If there’s one fall out of Bitcoin mania, it’s in how it has made previously arcane finance stuff become part of daily conversation. It’s made finance relatable and interesting to most people. I can’t tell you how many of my followers and even regular folks on the street who have held long, very nuanced conversations with me on inflation and deflation, money supply, central bank intermediation, hedging and of course, interest. Add to that the eye popping returns in the space and crypto assets are like a finance professor’s wet dream. Oh, and I no longer call them cryptocurrencies because they’re behaving and are being treated like assets.
Anyway, yesterday the biggest exchange company, CME in Chicago launched Bitcoin futures. Most people hear ‘futures’ and go “huh? What’s that?” Without going through all the intricacies, futures are a way to bet on the prices of any commodity at some point in the future. So if your asset is at $10 today and I think it will be at $50 tomorrow, I can enter into a futures contract with you to buy your asset for $20 guaranteed price tomorrow. If you think it won’t be worth up to $20 tomorrow you agree to the contract locking in a $20 sales price tomorrow.
Let’s say tomorrow the price is $18. Per our contract you sell it to me at $20. You buy it back at $18 (or not) but either way you’ve made and I’ve lost $2 on the spot price (spot price being whatever is the price RIGHT NOW). If on the other hand on our settlement date your asset is selling for $35. Per our contract you sell it to me at $20, and I go ahead and sell it on the open market, for my $15 gain and your $15 loss. There’s a few other details and nuances but that’s basically it.
So back to Bitcoin. What does it mean that CME will now allow you to buy and sell futures contracts on the price of Bitcoin? Well, prior to now we had no way of knowing what Bitcoin would be worth from one day to the next. We also didn’t have very observable markets that allowed us to get data on how the asset is being traded. This changes that.
With futures, we start to see what people are expecting Bitcoin to do months ahead from now. It gives us a kind of crowdsourced idea of investor sentiment, trading behavior and demand which should make pricing Bitcoin a more exact science than it currently it (not that that is saying much).
So in a weird way, by introducing this, the expectations and futures price pulls at today’s prices giving a semblance of predictability to the asset.
At the same time, it could introduce the ability to use margin to boost trading on Bitcoin and since the futures market is going to be somewhat thin and illiquid, few big players could swing prices this way or that. So the futures market is likely to make Bitcoin less volatile over time but there’s a small chance it makes it more volatile. That’s basically finance for you. There always exists the possibility that your solution to a financial problem could basically make the problem ten times worse, word to Ben Bernanke.
Also can you imagine the margin calls on such a volatile asset?
But anyway the long story is that you can now borrow up to the hilt to buy this asset that the prices yo-yo according to patterns that we basically have no insight to. I don’t know why anyone would do that but the point is if you wanna do it, then like a crack dealer in the hood, CME is willing to indulge you.
Also, we’re definitely fully in the grips of a cryptobubble. People still make money in bubbles (cue Mark Cuban) but it takes smarts. Trade wisely, book profits and protect your downside.
As always, it’s your boy El.