Bitcoin futures trading will crash the Bitcoin this weekend

So this weekend (10th December) CBOE is launching their futures trade of BTX. CME will launch it on 18th December. Both are large derivatives exchanges in the world and CME for example is the oldest in the world.

My prediction (note of warning: I own zero BTC and I am a nillionaire in IOTA/Ripple/XLM) will be that BTC will crash if futures trading actually happens in December and here is why:

In theory, futures trading launched on those platforms will allow institutional and retail investors to invest in Bitcoin which they could not do before (i.e. internal company rules, aversion of risk on trading on platforms such as Bitfenix and the use of various wallets). This will now become substantially easier for investors who are already familiar with futures trading.

How will Bitcoin future trading work

The basic premise of a futures trade is simply that you “bet” on the future value of the the commodity (such as gold, oil etc) and then make a trade. So in the case of Bitcoin currently trading at $16,000 I could add a futures trade that the value will be $20,000 in two months time. Someone offers me the chance to commit to paying $18,000 for Bitcoin in two months’ time. When I “buy” this futures contract and I am right, I will be paying $18,000 for something which is worth $20,000. If I am wrong and the price is lower, then I will be paying more that it is worth and I will make a loss.

Alternatively, if I think that Bitcoin is going to go down in price, I can “sell” a futures contract: I could commit to deliver Bitcoin in two month’s time for $14,000. When the contract is up, I buy Bitcoin at the market price, and deliver it to the contract holder in return for the promised amount. If I am right and the Bitcoin price in two months is lower than $14,000, I have made a profit.

There are also hybrid strategies such as holding the underlying asset and hedging: I hold Bitcoin and sell a futures contract at a higher pricer. If the price goes up, I make money on the underlying asset but lose on the futures contract. If it goes down it is reversed. Another strategy is buying and selling futures contracts to lock in price.

All of this is very complex to us common people, but quite easy for futures and commodity traders who currently work in the futures market of gold. Since in most cases the commodity (such as gold) never needs to exchange physical goods, the futures market is often a multitude of the physical goods (i.e. the gold futures market is a good ten times the size of all physical gold available). This is possible, because with futures contracts you don’t have to deliver a bar of gold when the contract matures. Most futures work on a cash-basis and instead of delivering that Bitcoin to a wallet you will settle on cash instead.

In the above example I would make $2000 in cash in the futures trades and would never own a Bitcoin. So both CME and CBOE will settle in cash as well and this automatically means that the Bitcoin market will be a multitude larger than it’s current physical limitation of 21 million coins (currently 16,7m coins are mined).

Why investors will like futures

There is now nothing scary or limiting trading futures on Bitcoin. This will most likely be done on the same trading desk platform and BTC will just be another ticker (CBOE will use XBT and CME will use BTC for Bitcoin) along with Gold – and those traders are very familiar with futures trading:

 

What is interesting with futures trading is that investors will get exposure to the mysterious trading of crypto-currency in an familiar environment where the Bitcoin as an asset will produce outstanding returns on a highly regulated and liquid exchange. What makes this even better is that none of the investors need to own a single coin or a Bitcoin wallet address. There is also no limit on the number of coins, the number of trades, the dependency on the slow Bitcoin blockchain or the worry of a website being hacked (NiceHash) and coins being stolen, as there is nothing to steal.

No money will go into Bitcoin

Let’s think about this: Futures trading does not require owning Bitcoin. So this means that no money will ever be invested into Bitcoin. It is somewhat gambling on the value of some arbitrary coin which happens to be more valuable than others and has no real purpose – it is no different than Zimbabwe printing bond-papers. Other coins have a purpose: Ripple (payment processing), IOTA (Internet of Things).

Since futures do not require ownership of the actual coins (not even at maturity) you can very clearly see how this could negatively affect the Bitcoin price. On the other hand if futures hedging happens, it could amplify the surge in value of the Bitcoin very quickly.

What can also happen is that current institutional funds who bought and own Bitcoin, have no reason to hold on to Bitcoin as this is not a requirement for futures trading. It would be opportune to rally the Bitcoin to $16,000 – $18,000 before the weekend and then start a massive sell-off in order to prepare for futures trading.

Pricing, contracts and settlement of Futures

Here is the low-down of how it is going to work:

  • Both CBOE’s and CME’s bitcoin futures contracts will be settled in U.S. dollars, allowing exposure to the bitcoin without actually having to hold any of the cryptocurrency.
  • CBOE’s contract will be priced off of a single auction at 4 p.m. Eastern time (2100 GMT) on the final settlement date on the Gemini cryptocurrency exchange.
  • CME’s contract will be priced off of the CME Bitcoin Reference Rate, an index that references pricing data from cryptocurrency exchanges, currently made up of Bitstamp, GDAX, itBit and Kraken.
  • CBOE’s XBT contract will trade on CFE, with regular trading hours of 9:30 a.m. to 4:15 p.m. Eastern time on Mondays and 9:30 a.m. to 4:15 p.m Tuesday through Friday. Extended hours will be 6 p.m. Sunday to 9:30 a.m. Monday, and 4:30 p.m. Monday through to 9:30 a.m. Friday.
  • CME’s BTC will trade on CME Globex and CME ClearPort Sunday to Friday from 6 p.m. – 5 p.m. Eastern time with a one-hour break each day beginning at 5 p.m.
  • CBOE’s contract will clear through the Options Clearing Corporation and a 30 percent margin rate will apply.
  • CME’s contract will clear through CME ClearPort and will have a 35 percent initial margin rate.
  • CBOE said it may list up to four weekly contracts, three near-term serial months, and three months on the March quarterly cycle.
  • CME said it will list monthly contracts for the nearest two months in the March quarterly cycle (March, June, Sept., Dec.) plus the nearest two serial months not in the March quarterly cycle.
  • CBOE will halt trading in its contract for 2 minutes if the best bid in the XBT futures contract closest to expiration is 10 percent or more above or below the daily settlement price of that contract on the prior business day.
  • Once trading resumes, if the best bid in the XBT futures contract closest to expiration is 20 percent or more above or below the daily settlement price of that contract on the prior business day, the futures will be halted for 5 minutes.
  • CME will apply price limits, also known as circuit breakers, to its bitcoin futures of 7 percent, 13 percent, and 20 percent to the futures fixing price. Trading will not be allowed outside of the 20 percent price limit.

The avalanche will happen

It’s natural offer- and demand situation and with futures contract the limitation of 21m Bitcoins is “stretched”. Now add to this the volatility of the various exchanges (Kraken and GDAX are often showing Cloudflare errors and are suffering frequent outages/DDOS) and the system issues they frequently face.

Futures now allows to arbitrage multiple exchanges to manipulate the Bitcoin price to benefit in the futures trades and this will introduce high volatility in the market.

With the above comments I have not even considered the possible impact on Clearing houses (they act as the middlemen between the parties of a futures contract): i.e. if a brokerage fails to meet its margin call, the clearing house typically steps in to take over the position which would further move the price of Bitcoin which then would result in other brokers to fail and then the avalanche in Bitcoin trading will start. My word of advise: HODL (or sell off and hedge).

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