Bitcoin futures: Everything you need to know | YAHOO FINANCE

in #bitcoin7 years ago

Despite the (well-founded) protests of JPMorgan, Citigroup and other Wall Street brokers, bitcoin futures are set to go live Sunday evening at 6:00 p.m. EST on the Cboe Futures Exchange (CFE). Next Sunday, December 17, the CME Group (CME) is expected to launch its own bitcoin futures.

Currently, bitcoins are mainly traded on one of the many “cash” exchanges that exist around the world — even the largest of which has been subject to outages. Though bitcoin derivatives already exist (LedgerX just launched in October), bitcoin futures are expected to eventually bring the liquidity and stability demanded by large institutional traders and small retail traders alike.

What happens to the price of bitcoin once bitcoin futures begin trading?

Critics may argue there’s a bit of tail wagging the dog here, with the futures market influencing the cash market prices. But it’s not uncommon for derivative markets (which include futures markets) to become bigger than the underlying commodity or asset. (This is the case for gold, crude oil and nearly all currencies.) The total value of all bitcoins (or its “market cap”) is about $250 billion, which is chump change for Wall Street. It’s easy to envision bitcoin derivatives becoming greater than the underlying cash market some day (the number of bitcoins theoretically being limited to 21 million).

Will bitcoin “shorts” crash the price of bitcoin?

Futures contracts allow traders to bet on a market moving in either direction by “going long” or “going short.” Aside from a few small bitcoin derivative markets, there’s currently not an easy way to short bitcoin. One question is: If it becomes easy to bet on bitcoin’s price decline, does that increase the chances of a bitcoin selloff, or even a crash? Or, might we see the opposite, where pent up money on the sidelines finally enters the bitcoin futures market and bids up the price of bitcoin?

The answers aren’t so simple. Unlike the stock market, futures markets are a zero-sum game. For every long there is a short. For every winner, there’s a loser. Every dollar of one trader’s profit is a dollar lost by another trader. If someone wants to bet big that bitcoin is going down — say, by shorting 1,000 bitcoin contracts — there needs to be one or more traders willing to take the opposite side. That liquidity may not be there from Day One. As the futures market grows, large institutional money will increasingly influence the price of bitcoin. If bitcoin derivatives become larger than the underlying cash market for bitcoin, Wall Street’s opinion will have an outsized effect on bitcoin prices. That might be bullish or bearish.

What’s the next step after bitcoin futures?

Bitcoin futures are only the start. The Holy Grail for bitcoin bulls is a U.S. bitcoin ETF, which would truly bring the cryptocurrency to the masses. For better or for worse, having bitcoin exposure in a 401(k) isn’t that far off. The Winklevoss brothers (who are partly behind the new CFE’s Cboe Bitcoin Futures) have tried unsuccessfully for years to register a bitcoin ETF with the Securities and Exchange Commission. The SEC’s main objection has been the lack of a transparent pricing mechanism — that the bitcoin market is too easily subject to manipulation.

First, the price of bitcoin futures will affect the prices on the cash bitcoin exchanges, and vice versa. Speculators will arbitrage the different prices, buying on one and selling on another, pocketing the difference. This isn’t very easy to do when bitcoin is moving fast and exchanges are crashing left and right. We’ll likely see one or more bitcoin “flash crashes.” But over time, the prices will roughly be in line.

And as bitcoin exchanges mature, become more reliable and robust — with the futures contracts become more liquid — this “arbing” will bring all the bitcoin prices much closer in line with each other. That will take time. (There’s also a non-zero chance that the whole thing comes crashing down, but that probability is pretty low.)