As Bitcoin’s price heads up towards the $20,000 mark, punditry has revolved around futures trading and it’s market impact.
Derivatives, of which futures are a type, are financial products which immediately strike one as structurally very clever, but are remarkably counter-intuitive by any common sense measure. Fair warning: upon reading the following explanation you may well find yourself shaking your head in incredulity, and thinking to yourself ‘that’s a stupid idea, no wonder the stock market collapses every now and then’.
Derivatives are contracts which derive their value from an underlying asset. I can sell you a contract to pay you the money required to buy something (could be bitcoin, or a car, or just a couple of toothpicks. Anything) the price of the contract is based on the value of whatever the asset is, so as the asset appreciates or depreciates either you or I end up better off. The fun part is that neither of us have to own the asset, and never have to. It’s a pure bet.
Futures are a more specific type of derivative, a future is an agreement for one party to sell an asset for a certain price to another party at a future date. So, again, any movement in value between signing the contract and the sale date will lead to one of the two parties being better off. The reason these types of financial products might leave you questioning the sanity of Wall Street’s inhabitants is that their combined effect can move the value of the underlying asset. If lots of investment bankers are signing contracts which assume the price of a given asset will go up, that will in turn drive the price up.
Derivatives are, in short, the looking glass through which we seem to be. They are the point at which investment bankers cease to be spectators, trading off their knowledge and assessment of the market, and become participants whose behaviour is built in to the value of that which they assess. And futures are, in part, behind the escalation of bitcoin’s recent price party.
On December 4th the Chicago Board Options Exchanged announced it would be launching bitcoin futures six days later, with bitcoin having just stretched over the $11,000 mark it then marched swiftly upwards to its current value, approaching £19,000. That was the inflection point around which bitcoin’s price graph has yet to relent.
Futures drive price up for a number of reasons, partly because their existence adds a stamp of approval to bitcoin as an asset, which then leads on to more professional investors entering the market, both increasing the integrity of the asset, and the amount of money at play.
With bitcoin’s already volatile price, futures are contributing to a market fresh with amateur behaviour. And that’s really the crux of this whole subject.
Futures are mere speculation, they do nothing for market stability – quite the opposite, exaggerating the height from which the price can fall; or the depths from which it can rise. The recent inflection point of bitcoin’s price graph will always be there to look back on, no matter what price fluctuations lie ahead. And it will always represent the moment when bitcoin investment turned “professional”.
