Bitcoin futures have arrived

For those less familiar with the finance lingo, their product enables investors to short Bitcoin. It might be tempting to dismiss such announcement as another promotional gimmick in the vast sea of leveraged finance products, but that would be short-sighted.

The meteoric ascent of Bitcoin in 2017 put it in an unusual position of being one of the largest cash markets. Such markets more closely reflect true demand for the underlying commodity, as there are no means of establishing leveraged position based on expectations other than actual supply and demand.

There are many such expectations and a simple way to think of them is they deal with supply of money as opposed to just the underlying commodity. For instance, take copper, which is a widely used industrial metal with its demand closely tied to economic growth. In times of low interest rates and easy money, copper can be used as a leveraged proxy for industrial growth.

The underlying demand for copper as an industrial metal can be multiplied many times over by speculators driving future prices up betting on other speculators doing the same, enabling them to exit profitably their positions in the future. This situation has been existing for years in China and elsewhere because of zero-interest rate policies throughout the world.

Futures can also be used for legitimate purposes such as hedging, i.e. locking future prices by producers concerned they may get lower. But there is no free lunch and their insurance hedging acts as selling short in the future, potentially depressing the prices and causing the very thing they are concerned about.

There is another well-known futures technique, where players bent on suppressing prices sell short futures that are financed. In periods of no significant news, this action serves to deter and scare marginal long investors who may have been considering going long, i.e. betting on higher prices.

Contrary to popular myths and opinions, it is never the case that all market participants form their opinions and positions solely based on rational analysis of fundamentals. Many, often most, act on price action alone and things such as momentum and trends. And their principal cost factor is the interest they are charged to borrow money to establish their positions. This is the core reason low interest rates promote speculation.

Now that Bitcoin futures are here for the masses, at least in principle, one may think the days of endless rises are over. That is not necessarily the case, as futures market cannot overpower true underlying demand. A strong short seller can establish low price positions in the future to scare marginal buyers, but should there be lots of demand from other stronger players, prices will rise anyway causing great losses for leveraged shorts. This is why this is a game for players who know what they are doing, and even then things can go disastrously wrong, as in the Great Financial Crisis of 2008.

In any case, if you thought Bitcoin is volatile, the ride is going to become even more so.

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