The outlandish rocketing of Bitcoin’s price over 2017, and particularly since November, has led to many scions of the financial markets to call the rise of the original cryptocurrency a bubble on a scale never seen before. Even back in September, when Bitcoin’s exchange value was in the $3000 and $4000s, JP Morgan CEO Jamie Dimon said that he believed the phenomenon had surpassed the extent of the legendary ‘tulips bubble’ of the 17th century. That comparison was echoed in early November by UBS when the Chicago Mercantile Exchange first announced that it planned to start offering traders Bitcoin futures.
The catalyst for the most recent acceleration past $16,000 has been the start of Bitcoin futures trading on regulated exchanges. In the end, the smaller Cboe exchange beat the CME, which will launch its futures trading on Monday December 18th, to the punch by launching its own futures on Sunday December 10th.
The launch of Bitcoin futures on regulated commodities and futures exchanges has been heralded by cryptocurrency fans as the ‘tipping point’ moment for the cryptocurrency. It is now considered to be part of the financial markets mainstream. However, for those who still strongly believe that Bitcoin’s price, have returned more than 1500% so far this year, is the mother of all bubbles, futures provide an opportunity for them to put their money where their mouth is.
Futures are a financial derivative – a contract to buy or sell actual Bitcoin at a fixed date in the future for a fixed price decided at the point the future is taken out. However, the holder of the future doesn’t usually intend to actually take receipt of the asset, or send it to a buyer in the case of a short position, and will close the position before its expiry. This means that futures can be used to short Bitcoin’s price. If someone investing online believes Bitcoin’s value will crash before the point the future expires, which could be in January or March for now, they would take a short position. This means they profit by the price dropping.
For those convinced Bitcoin’s price is a bubble set to burst before the expiry of futures available, futures mean they could profit if right. However, anyone considering shorting Bitcoin may want to take note of a warning provided over the weekend by Black Swan author Nassim Taleb. The term ‘Black Swan’ was coined by Taleb to refer to highly improbably events as the work was included by The Sunday Times in its list of the 12 most influential books published since World War II. The academic, intellectual, statistician and professor, who teaches risk engineering, correctly forecast the popping of the U.S. housing bubble in 2008 that led to the international financial crises as well as Brexit and Trump’s election victory last year.
Taleb believes that anyone who does use futures contracts to short Bitcoin is likely to lose their money. He doesn’t see Bitcoin’s price crashing any time soon for two main reasons. The first is that the lack of a deliverable for Bitcoin futures removes a significant pillar of stability that normally keeps buyers and sellers aligned. Cboe and CME are only settling Bitcoin futures contracts in USD, not Bitcoin itself. This, says Taleb, means that “someone long the future can push prices higher at settlement time with impunity, by “locking” profits (never having to resell a deliverable)”.
The second problem for would be Bitcoin bears is that the market has a lack of both liquidity and “natural sellers”. Because supply is limited to 21 million Bitcoin, and the rate at which these are released into circulation drops over time, Bitcoin’s supply is much more limited than other assets. Most small buyers also plan to hold onto their holdings speculatively and around 40% of all the Bitcoin in circulation are held by around 1000 individuals who were big early investors. This means that there is a lot of vested interest in maintaining the upwards price trajectory and a very large proportion of owners of Bitcoin outside of those 1000 or so holding 40% would need to sell simultaneously to effect a steep price drop.
This all means that even if there eventually is a Bitcoin crash it may take a lot longer to arrive than many bears currently think. It also means that short positions may require serious cash to be held on margin to not be closed out if the price keeps climbing in the meanwhile. Taleb may of course not be right on this occasion but his arguments do seem logical and he does have a phenomenal track record.
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