How Futures Trading Changed Bitcoin Prices Summary

Emir Zecovic | Posted on July 11, 2018 |

4 min read ⌚

Some hail it as the future; others warn that it may be the newest economic bubble.

Either way, few people haven’t heard of Bitcoin by now.

In this May 2008 FRBSF Economic Report, authors Galina Hale, Arvind Krishnamurthy, Marianna Kudlyak and Patrick Shultz take a careful look at “How Futures Trading Changed Bitcoin Prices.”

Who Should Read “How Futures Trading Changed Bitcoin Prices”? And Why?

“How Futures Trading Changed Bitcoin Prices” is not exactly an article for people who have been, are or are planning to trade with bitcoins or bitcoin futures.

Simply put, there isn’t any investment advice here – especially not in relation to Bitcoin.

However, there is an interesting conclusion concerning the relationship between price dynamics and futures trading in general.

Which should make this article interesting for any future investor or trader.

About Galina Hale, Arvind Krishnamurthy, Marianna Kudlyak and Patrick Shultz

Galina B. Hale is a research advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco.

Arvind Krishnamurthy is a Professor of Finance at the Stanford Graduate School of Business, with a Ph.D. in Financial Economics from MIT.

Marianna Kudlyak and Patrick Shultz are both research advisors in the Economic Research Department of the Federal Reserve Bank of San Francisco.

“How Futures Trading Changed Bitcoin Prices PDF Summary”

Nobody knows who Satoshi Nakamoto is, or even if it is one person for that matter.

But many people know that, almost a decade ago, he/she/they developed Bitcoin and devised the first blockchain database.

The first decentralized digital currency, bitcoin was hailed by the leaders of the bitcoin movement as “inherently anti-establishment, anti-system, and anti-state,” not to mention “fundamentally humanitarian.”

Now, between January 2009 and February 22, 2017, bitcoin’s price never exceeded $1,150.

And, then it suddenly started skyrocketing, reaching $19,511 on December 17, 2017.

Coincidentally, the day Bitcoin reached its peak was the very same day the Chicago Mercantile Exchange (CME) opened up a futures market for the cryptocurrency.

In barely a month, bitcoin’s price fell to half of its peak price and is currently at half of that, selling at about $6,000 per bitcoin.

So, you can’t blame the authors of “How Futures Trading Changed Bitcoin Prices” for seeing much more than just a coincidence between Bitcoin’s fall and the opening of the futures market for bitcoins.

Even less so if you take into consideration that the same happened in the home financing market in the 2000s, when “financial innovations in securitization and groupings of bonds” attracted optimistic investors before instruments were created which “allowed pessimistic investors to bet against the housing market.”

Similarly, the advent of blockchain introduced a new financial instrument, bitcoin, which optimistic investors bid up, until the launch of bitcoin futures allowed pessimists to enter the market, which contributed to the reversal of the bitcoin price dynamics.

Simply put, before December 17, 2017, there was no way for pessimists to bet on the decline in bitcoin prices.

The only ones who traded were optimists who, by buying bitcoins, were betting on the rise of bitcoin.

It’s always easier to bet on the rise because all you need to do is just buy a Bitcoin.

However, once CME futures trading for bitcoin was launched, pessimists entered the equation.

Now, they could finally bet on the bitcoin prices going down, by short-selling the digital currency.

The prophecy was, once again, self-fulfilling: as many people took short positions on the digital currency, its price started falling, and this triggered even more pessimism.

According to the authors, this pricing dynamic happens over and over again:

Once derivatives markets become sufficiently deep, short-selling pressure from pessimists leads to a sharp decline in value.

Now, the only question left is: do we know the real price of Bitcoin?

Of course, this is not an easy question to answer.

However, in time, by analyzing some fundamentals such as mining costs, transactional demand, regulatory governance, and the use and benefits of rival cryptocurrencies, investors will reach a clearer picture of Bitcoin’s value. This analysis can be significantly aided by studying crypto signals.

By then – it’s all a speculation.

Key Lessons from “How Futures Trading Changed Bitcoin Prices”

1. Bitcoin Was the First Decentralized Digital Currency
2. Bitcoin’s Decline Coincided with the CME’s Opening of a Futures Market for the Cryptocurrency
3. In the Future, Sell Before the Futures

Bitcoin Was the First Decentralized Digital Currency

Bitcoin is a cryptocurrency, i.e., a digital currency not backed by any asset of intrinsic value.

Launched in 2009, it was the first decentralized digital currency since its system was designed to work without administrators or a central bank.

Bitcoin’s Decline Coincided with the CME’s Opening of a Futures Market for the Cryptocurrency

Between 2009 and February 22, 2017, bitcoin’s price was relatively steady, never passing the $1,150 threshold.

However, during the next 11 months, it skyrocketed, and on December 17, 2017, one bitcoin was selling at a price of nearly $20,000.

That very same day, the Chicago Mercantile Exchange opened the futures market for bitcoin.

This provided pessimists with a mechanism to express their opinion about Bitcoin by short selling. In merely a month, the price of bitcoin halved, and half a year after that, it revolves in the realm of $6,000 per bitcoin.

In the Future, Sell Before the Futures

“How Futures Trading Changed Bitcoin Prices” argues that Bitcoin’s price volatility is consistent with the rise and collapse of the home financing market of the 2000s, i.e., that, once again, the price dynamics was reversed once futures were launched.

If the logic of the authors is sound, be sure to sell before the futures start trading during the next investing craze.

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