In the past few weeks, the launch of bitcoin futures on traditional stock exchanges and other sites has become one of the hottest topics. The beginning of trade in these financial instruments was announced by the world’s largest commodity exchange CME Group, the Man Group investment fund and the Swiss bank Vontobel. In this article, we will try to explain what these derivative financial instruments are and how futures affect the rate of bitcoin.
What is bitcoin futures?
To begin with, consider the concept of futures, or, more broadly, a derivative, that is, a derivative of a financial instrument. A derivative is a financial contract between parties to a transaction that is based on the future value of the underlying asset. This contract has certain conditions for its existence and implementation, of which the main ones are the price of performance and the duration of the contract. As a basic asset, any goods or services can act. In our case, the basic asset is bitcoin.
Futures (futures contracts) – the most common form of derivatives. Under the terms of such a fixed-term contract, its holder undertakes to buy or sell a certain amount of the underlying asset at a fixed price in a strictly stipulated time. Futures can be sold and bought before the expiration of their validity, and for these transactions, payment of the full value of assets recorded in the futures contract is not required. In the mortgage for the right to own futures, only a part of the full value of the transaction is transferred, the so-called guarantee security.
From the history of futures contracts
Chicago Stock Exchange
The emergence of the futures market is attributed to the ancient world – it is believed that they arose in ancient Mesopotamia in the XVIII century BC. e. during the reign of the Babylonian king Hammurabi. The description of futures was also found in the works of the ancient Greek philosopher Aristotle in the IV century BC. e.
The first futures in their modern understanding appeared already in Japan in the XVIII century. The most famous in our time commodity stock exchanges appeared in the next century. Thus, the above-mentioned Chicago Mercantile Exchange (CME) was opened in 1848, and the London Metal Exchange (LME) in 1877.
How bitcoin futures works
A bitcoin futures contract is an obligation to sell or buy a certain number of bitcoins at a certain price before the contract expires.
The guarantee security, which is considered to be the futures price, can be only 10-15% of the transaction amount. In this case, the effect of “leverage” appears, and market participants have the opportunity, with small investments, to obtain a relatively large income.
Derivative financial instruments are related to investments with high risks, because incorrectly predicting the price of the underlying asset, the market participant is losing significantly more than he initially invested in the purchase of futures. Execution of obligations under futures contracts is guaranteed by the exchange on the basis of the legislation within which it operates.
Suppose that the price of one bitcoin is $ 1,000. You, as a trader, in the hope of raising the price to $ 2,000, buy 10 future bitcoins at a price of $ 2,000 for a period of 2 months with 10% security, leaving $ 2,000 as collateral. Actually , you acquired the obligation to buy 10 bitcoins at the market price at the time of the expiration of the contract. The leverage in this case is 1000/200 = 5.
When the price reaches $ 2,000, you sell the contracts to another market participant, earning $ 2,000 in excess of the funds invested in the purchase, minus various fees and commissions, or leave the contracts until the end of the term, if you think that the price will go even higher.
However, if within two months the price does not reach $ 2,000, your contracts are automatically closed at the market price. The bad news is that the difference between the exercise price ($ 2,000) and the actual closing price of the transaction is deducted from your collateral, that is, you risk losing $ 2,000. Relatively good news: you will not lose more of the security you have contributed.
Throughout the life of the contract, you can sell or buy futures, and their price may differ significantly from the price of the underlying asset. Depending on the price of the underlying asset in the futures contract and the price of the asset in the market, you can earn not only on the growth of prices, but also on their fall. Any change in price with the right approach and analysis can bring a trader income while there are buyers and sellers of the futures contracts he needs.
Large exchanges, such as CME, set a fairly high entry threshold in the market; for smaller amounts you can trade by concluding an agreement with one of the brokers. For example, in the specification for prospective bitcoin futures, the CME sets the amount of one contract at 5 BTC (now it is about $ 40,000). The minimum number of contracts for the transaction and the amount of collateral for the contract have not yet been established.
The impact of futures on the exchange rate and bitcoin market
Why do analysts think that the appearance of future contracts for bitcoin will cause an increase in the price of the bitcoin itself? Mainly, the matter is in the interest of large traditional financial institutions acting solely within the framework of existing legislation and having powerful analytical departments that would not allow making decisions on the launch of bitcoin futures without calculating financial, reputational and other risks.
The presence of futures contracts on bitcoin on traditional exchanges will in fact make bitcoin’s position “legitimate” in the existing financial and legal system. Bitcoin, and later, perhaps, other crypto-currencies, will become one of the asset classes traded on global exchanges, taking the place among precious metals, energy resources, agricultural products, government bonds and many other commodities and securities for which futures contracts are concluded.
The fact that there are financial guarantees for transactions with bitcoin derivatives is undoubtedly capable of increasing the investment attractiveness, and hence the demand for the underlying asset and its price. This means that the global demand for bitcoins and market liquidity will significantly increase. Given the limited resource and predictable emission of “digital gold”, these factors should significantly increase the price and at the same time reduce its volatility. And this will make bitcoin even more attractive for long-term investments.
However, any medal has two sides, and the output of bitcoin to “adult” markets carries significant risks for its future. After all, unlike classical trade, that is, direct exchange of bitcoins for dollars and other currencies, derivatives can move the price both up and down. This opens wide scope for market manipulation and can not only raise, but also drop the price of bitcoin.
For example, if large traders on the same CME open contracts for billions of dollars to lower bitcoin, then there will be panic at the crypto-exchange markets and traders will start massively discarding the bitcoins, and where open-ended trading – open “short” deals or “shorts”. This will cause a completely uncontrollable price collapse – in fact, bitcoin does not have a “bottom” and its participation in the real economy is extremely insignificant.
Despite the optimism of the large holders of bitcoin, speculators, armed with derivatives and large stocks of liquidity, can easily crash the price many times, even for a short time. And this means that the introduction of bitcoin futures on large exchanges should be treated with caution and do not expect explosive and continuous growth. Bitcoin has yet to win a reputation among institutional investors.