economics

Futures Trading to Reduce Bitcoin Volatility

Published November 18, 2017 by Carl De Luna
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Bitcoin is the latest trend which has surprisingly kept its global popularity for less than a year or two. It has proven to be an important investment tool for a growing number. But, it is not for the faint hearted. The latest example was on November 8, 2017, Bitcoin plunged 29% from its record high after the cancellation of a technology upgrade. It continued losses until it bounced back on November 13 in early trading and would then follow it up with wild fluctuations between gains and losses. This type of volatility has been synonymous with Bitcoin since it was founded, and is a major reason some investors will not commit to the product.

Bitcoin is the largest crypto-currency in town and despite claims that it is currently in a bubble, it looks like it will stay with us for the time being. It is now pushing up to $8,000 USD on major trading exchanges, indicating an increase in Bitcoin demand. Earlier this week, demand for the offshoot Bitcoin Cash or BCH increased, which had a negative effect on Bitcoin or BTC, where it experienced a dip to $5,600.

Exchange giant The CME Group pounced on Bitcoin’s popularity by introducing Bitcoin futures. Bitcoin futures would consider Bitcoin’s erratic price movements and be hopefully launched by the second week of December. But there is growing opposition to the possible introduction of Bitcoin futures as a product offered in the traditional capital markets. Interactive Brokers is the largest electronic brokerage firm in the United States and among the leading derivatives traders, providing clearing services to hundreds of brokers. Its chairman Thomas Peterffy even had a full-page advertisement in the Wall Street Journal warning regulators about the possible effect of a crypto-currency or any related derivative on traditional capital markets. He is not entirely against the entry of Bitcoin but requested the Commodity Futures Trading Commission or the CTFC have crypto-currency or any derivative placed “in a separate clearing system”. He added that Bitcoin’s volatility could have an adverse effect on other futures products trading in the market. He also noted that crypto-currencies lack “a mature, regulated and tested underlying market.” They have existed for less than 10 years and have little relationship with “any economic circumstance or reality in the world”. It would be up to the CTFC to study whether the entry of Bitcoin futures would be beneficial or not to the market.

CTFC is the financial watchdog which oversees derivative and futures markets in the US and would be the agency responsible for approving and regulating Bitcoin futures. They noted that the entry of Bitcoin futures could lessen Bitcoin’s volatility. It cited that the coin markets already have a small group of participants which would consider short coins on strong days and vice versa. According to them, this could reduce overall volatility. But Peterffy was less than positive about Bitcoin futures effects. He warned that unless they are isolated, Bitcoin futures could “destabilize the economy”.

CME Group head Terry Duffy assures that they would only release a safe cypto-product. Bitcoin futures would be under two mandates that reduce its volatility. The first one stipulates that the Bitcoin futures will not be able to trade 20% above or below the previous day’s settlement price and that a Bitcoin future trader would have to put up approximately 30% collateral if ever they lost a bet. However, Peterffy disagrees with CME’s plan to margin Bitcoin futures as it requires traders to put up high collateral. He thinks that this would not work and branded the margining efforts on a product such as Bitcoin as impossible. But Duffy contends that the Bitcoin futures is a “client-acquisition play” which would hopefully attract younger people to invest in the futures market. The futures market is the less sexy and popular market for stocks.

In other parts of the world, there has been an increase in demand for a futures product aimed at betting against Bitcoin’s price. The latest is Vontobel, a Swiss asset management firm, started trading two mini futures. Mini-futures are derivative instruments which would represent a fraction of the value of standard values. The offering would also be beneficial to investors even if the price of Bitcoin plunges. Fellow Swiss company Leonteq Securities AG is also launching a separate product which has a two-month maturity. LedgerX, a New York based start-up, also went live and now offers live crypto-currency futures trading. On its first week, $1 million was traded.

Among investment companies and major banks, there is still uncertainty on how to treat Bitcoin. JPMorgan Chase CEO Jamie Dimon famously stated that Bitcoin is a fraud. Goldman Sachs CEO Lloyd Blankfein stated that he isn’t comfortable with Bitcoin. But Morgan Stanley chairman and CEO James Gorman has a different take on things and he believes that the growing acceptance of Bitcoin and its increasing usability would mean that it would not go away overnight. Japan Post Bank chief investment officer Katsunori Sago believes that Bitcoin’s market capitalization is in bubble territory. Sago argues that the true fair value of Bitcoin would be around $100. Financial Journalist Max Keiser is an outspoken proponent of Bitcoin saying it is the world’s greatest store of wealth, replacing gold.

Such sentiments are representative of the divided opinion of people towards Bitcoin. More and more people are gravitating towards Bitcoin due to its impressive rise this past year. Its acceptance as a payment method is also growing as more and more stores are accepting it. Mobile payments firm Square added to the list of platforms which offer the buy and sell of bitcoins. This would allow them to compete with established crypto-currency exchanges such as Coinbase and Gemini. The fears of a bubble in the Bitcoin market are real and would must likely be evidenced by the fact that Bitcoin investors aren’t thinking of giving up their coins yet. LendEDU recently had a survey of 564 American Bitcoin investors and the results showed that the average Bitcoin investor is not interested to sell their Bitcoin until it reaches a value of $196,165. The survey also showed that only 32% of those surveyed has ever sold some of their Bitcoin. 39.54% of them also said that they would like to hold their Bitcoin investment for 1 to 3 years. The fear is that once the Bitcoin reaches a high value, it will be the sign for investors to cash out on their investment and the bubble might burst.

Efforts and statements issued by those in the traditional capitalist markets are good for determining on how to properly mandate and regulate Bitcoin futures. Since Bitcoin’s price is volatile, it would need thorough study on how to manage the price gains and losses of Bitcoin on the futures market. They do not need to rush on a decision on how to handle the crypto-currency. It might be best to isolate them first and see how they act before doing it on a full-scale basis. Since it is different than fiat money and is less regulated by authorities, prospective traders would be best advised to limit the risk of Bitcoin from affecting their bank accounts and not put all their eggs in the lucrative Bitcoin market. Stores accepting them as a mode of payment should also be careful of putting their business at risk.

At this point, it is hard to determine if Bitcoin would be the future of currency and investment. It is better for us to wait and see for the future of Bitcoin. Is it a fad? Or will it be the future of how we pay for goods and services? How will it shape our future?

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