Financial Times: Sell Bitcoin Because The Market Is About To Become "Civilized"

On 31 October 2017, we discussed the announcement that the CME Group was responding to client interest and launching a Bitcoin Futures contract before the end of this year. CME stated that the contract would be cash settled based on the CME CF Bitcoin Reference rate, a once-a-day reference rate of the US dollar Bitcoin price at 4.00pm London time. In the run-up to the launch of the futures contract, the Financial Times has written a piece on the likely impact of futures trading on the Bitcoin price.

The title of the piece makes the FT’s view clear, “Prepare to bet against bitcoin as it becomes civilised”. We disagree with using the word “civilised” in this context (see below), but here is the FT’s take. 

In recent years, bitcoin has been the wild west of the financial world. Now, however, it is being civilised — a touch. In the coming weeks, the Chicago Mercantile Exchange plans to start listing bitcoin futures, with a centralised clearing mechanism. Cboe Global Markets may follow suit. That will enable investors to bet on the coin’s future value without actually holding it — just as investors can use the Chicago exchange to bet on hog prices, say, without ever handling a pig.

To its credit, the FT reflects the concerns from some CME participants that there is insufficient regulatory oversight and Bitcoin’s stratospheric vol could lead to significant losses for some traders.

Is this a good idea? Some of the CME’s members do not think so. This week Interactive Brokers, an important clearing firm in the exchange, took the extraordinary step of using a newspaper advertisement to ask for more regulatory oversight. It fears that bitcoin is potentially so volatile that these futures will create huge losses for traders, which might then undermine the health of the CME and hurt other brokers, given its part-mutualised structure. The CME — unsurprisingly — dismisses this as poppycock: it argues that any risks will be contained by rules that allow traders to charge more so as to generate fat margins (of about 30 per cent) and thus absorb losses, and by circuit breakers that would stop a trade in the event of wild price swings.

Our suspicion is that CME Group has seen the volume of Bitcoin trading and is determined to get its “cut”, whether or not some of its members take some big hits or not. It can deal with those issues if or when they occur. Anyway, the FT moves on to the more interesting subject of the impact on Bitcoin’s price. We should note that when the futures contract was announced the price surged more than $100 to a then all-time high of $645.

But while the regulatory debate bubbles on, there is a more immediate question facing investors: bitcoin prices. Until now, it has been an article of faith among bitcoin evangelists that if — or when — the currency became more “civilised”, this will boost the price. After all, the argument goes, assimilating bitcoin into the mainstream investment world should boost its appeal and demand, making it more valuable.

As the FT alludes to in the articles title, it expects the Bitcoin price to fall.

It is highly likely there will be an opposite effect. Until now, investors have not had an easy way to bet against bitcoin — the only “short” was to sell coins. But the CME futures contract will let investors place those negative bets. You do not need to be a conspiracy theorist to imagine that some bitcoin cynics will be doing just that.

To support its case, the FT cites the example of Japan launching equity derivatives in 1989, just before the bubble burst.

Think, for example, about Japan. Before the mid-1980s, its stock market seemed to exist on a planet of its own, subject to its own valuation rules. But when Japanese equity derivative contracts were launched, and then integrated within the wider global market system as a result of financial reform, that sense of “otherness” broke down. The change in how Japan was seen through a comparative investment lens was not the only reason for the 1990 Nikkei crash, but it contributed.

We have a slight problem with using this as an analogy for Bitcoin. Firstly, an ultra-hawkish BOJ-governor was nominated in mid-1989 who announced his intention to crackdown on house price inflation and the shadow banking system which was facilitating much of the leverage. Secondly, all bubbles burst and Japan’s was extreme. For example, depending on whether you use the highest per square metre property deal in the Ginza district, or one in the Chiyoda district, the land underneath the Imperial Palace was valued between $852 billion and $5.1 trillion at the time. Futures trading, we would suggest, played a tiny role.

The FT cites the launch of trading in the ABX Index prior to the sub-prime crisis, as another example.

So too with US mortgages. Until 2005 or so, outsiders could not easily assess or price the risks of America’s subprime mortgages: mortgage-backed bond prices were opaque, and the only way to short the market was to sell bonds. But when mortgage derivatives, such as the ABX index, were launched, it suddenly became easy to make negative bets. Then, the ABX index was published in newspapers, such as the Financial Times, in 2007, creating a visible barometer of sentiment. That helped a sense of panic to feed on itself after 2008.

Once again, we would suggest the FT is confusing the impact of derivatives with an inevitable reversion of market price of an asset in a bubble as expectations regarding the outlook changed. In the case of sub-prime, housing prices in the US had never fallen, then they did, the AAA-ratings of the bonds were manifestly incorrect and the dramatically overpriced sub-prime bonds were pledged as collateral in all manner of other risky, leveraged trades.

