The launch of the first Bitcoin future contract on Sunday, December 10th has generated a good dose of questions from cryptocurrency investors and holders. This article intends to address what financial futures are and the kind of implications they might have for the cryptocurrency markets.
Financial futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price. This means a futures contract imposes both parties to buy or sell the agreed amount of the asset in the deadline date set at the contract.
That was the original function of the futures contract, but market players quickly found in futures contracts the perfect instrument to conduct their speculative operations even if they didn’t have any real interest in the underlying asset.
The main advantages of a futures contract are:
- High liquidity: Being an instrument mainly used by professional investors in a frequent manner and with high volumes, they are very liquid instruments. It’s fairly easy to find buyers or sellers of futures contracts.
- Quick execution: Financial futures market makers have at their disposal ultra-quick and very-well dimensioned technology. Lots of HFT software programs use this kind of platforms, something that would not be possible if it wasn’t on point.
- Low operational costs: Transaction costs for futures transactions are really low compared to other financial instruments, especially when compared to the total value of the asset being traded
- Market depth: Financial futures markets distinguish themselves by their information depth and detail. They include Level 2 market, instantaneous and very detailed Time&Sales or professional trading platforms, among other tools for traders.
But financial futures also have their weaknesses:
- Futures are leveraged instruments, with investors only making a small guarantee of the total amount traded that has to cover for potential moves against the asset. That means you don’t invest the total amount you are trading, just a small part of it. In the Bitcoin futures, the margin percentage used is around 30%-35%.
- Futures markets are the natural habitat of professional traders, which makes the independent average trader operate with a disadvantage, given the smaller investment in information and technology he will have against the biggest financial firms.
- Futures markets take no prisoners: when a trader gets into red figure territory and his position is getting close to the margin contributed, he will receive a margin call to get more funds. If he decides against investing more money, the platform will close the position confirming the losses.
How will financial futures impact Bitcoin market?
It’s difficult to analyze the real effect that Bitcoin future contracts will have in the value of the main cryptocurrency, but we can surmise some conclusions from the first hours of trading:
- BTC futures has been trading way over the nominal asset price, which might be read as a lack of sellers willing to offer contracts against an asset with the current Bitcoin steam.
- Low volumes are normal. Market operators might be waiting to see how the market flows, what is the size of intraday ranges being traded, the amount of Level 2 positions, how other market actors play the markets, etc. Very few will be ready to speculate on such a volatile asset without having studied it first. CBOE has already admitted that they expect activity levels to be quite limited for some weeks.
- CBOE website went down on Sunday after an avalanche of users collapsed their servers, but the trading platform didn’t experience any problem. The safety net of being able to trigger any trade at any given time is of vital importance to any trader. That’s the weakest point for the nominal Bitcoin trade, as futures platforms are much better equipped to deal with the two full sides of the market.
It should be evident to any trader willing to operate Bitcoin in a speculative way should be using BTC financial futures, as they offer much lower operational costs and are quicker and more liquid markets.
In the opposite side, those who see in Bitcoin a safe-haven asset or just don’t want to sell the main cryptocurrency in the mid-term, they should still buy the asset in any cryptocurrency exchanger as it has been done up to nowadays.
It’s difficult to make projections for longer timeframes. Plenty of theories are out there.
One of the main lines of thinking argues that Bitcoin trading will naturally transition into derivative markets, with BTC ending up serving as a de-facto commodity. If we ignore that nothing besides faith in its technology actually backs BTC value (something that can be said, more or less, of any other financial asset), the main cryptocurrency could reach safe-haven status as an anchor for any other Blockchain-based investment or asset.
Others foresee an apocalyptic end to the main cryptocurrency value, judging that the launch of financial instruments such as futures contracts will only accentuate risks. Some of them even consider cryptocurrency risks to be potential disruptors for the entire world’s financial system.
It’s not reasonable to think to expect traders to be waiting for days or even weeks until a buy or sell order gets triggered, even less in a market so volatile that might experience huge price swings in a small glimpse of time. Financial futures have arrived to solve this problem and attract professional and institutional investors to the Bitcoin market. But this kind of instruments carry high risk and are not appropriate for non-experienced traders. Any investor should decide according to his profile and act consequently.
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