Cryptocurrency futures
It was all over the news, Bakkt would be the first to launch a physical settled Bitcoin futures market. Sadly, Bakkt has disappointing trading volumes. Institutions are not rushing into it in the first week of its existence. Commentators quickly judge it as a failure. We want to show you why we think it is of incredible importance for demand and a big step for Bitcoin and the entire cryptocurrency industry.
What is a Bitcoin future?
A Bitcoin future is a contract between two parties to physically trade one Bitcoin at a certain price on a specific date in the future. It allows you to settle on a price beforehand and make the trade later. If you sell or “Short” a Bitcoin Future position you are expecting the market to go down. If you buy or “Long” a position you expect the opposite. It is used as a risk management tool and works as an insurance. Holders of Bitcoin will want to sell futures to protect their Bitcoin from downwards risk. Speculators will buy into that risk if they expect the price to go up.
The Bitcoin future will only follow the price of Bitcoin. There are two main reasons to buy the future instead of the underlying asset. The first reason is that it may not be possible for you to buy Bitcoin directly on an unregulated exchange as an institution. The second reason is speculation because futures allow you to leverage your position. To buy one Bitcoin future you only need around $4000 or the equivalent in Bitcoin in your account. You can therefore multiply your gains (or losses) by trading futures.
The CME Bitcoin future
Existing CME Bitcoin futures are settled in dollars. This allows speculators to use the futures not as insurance but as a “bet” on what they think the price of Bitcoin is going to be. Traders never have actual Bitcoin and the Bitcoin price should not be affected by futures trading. It should not, but unfortunately in reality it does. In a market with low volume it is too easy to manipulate the price to benefit your future contract. While “betting” on a lower price you can sell a large amount of Bitcoin deliberately to manipulate the price lower. You no longer have Bitcoin, so this is not a problem for you. Your future contract just gained a lot in value. Watch out for big moves in the Bitcoin price near the last working day of the month. That is the CME futures settlement day.
The Bakkt Bitcoin future
Bakkt Bitcoin futures are what is called physically settled at the end of the contract. It means that the trade of actual Bitcoins always takes place between the two contract partners. Physical settlement is used for other markets like bonds, oil, cattle and metals. It is an efficient way for buyers and sellers to protect themselves from volatility. We need this especially in the cryptocurrency market. This future contract is different from the CME future’s cash-settlement in dollars. The settlement in actual Bitcoin makes it less likely the price can be manipulated because Bitcoin must be held in margin on your account. The Bitcoin must be traded so held or bought at that time. These futures are perfect for institutional investors that already hold Bitcoin. They can insure themselves against price fluctuations. This is also the first time Bitcoins can be bought by institutions on a regulated market.
Why is Bakkt important for Bitcoin?
Bakkt has a normal 30-day future and a 1-day future. The first will mitigate volatility and improve price discovery. The latter creates a market where you can buy Bitcoin for a fixed price at the end of the day . Meanwhile your contract insures you will not lose money if it suddenly drops in price during that day. Institutions carefully manage large amounts of money for other people. They do want to offer Bitcoin but not by buying it from an unregulated cryptocurrency exchange with high volatility and problematic regulation. Bakkt is regulated in the US and allows them to offer fixed prices to their clients. They also need enough liquidity so as not to push the price up or down with every large buy or sell they make during the day. This can now all be taken care of on the Bakkt marketplace.
Bakkt is not competing with CME, because the product is different. With physical delivery it adds a superior mechanism for price discovery to Bitcoin. The CME cannot do this because they only offer sidebets and not the real deal. It is even better price discovery than exchanges because it involves Bitcoin against real dollars and not USD Tether stablecoins. Bakkt is not competing with the cryptocurrency exchanges, because Bakkt is regulated and exchanges are not. They have a totally different target audience. It is important to see this futures market adds a whole new group of potential investors to Bitcoin.
Why is Bakkt a big step for the cryptocurrency industry?
The New York Stock Exchange (NYSE) is by far the world’s largest stock exchange with a market capitalization of $30 trillion as of February 2018. The value of the entire marketcap of all cryptocurrencies together and more changes hands here on a daily basis. This institution has been around for centuries. The owner of the NYSE is the lesser known Intercontinental Exchange (ICE) and they have started Bakkt. For such financial giants to be involved with cryptocurrencies should make every Bitcoin holder extremely optimistic. This is a big step and other big traditional stock exchanges will pay close attention.
The future will be more cryptocurrency futures
Wait and see how a trickle turns into a flood. The Bakkt futures market brings a trusted player and a familiar infrastructure for institutional money to the cryptocurrency market. Bitcoin is the first and most important cryptocurrency. Therefore, it is expected that derivatives (futures, options) first focus on Bitcoin. As more institutions become familiar with trading Bitcoin this will increase acceptance of Bitcoin with their clients. If more people learn about Bitcoin, it will make more people aware of alt coins as well. The most likely scenario is that some of the stronger altcoins, such as Ethereum, Litecoin and Ripple, will also become tradable as futures when investor interest becomes high enough.
Update October 9, 2019: Bakkt trading volume rises to new heights of 224 BTC with Bitcoin rising.
Update October 10, 2019: CFTC chair says ETH is a commodity; anticipates ETH derivatives to trade in the US soon