From our perspective, the impact of the futures launch is difficult to gauge as it depends on the interaction of two opposing forces.

Firstly, as cryptocurrencies gradually become accepted as an asset class, more institutional money is likely to enter the sector and holding long futures positions is one way to do it.

 

Secondly, as the article notes, Bitcoin futures will be settled in cash, which means there is potential for the volume of futures trading to vastly outweigh the buying and selling of “actual” Bitcoins. If this occurs, then the “tail can wag the dog” as price discovery is dominated by futures trading. This permits all manner of market abuse via naked short selling by investors, major banks and any “official” players who deem it necessary to manipulate the Bitcoin price.

For this reason, we don’t agree that adding a futures contract will necessarily “civilise” Bitcoin, indeed, it might have the opposite effect.

The second scenario precisely describes the state of the “gold” market today. According to the Reserve Bank of India’s estimate, the ratio of “paper gold” trading to physical gold trading is 92:1, meaning that the price of gold on the screens has almost nothing to do with the buying and selling of physical gold. This makes the gold market and, therefore, the gold price something of a mockery. As Zero Hedge has highlighted time after time, the gold price has frequently been subject to waterfall declines, as huge volumes of gold futures are dumped on the market with no regard for price. See "Gold Slammed After Someone Pukes $4bn Notional In Gold Futures" on 10 November 2017. Perhaps the FT journalist, Gillian Tett, could write an article on gold, instead of Bitcoin, explaining how the price of the former – a widely viewed indicator of financial risk – is being suppressed by derivative trading. Indeed, Tett was present at a private dinner in Scott’s of Mayfair several years ago when the Gold Anti-Trust Action Committee gave a presentation on exactly the same process which she expects to lower the Bitcoin price.

Comments

YUNOSELL ThePhantom Fri, 11/17/2017 - 19:21 Permalink

Selling Bitcoin futures where it is leveraged say 100 to 1 (paper Bitcoin vs actual Bitcoin) will destroy Bitcoin since it will allow price manipulation the same way they can do it with the Gold and Silver markets. But unlike physical gold and silver which you can hold in the flesh and the price can NEVER go to zero.After each economic crisis the price will always correct up to its true value relative to all true physical goods in the world, since suppressing its price will at that point be the least concern on the minds of the banksters. With Bitcoin, the price manipulation with highly leveraged futures will just erode trust in it, since there is nothing physical to hold, but maybe eroding trust in it is what they want all along.

In reply to by ThePhantom

EndOfDayExit Txpl9421 Fri, 11/17/2017 - 19:51 Permalink

In order to short BC today one would have to borrow it. And it is usually difficult to borrow more than say 100% of what physically exists. With futures there is no such constraint - if I am a central bank I can now keep selling BC futures in pretty much unlimited amounts, thus damping any buying attempts and hence preventing the price from going up. This is exactly what is being done to gold. Because why not?

In reply to by Txpl9421

Lockesmith EndOfDayExit Fri, 11/17/2017 - 20:29 Permalink

Brief thoughts:

Few people who buy gold futures want to take delivery of gold, because it is relatively illiquid;it is a pain in the ass to transport, insure and store, especially as the volume goes up. Thus, cash settlements are easily accepted, even if the price of gold is going up slightly.

Cryptos in the other hand have almost nil storage costs and the transportation costs actually decrease as the volume increases.
Will holders of crypto futures be as happy to settle in cash as gold holders, especially as the price of the crypto starts significantly exceeding what their settlement is?

I certainly think the banks will try, but I think they may get burned to the ground doing it.

In reply to by EndOfDayExit

Kafir Goyim Lockesmith Fri, 11/17/2017 - 20:49 Permalink

This is a cash settled derivative.  They are just placing side bets on the direction of bitcoin.  There are no actual bitcoins being bought or sold.  So this will hurt bitcoin because it will siphon off money that would otherwise have purchased actual bitcoin.  That's a given.  As for manipulation, like the gold market has, I am stil uncertain.

