Chicago Mercantile Exchange launching Bitcoin Futures
Little by little cryptocurrency is winning the trust of business community, despite its vague legal status. Not so long ago, on October 31, the world’s largest commodity exchange — Chicago Mercantile Exchange — announced its intention to launch Bitcoin Futures. Bitcoin listing on CME might be the most important evidence of cryptocurrency legitimacy and significance recognized by corporations.
This significant decision could be assumed as a driver of bitcoin growth. Should we be so optimistic anticipating BTC/USD on CME?
BTC futures trading is expected to start on December 11. Does it make sense to welcome December 11 with your trade terminal opened? To place order in advance anticipating significant fluctuation on your trading platform? That’s a controversial question. There is a common opinion that the market takes in consideration such important news before their publication.
The up-trend since the publication may have already been inspired by the wise market. When you see a trend the trend is already the past. What about the future (supposed) market dynamics in one year term?
Factors influencing bitcoin exchange-rate
First, let’s consider the benefits: big players will surely join cryptocurrency trading. Until recently the only way to enter cryptocurrency world for the funds was buying ETF shares. Cryptocurrency as an investment instrument is not available for the most of institutional investors. Still there is an option for investing in crypto-market: investment funds’ shares, ETF (TheTokenFund, Crypto20, GBTC).
GBTC: 35.5% growth since OCT 31, BTCUSD: 33.3% growth since OCT 31
For example, dynamics of GBTC token nearly coincides with rises and falls of bitcoin value. Are such ETF good enough as an investment instrument in bitcoin?
GBTC shares are traded in over-the-counter market which doesn’t have CME strict regulation. Therefore CME as an alternative might be in high demand by the big players.
Let’s assume institutional traders have entered cryptocurrency market. The question is how it will affect crypto assets exchange rates?
There isn’t a simple answer. Fund entering cryptocurrency market by ETF actually buys a crypto asset, albeit via intermediary fund. But what will he get on Chicago Mercantile Exchange? An air. Cash-settled futures.
Bitcoin’s value growth is a result of two factors which are feverish demand for bitcoin and limited and costly emission (mining). What will the trend be when all bitcoin buyers turn to the inexhaustible source of cryptocurrency — derivatives?
And the other question — when we’ll be able to call bitcoin a currency? Without the “crypto” prefix?
Bitcoin as a means of payment
For example, when we’ll see McDonald’s Menu with prices in cryptocurrency. Or when it’ll be possible to pay for Amazon Web Services directly, without converting to fiat money.
Let’s omit the issues concerning the financial regulation of huge corporations. Let’s imagine that I am Jeff Bezos, the CEO of Amazon.com. I’m responsible for the future of 180,000 employees. Employees whose expenses are certainly not incurred in bitcoins. Moreover, don’t forget administrative expenses, logistics costs…
Futures, as we know, originally were meant not for exchange speculation, but for hedging exchange-rate risks. Amazon who has part of its operating income expressed in cryptocurrency, can now hedge this unpredictable asset on Chicago Mercantile Exchange so that all the planned expenses can be covered on time and in full.
Bitcoin futures from the largest worldwide trading platform is essential for the corporations in order to use digital assets in their financial settlements. CME brokers will provide them with the appropriate services — in particular, segregated accounts. Segregated accounts are service available for mature markets and big brokers. Service, which existing cryptocurrency exchanges lack a lot, since security of the clients’ assets has been their number one problem so far.
To sum it up, bitcoin futures might induce corporations to enter the cryptocurrency market. Not before corporations’ recognition the entire community will adopt cryptocoins as a universal payment instrument.
Hedging exchange-rate risks
Speaking of hedging, let’s estimate BTC futures strictly as a technical instrument, as a tool for the complex hedging algorithms, as a speculator’s asset.
Bitcoin is a volatile commodity. According to CME specs, BTC futures trading will be suspended, if the difference between its current price and the previously settled one exceeds 20%.
Thankfully, BTC exchange rate hasn’t experienced such a turbulence since the end of 2015. But the risk of trading suspension persists, and it’s significant.
Cryptocurrency market hasn’t experienced “bear canines” yet. The reason is trivial: speculators haven’t had a chance to settle the naked short selling of bitcoin. Only a few cryptocurrency exchange platforms allow margin trading, and they grant a minor credit shoulder.
Let’s calculate the possible value of maintenance margin for the contract of 5 bitcoins. To do this, we’ll apply the method of asset’s risk estimation which is used on stock exchange. The collateral should cover the greatest two-day price deviation for the observed period of time.
The bitcoin history is a good example of the American Dream fulfilled. But dismiss the period of time when one could get 10,000 bitcoins in exchange for only 2 pizzas.
Consider bitcoin prices since the beginning of 2013. The greatest two-days price deviation was neither more nor less than 60%. Examining the bitcoin price since the beginning of 2017, you’ll discover a 20% increase of it in July. Thus, the amount of collateral for margin trading of BTC futures is expected to range from ⅕ to ½ of the contract value which is equivalent to 8,000–25,000 USD.
Theoretically, BTC option could be popular instrument of hedging. It could be a profitable strategy for the market most players on which push BTC price up exclusively by their faith in cryptocurrency. Option buyer pays the seller a premium for the risk, but he’ll still have a chance to win if crypto asset rises in price.
For the time being, it’s hard to think of what pricing for the options on BTC futures would be like. First, the market will be in contango permanently. Secondly, the volatility of bitcoin exchange rate is extremely high.
The classic Black-Scholes Option Pricing Model is not absolutely fitting for this scenario. Instead, let’s calculate a premium of the vanilla BTC option that expires in 30 days by modelling the instrument price on the history basis (using time series of BTCUSD prices).
According to calculations, the premium of the vanilla call option (with the base asset price about $42,000) amounts to almost $8,000! The premium of the put option will be four times less — $1,900.
My opinion: with that pricing for the BTC option only few investors will actually consider it as a strategy for hedging cryptocurrency exchange-rate risk.
The final equation
In a nutshell, there are two important factors, two significant preconditions for the bitcoin exchange rate to rise:
- institutional investors’ entering the market
- accepting the cryptocurrency by corporations.
Since October 31 the aforementioned scenario seems more plausible due to emerged options of hedging cryptocurrency risk.
On the other hand, there are at least two reasons for the bitcoin value to go down:
- covering a BTC shortage by BTC futures
- a new foothold for the short sellers.
The main market growth driver is bitcoin becoming a means of payment. This driver, however, will take time to prove itself.
In closing, CME decision to launch bitcoin futures gave the crypto community a certain amount of optimism. In the long term it’ll help bitcoin to strengthen its position. But one should take into consideration that the market might has already treated these news. Along with optimistic long-term forecast for BTC/USD pair, we can expect periods of considerable decreases in BTC value.
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