Interactive Investor

Here's what happened when bitcoin futures launched

11th December 2017 12:54

Gary McFarlane from interactive investor

Bitcoin futures started trading under the XBT ticker on Sunday at 23:00 GMT with the bulls firmly in charge, topping $18,000 and triggering two trading suspensions!

The first contracts on the CBOE were bought at $15,000 and quickly jumped to $16,600 before falling back.The price a little later then soared to $18,220. However, the futures contract pricing was out of kilter with the actual prices on exchanges, with Coinbase showing a high below $17,000.

It will probably take a few days for the futures market to settle down, but the possibility of short sellers pushing down the price hasn't materialised as yet.

The CBOE futures contract is cash-settled, as is the CME version launching in a week's time, which means if you're holding until expiry you do not have to take delivery of bitcoin, but instead receive the equivalent cash sum.

Most derivatives traders don't hold contracts to expiry in the asset classes they are taking a price view on, and bitcoin will likely be no different.

The CBOE website went down when futures trading began due to the strain on its servers created by the surge in interest in its bitcoin instrument. Cryptocurrency exchanges have suffered similar problems recently, as they race to upgrade their infrastructure to keep pace with demand.

Market participants believe the futures market should help to improve price discovery and ease volatility, although traders at the moment are still taking advantage of the arbitrage opportunities afforded by the variance in prices on crypto exchanges.

Supply and demand

Regarding the demand for the new futures contract, Naeem Aslam, chief market analyst at TF Global Markets, told Bloomberg "there is decent demand and this is driving up the price of bitcoin".

Currently, the notional value of traded futures contracts is only around $40 million compared to the more than $1 billion traded in the same eight-hour time period since futures went live.

Demand might be lower than hoped for because of the refusal of a number of major investment banks and brokers to take bitcoin futures business, restricting sales to certain clients.Many traders, though, are sitting on the sidelines, looking to see how things play out before dipping their toes in volatile waters where the spreads are very wide compared to traditional assets.

Interactive Brokers, whose chairman and chief executive Thomas Peterffy is one of the sternest critics of bitcoin futures, is allowing its clients to buy the contract, although on a margin of 50% and with a prohibition on short selling.

The CBOE and CME are fierce competitors in the derivatives market. CBOE has announced free trading on its bitcoin futures contracts until the end of December. The CBOE takes its price data from the Gemini exchange owned by the Cameron and Tyler Winklevoss, a relative minnow among exchanges.

Asian demand for bitcoin has been strong in recent months, with Japan accounting for as much as 60% of global trading. Yuzo Kan, chief executive of bitFlyer, the dominant Japanese exchange, estimated to have 20-30% of the global market in bitcoin, told the Financial Times that 25% of its business is clients buying bitcoin and the rest is in derivatives, often being traded on as much as 15x margin. "We don't take any risk. The trading is between customers."

There are of course buyers and sellers on each side of a trade in bitcoin futures, too, but clearing houses and brokers sit in the middle and could potentially find themselves threatened with catastrophic loss of capital by the wild gyrations in bitcoin prices.

Bubble trouble?

Bitcoin's detractors are not dissuaded from their views by the 20% rally since futures bounded out of the gate on Sunday.

UBS analyst Paul Donovan restated that "UBS believes cryptocurrencies are a bubble", but nevertheless warned against trying to call the crash. "Predicting when a bubble will burst cannot use rational analysis. Ignoring a bubble is the best course of action," he concluded.

Tech website Ars Technica asked two business professors for their thoughts on the bubble issue and both concurred that it had all the classic hallmarks of an investment mania.

William Deringer, a historian at the Massachusetts Institute of Technology, said: "A lot of bubbles historically involve some kind of new financial technology the effects of which people can't really predict."

However, Professor Brent Goldfarb at the University of Maryland pointed to its similarities to gold, observing: "It will have value so long as people believe it has value", suggesting this could become a self-fulfilling prophecy given the number of true believer "hodlers" in the market.

It has been estimated that as much as 40% of all bitcoins in circulation are held by just 1,000 people, according to Aaron Brown, a former head of financial market research at AQR Capital Management.

If many of those "whales" are holding for the long term, that puts a floor under the price, although it could also mean there is a danger of price manipulation.

Next stop $100,000

A trader who predicted bitcoin would finish on five figures in 2017 is now pencilling in $100,000-plus as a price target for 2018. Dave Chapman, managing director of Octagon Strategy told CNBC: "I wouldn't be surprised to see a six-figure headline."

Octagon trade cryptocurrencies, so could be said to have an interest in talking up the bitcoin price. However, Chapman says commentators focusing on price are missing out the fundamentals, namely how bitcoin and other crypto could usher in a new form of money.

"I'm more excited in the applications and more excited about what this means for people who don't have access to financial inclusion," he explained.

The mainstream credibility that futures lends to bitcoin could lead the US Securities and Exchange Commission to revisit its decision earlier this year to block the launch of exchange traded funds (ETFs).

CBOE chief executive Edward Tilly speaking to crypto news website CoinDesk said: "One of those potential next steps would be moving into ETFs and ETNs that would take SEC approval."

Further underlining how bitcoin futures brings legitimacy to the crypto assets space, Greg Dwyer, head of business development at the BitMex exchange, said: "It's going to bring in mainstream and professional investors, and have them be more comfortable participating in the futures market which is more regulated."

If futures become a route in for institutional investors, the $3.5 trillion global ETF market could do the same for mainstream retail investors.

Best of the rest

Bitcoin's latest push upwards is lifting altcoins across the board. Eighteenth placed Waves coin catches the eye. It offers a platform for companies to launch coins relatively easily, with minimum coding know-how and may be benefiting from the congestion on the Ethereum network.

A game called cryptokitties has become an unlikely success story on the Ethereum blockchain, as the first decentralised app to run on the platform that has garnered any sort of scale.

Litecoin, which back in the days when bitcoin was priced in the low hundreds and was considered the silver in comparison to bitcoin gold, is up 17% at $161.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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