In reply to by Lockesmith

Al Huxley Fri, 11/17/2017 - 19:23 Permalink

Ha ha - now bitcoin's going to be dominated by the 'paper bitcoin' market.  Maybe they can open a BTCN etf that will have to buy and sell bitcoin, but who's actual bitcoin holdings will be murky and difficult to determine.  Ho ho ho, this is hilarious, the irony, the hilarious irony.

shamus001 Al Huxley Fri, 11/17/2017 - 20:12 Permalink

Whats worse is if theres say a notional 30bn in current bitcoin value, and "someone" fat-fingers a 4bn short sell... They'll make money ALL THE WAY DOWN. (effectively stripping the value/cash value from those who actually purchased unfractioned BTC.SHORT = STRIP MINE YOUR WEALTH!SHORT.....SHORT,SHORT,SHORT . . . . .BTC VALUE = .36/BTC

In reply to by Al Huxley

webmatex Linda Hand Sat, 11/18/2017 - 06:08 Permalink

Then again i could (but cant be bothered) to write some code for a wallet which would send 1 Satochi to a specific address until the wallet had a BTCvalue of zero. This could theoretically flood the blockchain with a greater number of transactions than normal peak and at the least start to delay the completion time of all transactions on the block chain. 

In reply to by Linda Hand

webmatex webmatex Sat, 11/18/2017 - 06:48 Permalink

Satoshi = .00000001 = 10,000,000, transactions per Btc10 Btc = 100 million transactions So for a layout of 10 Btc i could (less the commision) generate 100 million blockchain transactions to myself, legally.I think even using Basic and this old machine i could pump out far more than 50,000 per hour.I used something similar with MS Outlook which would send 50,000 Emails in just a minute to people who had Emails that refused to refund me for fraudulent web biz - worked like a charm when i telephoned them and explained i could send a few more.So it IS possible to interfere with blockchain traffic and use forknowledge of this to trap or block accounts for pre-calculated periods of future time. Plus you can put em in but you can't put em out - so backlog would increase to days or weeks as further transactions are generated untill wallet value = zero. Guess 1 trillion total.If the blockchain can process less than 10 tps then my 100 million would create a backlog of 115,74 days or for the entire 1T a total of 3,17 years!I think this is serious (soros) weakness regardless of the CME stuff.I may sell my Btc (always ask intuitive Madame Wm first) before this post is torn to pieces (good) or someone (Tyler)? actually thinks its a great idea(bad). Thats all folks.

In reply to by webmatex

BigJim webmatex Sat, 11/18/2017 - 07:09 Permalink

I am no crypto expert but this makes perfect sense to me.Also... Could you not own both seller and buyer wallets and just keep moving the satoshies back and forward between them?It seems to me the only way that this could be stopped is if the exchanges start slapping a maximum number of transactions per hour on each wallet.Or maybe they already do.Paging TMosely ...

In reply to by webmatex

webmatex BigJim Sat, 11/18/2017 - 08:11 Permalink

That indeed was my point - one could tranfer to you own wallet exclusively or transfer between 2 - 1 Btc = 10 million transactions less the fee - rinse and repeat until fees have reduced your balance to zero - possibly 100 million total transactions for 1 Btc.Sounds pretty cheap - wonder how the miners wouls react. lol!Anarchy makes and breaks.

In reply to by BigJim

swif_siqol BigJim Sat, 11/18/2017 - 10:11 Permalink

nonono, there is the transaction fee, and also competition to push transactions into blocks.Consider an avg. transaction fee of 10 U$: 10 BTC (77k USD) would make about 7k700 transactions (about 10 full blocks, or ~1h30min of block creation). But if trying to push it to fast, the average transaction fee will tend to rise, and there's no limit on that. So it could tend to steadly rise to 30 U$ during that time, so maybe you could actually achieve only about 3k transactions, or 40min of block creation time. Stopping the network of an entire day, considering an steady fee increase up to 200 USD would cost about 400 million dollars.

In reply to by BigJim

webmatex swif_siqol Sat, 11/18/2017 - 10:53 Permalink

Not sure that i fully understood but thanks for reply however actually calculating fees from my search results seems pretty difficult to find and ultimately depends on the byte size. However i found this which would indicate that for less $600 fee is .25%...https://poloniex.com/fees/MakerTakerTrade Volume (trailing 30 day avg)0.15%0.25%< 600 BTC0.14%0.24%? 600 BTC0.12%0.22%? 1,200 BTC0.10%0.20%? 2,400 BTC0.08%0.16%? 6,000 BTC0.05%0.14%? 12,000 BTC0.02%0.12%? 18,000 BTC0.00%0.10%? 24,000 BTC0.00%0.08%? 60,000 BTC0.00%0.05%? 120,000 BTCSo it seems pretty cheap - 40 Satochi will transfer for 1 satochi with these guys but i was using theoretical wallets not an exchange.Im often wrong.  

In reply to by swif_siqol

Catalonia Fri, 11/17/2017 - 19:23 Permalink

A currency of which a single transaction uses more power than your house for weeks. A currency which has skyrocketed over a 1000% in a few months on nothing but speculative investment...Yeah, why would I sell :)