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Date: 2018-12-10

Bitcoin Futures

December 10th 2017 will go down as the day that bitcoin futures were introduced onto the world markets. The bitcoin cryptocurrency was the developed by the person or people who used the codename Satoshi Nakamoto, and ever since its inception the people of the world can't seem to get enough of it, with some taking drastic actions like taking out loans just so they have the capital to buy it.

Once the news had broken that bitcoin futures would be launched by CME Group, which is the largest derivatives exchange in the world, the price of bitcoin fluctuated from $12,000 to $16,000 all within a few days. This was the news many people had been waiting to hear as it would certainly increase its value, because it would allow people to own bitcoin without actually owning it.

I understand that all this finance jargon might be a little confusing, so allow me to break it down for you. Let's say I am scrolling through the internet and I see a company that I like the look of, which we will call company X. I have taken a look into the company's filings and history and I feel like investing in it, and right now company X is valued at $10.

Imagine that I have good information which indicates that the value of that company will rise from $10 to $15 in a few months time. Someone then offers me the chance to buy a futures contract for $12 for company X in 2 months time. I accept the offer and I now own a futures contract which in a few months time could be worth $15 that I paid for $12.

It would be the same if I thought that the value of company X would fall below $10 and I wanted to sell, then I'd still be in a position where I stand to make money.

There are futures market for almost everything and it is often the case that the size of a futures market will far exceed the size of the actual market it is representing. Take the gold market for example, the futures market for gold is 10x the size of the actual gold market itself. I'd imagine you're trying to figure out how a futures market could possibly be larger than the market of an asset or commodity itself. Well these contracts are settled in cash, rather than the physical delivery of the asset or commodity.

All of this interest from financial institutions has generated so much hype that the price of bitcoin has grown exponentially. It opens up the doors for more ways to make money, and we all know that hedge funds and traders love to make money. One popular scenario that has been doing the rounds recently, is that powerful hedge funds have already bought up as many bitcoins as they can, then broke the news of the inevitable bitcoin futures and artificially pumped up the price to make their stake even more powerful and have their gains catapult.

How Do Bitcoin Futures Work?

It's reasonable to assume that a product named a future is attempting to predict the future. Bitcoin Futures are Not Trying to Predict the Future!

For example, an investor can bet on the price of bitcoin rallying in the new year by buying a bitcoin futures contract today that expires in March at the price of the current March futures contract. Let's say this price is $16,000 and the investor buys one futures contract worth one bitcoin.

Should the price of bitcoin be worth $20,000 when the futures contract expires in March, the investor makes a profit of $4,000 on his futures contract. Of course, the investor does not need to hold his futures contract until expiry. He or she can sell it at any time during trading hours on the exchange where the futures contract is listed.

How Are Futures Prices Established?

If you look at the quotes for Bitcoin futures you'll see at least three things, the expiration code (shorthand for a specific expiration date ) the bid (buy price) and the ask (sell price). If you're ever confused as to which one to use in your situation it's easy to sort out-start with the price that's worse for you.

Important agents interacting with those prices are operating in one of three roles: individual speculator, market maker, or arbitrageur. A key role is market maker-a firm that has agreed to simultaneously act as both a buyer and seller for a specific security.

When companies sign up for this role they agree to keep the bid/ask prices relatively close to each other-for example even if they aren't keen on selling Bitcoins at the moment they can't just set the ask price to an outrageous level. The agreed-upon maximum bid/ask ranges might be tied to market conditions (e.g., wider when deemed a "fast market") and might allow time-outs but in general, the market maker agrees to act as a buffer between supply and demand.

As the first Bitcoin Futures Expire

There have been some vague concerns that because bitcoin futures are settled in cash, it might be possible for investors to push around the futures contracts at the close simply by aggressively buying and selling. Maybe, but presumably if the futures prices got out of whack with the cash, arbitragers will step in.

First Futures Closed at $10,900
According to Coin Telegraph, the first bitcoin futures contract closed on January 17 at $10,900. As of roughly a week before, there were just under 2,000 short position contracts for bitcoin futures active on CBOE. As of the time that the first batch of futures closed, bitcoin had fallen significantly.

Down From $17,000
On December 11, 2017, the day that CBOE launched the bitcoin futures contract, the price of a single coin hovered around $17,000. (See also: CBOE to Start Bitcoin Futures Trading on Dec. 10.) The flurry of activity on the CBOE site crashed the exchange temporarily.