bitcoin particularly risky.
“It looks remarkably like a bubble forming to me. We’ve seen them in the past. Over the centuries we’ve seen bubbles, and this appears to be bit of a classic case,” acting Governor of the Reserve Bank of New Zealand said while cautioning traders against Bitcoin futures.
A Step Towards Legitimacy
An alternative view is that the listing of Bitcoin in regulated exchanges bolsters its position as a legitimate asset in the market. Bitcoin futures however still represent a tiny fraction at about 3500 contracts worth $62m per day compared to more established commodities like Gold which transact over 400,000 contracts.
The lack of liquidity in the futures contracts explains the huge difference between the asking and spot prices. At just over $100 million, the volumes are still too low to find a settlement price. This will remain the case if the underlying spot markets continue to experience high volatility.
In the long term, the entry of speculators will iron out the difference, but at the moment, their influence might have skewed the prices due to the low volume. As more and more players enter the fray in 2018, we can expect the gap to be reduced significantly. That seems to be already happening with Bitcoin prices having difficulty crossing the $17,000 mark.
As it stands, the difference does not serve hedgers – who want to enter and exit the market.
The price spread between the futures and spot markets has already shrank according to a Bloomberg report in the few days after the CBOE launch.
Going forward, more and bigger players are going to launch Bitcoin into their trading platforms. TD Ameritrade which operates the largest online futures operations is the latest to take up this currency. Wall Street’s Nasdaq has also announced that it will list Bitcoin futures in the first quarter of 2018. This means that Bitcoin will increasingly come under some form of regulation that will in turn boost transparency and gain some credibility in the market.
More regulation will also give rise to more securities tokens. We can then expect more predictability and an end to the unusual volatility. With this trend, we expect larger institutional players like Morgan Stanley to make their entry and bring with them big money and hedge funds. Market cap for the industry is expected to reach $5 trillion at the end of 2018.
An overwhelming part of Bitcoin players are retail traders who live outside the US mostly in developing nations. The cryptocurrency is particularly popular in countries hit by inflation such as Zimbabwe and Venezuela. Much of bitcoin mining also happens outside the US majorly in China. It is, therefore, easy to see how the listing in the major exchanges may take time before it can influence the markets.
Volatility Will be a Major Risk
Price volatility which can swing by as much as $1000 in a day will remain a major risk for investors and even other markets in 2018, as the bitcoin craze takes over the rest of the world and becomes more mainstream.
Tax authorities too will be knocking at the door and we are likely to see more disclosures from Bitcoin millionaires.
Trading firms and miners will take centre stage, but retail investors can also take advantage of the volatility to make profit using futures.