Last night saw a change in the Bitcoin world. This is because a Bitcoin futures contract started trading on the Chicago Board Options Exchange or CBOE. It would appear that plenty were watching as this took all of 30 minutes.
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The system trouble was accompanied by yet another surge in the price. From Bloomberg.
Bitcoin futures expiring in January were priced at $17,780 as of 12:57 p.m. Hong Kong time, up from an opening level of $15,000. About 2,300 contracts changed hands.
So not an enormous amount of contracts but the interest and price swings did have an impact.
Futures on the world’s most popular cryptocurrency surged as much as 25 percent during their debut session on Cboe Global Markets Inc.’s exchange, triggering two temporary trading halts meant to cool volatility. Dealers said initial volumes exceeded expectations, while traffic on Cboe’s website was so strong that it caused delays and outages. The exchange said all its trading systems were normal.
Who could possibly have forecast that lots of people would be watching? Anyway as I type this the price for the January 2018 contract is US $17640 ( up 14%) with the volume being 2695 and the high having been US $18850.
What is the point of a futures contract?
The purpose of a futures contract is to bring trading on a particular instrument into one place. Why? Well even what are considered to be active markets may have bursts of activity followed by quiet periods which are awkward to say the least if you wish to trade in them. The impact can be boosted by the contract covering a concept rather than a particular asset as for example in bond futures where a generic is traded rather than an individual bond. So the ultimate end product of a successful futures contract is liquidity or the ability to trade consistently which benefits investors and traders as well as the exchange itself which charges fees on the trades.
It also brings into play the ability to “short” an instrument as you can sell as your opening trade whereas with ordinary trading you have to buy something before you sell it. This is much simpler than what you have to do in equity markets which is borrowing the stock so you can sell it which you have to plan and work at rather than just contacting an exchange and selling.
Obviously the exchange is at risk as prices move so you have to put up cash or margin to cover your position. When people refer to gearing on a futures contract this is one way of measuring it as if you have to put up 10% margin then if you wished you could buy ten times as much of the instrument concerned for the same outlay. Some care is needed though as there is also variable daily margin to cover losses ( as well as lower margin if profits arise)
Success or failure comes essentially from volume and liquidity and from that flows the other factors.
How does it work?
The basis is that you have a point in time when everything has to be settled hence the concept of a January contract in the case of Bitcoin ( there are also February and March). At that point anything outstanding is delivered for example I had a colleague some years back who had 2 potato futures contracts delivered on him and was in danger of getting more spuds than he could handle even with his barn.
Also there is a clearing house who organises and guarantees settlement. In the UK the main clearing banks back the London clearing house which back in my main trading times was seen as a big strength. Well we all make mistakes don’t we? Also the exchange is regulated.
The point for Bitcoin
In a way futures trading is a sort of coming in from the cold for Bitcoin. It gives the potential for there being one price rather than the multitude of them we currently see. That would be a clear gain and if we add in the regulated and clearing issue another potential gain is that institutional investors join the party. This would have positive impacts on volume and liquidity which would be likely to settle the price down and make it more stable.
Something has troubled me from the beginning and it is this. From the CBOE.
XBT futures are cash-settled contracts based on the Gemini’s auction price for bitcoin, denominated in U.S. dollars.
This needs to turn out to be both stable and reliable as for example the market would be damaged if there were even suspicions that there were ways of manipulating the settlement price. I do not know Gemini but their price will have to be 100% reliable and what if the overall Bitcoin price is squeezed?
Next is that one of the benefits of futures trading may not actually apply and h/t to @chigrl for raising the issue. Remember I said that allowing short selling was one of the key points of a futures contract? Well here are the rules of Interactive Brokers and the emphasis is mine.
Due to the extreme volatility of cryptocurrencies, clients will be unable to assume a short position including as part of a spread. The only time a short order will be allowed will be in the case of a roll trade that results in a long position. In addition, market orders will not be accepted.
If this is in any way widespread the whole concept of a futures contract on Bitcoin may be holed below the waterline. As I pointed out earlier the ability to sell short is if not the modus operandi a big point of having a futures market. Added to that is that there are of course plenty of risks in being long Bitcoin at current levels. Are market prices supposed to bring a balance between the risk of buying and selling?
Actually although the media seems to have mostly overlooked it there was a clear signal of the inability for at least some to short Bitcoin futures.
No wonder sellers want a premium if it is difficult or even not possible to sell unless you have already bought. On such a road then the price may well keep singing along with Jackie Wilson.
Higher (lifting me)
Higher and higher (higher)
As someone who has spent plenty of years in such markets the apparent inability to do spreads ( trading January versus March for example) is another issue. Say there is a large buyer for January futures and a seller in March, what used to be called locals would arbitrage that out adding to liquidity. You see these markets need someone to trade with otherwise they curl up and die. Another sign of trouble can be higher fees like this from the FT earlier.
The Singapore Exchange is to increase fees as much as 10-fold for derivative trading members next year, following a recent large technology upgrade. As of January, annual fees for proprietary trading members such as big global banks with direct market access will jump from S$2,000 to as much as S$25,000 in some cases, SGX said on Monday.
Also there is the underlying issue of what is a Bitcoin and if it is suitable for a futures contract in the first place?
Some of the issues I have raised today could be fixed if not at a stroke quite easily. But they need to be done as you see once a contract gets a reputation for being illiquid then it tends to die a death. So far 2768 is not all that brilliant especially if we allow for this.
CFE is waiving all of its transaction fees for XBT futures in December 2017.>
All that is before the Merc ( CME) starts trading them too.
Oh and some are suggesting option contracts ( my old stomping ground). How would that work unless you had the ability to hedge via selling futures?