I’ve been asked by a few subscribers to further discuss the potential effect of the major exchanges starting up futures trading in Bitcoin. Last month the CME Group and the CBOE – Chicago Board of Exchange — announced they would begin trading futures contracts in Bitcoin due to popular demand.
The SEC fast-tracked approval, because, what the big banks want the big banks get. This is called ‘regulatory capture’ for short. Trading is due to begin on December 18th.
Now there are a lot of issues here but the main thing is that these are cash-settled contracts. This means that, for all intents and purposes, these are dollar-based bets on where the price of Bitcoin is going in the future.
And dollars, unlike Bitcoin, are in nearly infinite supply. I’ve heard arguments that the recent price rise in Bitcoin is partly because the CME and CBOE are building inventory. That’s pure disinformation. What inventory are they building when they are never going to settle the trades in Bitcoin?
Futures markets are a function of coordinating supply of an asset with time. If you anticipate the future need for a few million barrels of oil and want to lock in your future liability to obtain said oil, you buy some oil futures which will deliver you that oil on by that date.
By contrast, a cash-settled contract is, in effect, no different than a CFD offered by a forex broker. A CFD is a contract for difference which are simply bets on the movement in price of something. They are divorced from the underlying asset and do not affect its supply or demand like an asset-settled futures contract is.
CFD’s are really no different than betting on a football game or who will win the election. It is a pure derivative of the underlying asset and has no relation whatsoever to the trading behavior of the asset itself.
Except, of course, that traders who are looking for any edge they can get will use that data to influence their decisions. And so, as a secondary or tertiary effect, the structure of CFD markets have an effect on the market of the underlying asset.
In short, the tail wags the dog.
The question on everyone’s mind is, how much of an effect this will be.