Bitcoin Futures Contracts: Useful, or Premature?
By: Steve Smith
Despite Jamie Dimon’s calling Bitcoin a fraud, the digital currency continues gain assets and legitimacy. With two seemingly going hand in hand.The latest step was the CME Group (CME), formerly known as the Chicago Mercantile Exchange, announcing it would begin trading Bitcoin futures contracts by the end of 2017.
The news helps propel the value of BTC to above $7,300 per U.S. dollar and it now over 750% for the year to date. The capitalization is above $120 billion which is more than all but 28 of components of the S&P 500.
While I believe that Bitcoin and other decentralized digital assets have a future, I think it’s a premature to list actual futures contracts.
My main complaint is that futures contracts have historically been created or brought to market because they offer a true economic purpose. Namely, it’s been a way for producers and users of a commodity or asset to hedge.
For example, farmers or drillers may want to lock in sale price of wheat or gold. A cereal maker like Kellogg or airline like United Airline might want to lock a purchase price of those key cost inputs for their products or operations.
The speculators or ‘traders’ are supposed to be secondary participants that help provide liquidity and make a profit for the risk they assume.
But at this point, aside from some high profile big ticket items like the sale of a house, not much business is conducted in Bitcoin. The estimate is just $2 million per day for a variety of retail and services. This means there is no real need for a currency hedge by either buyers or sellers.
Also, it is estimated that nearly 97% of all production of bitcoins is done by just 5 miners. Since they have a vested interest in keeping the supply scarce and access to selling limited, I highly doubt those guys are worried about or even want to have the ability to hedge.
Still, given the incredible growth in assets and speculative activity, some would say bubble, brewing in Bitcoin it’s easy to understand why the CME would want to jump on board. The trading volume and associated exchange and transaction fees would be a boon to the exchange which has seen volume in many of its traditional futures products dwindle and profit margins squeezed.
Ultimately, Bitcoin futures contracts will be a good and efficient way for BTC producers and users to effect price discovery and hedge their true economic risk. But right now, the trading will be strictly speculative with no underlying purpose or benefit.
It will be fun for professionals who understand Bitcoin futures contracts and the associated risk, but I’m afraid many novice or retail investors will sucked in over their heads.
Me? I’m waiting for my old stomping ground the Chicago Board of Trade (CBOE) to launch options bitcoin ETFs that are also in the works.
I’m sure I’ll be covering that Wild West show in these pages in the near future!
Related: Is There a Liquidity Crisis in Options Trading?