The role of futures contracts is to reduce volatility and allow traders to utilize a highly liquid investment vehicle.

What is bitcoin worth? Where is its price heading? These questions are the center of many debates featuring economists, investors, enthusiasts and other "experts." And now, bitcoin futures are adding a new level of complexity to the conversation.

Introduced in December 2017 by the Chicago Board Options Exchange (CBOE), the much-hyped futures contracts allowed institutional and retail investors an opportunity to make bets on bitcoin in an entirely new way. As the driving factor behind the price of gold, oil and other commodities, these contracts gave bitcoin a level of legitimacy in the eyes of otherwise uninterested parties.

The move sparked the largest futures market in the world, the Chicago Mercantile Exchange (CME), to follow suit.

Many hailed the new investment opportunity as a positive move for bitcoin, with some even suggesting it would cause a new wave of interest in the cryptocurrency, potentially even sending its price soaring well beyond its run-up to $18,000. But what actually happened left many scratching their head.

Days after CBOE contracts launched, bitcoin reached its temporary peak, and saw prices fall drastically in the following months.

Economist Yukio Noguchi argues that the new futures market had a direct impact on prices. Though his claim is based on little more than coincidence, the report was widely covered by major publications in the space, featuring the quote: “Because it’s now possible to trade on bitcoin futures, you’ll never see a rapid surge again.”

But what’s the real story?

In the crypto-space, it’s almost a faux pas to suggest that a price decline is justifiable without some sort of bad actor being involved. From Jamie Dimon’s dismissal of bitcoin to the Mt. Gox whale dumping, media outlets scramble to peg price movements to something. The same journalists even rush to make predictions, suggesting that a major conference or even the World Cup will lead to a major spike in prices. These headlines do get views, after all.

The honest truth is that bitcoin was probably just overvalued at the time. And there’s nothing wrong with that. Though it’s likely to climb much higher in the future, bitcoin’s $18,000 valuation in December was the result of a speculator frenzy and a wave of mainstream media coverage. While there may or may not have been some market manipulation leading up to that point, the run-up echoes other new asset classes in which buyers and sellers are searching for a fair price.

While some of these price movements may have a story behind them, the reality is that bitcoin is a brand-new idea and its value is going to fluctuate with dramatic climbs and falls without any ‘real’ reasons behind the moves.

Yeah, but what about futures?

Currently, futures contracts make up a tiny fraction of the total market.

Mati Greenspan, a senior market analyst from eToro notes: “On average, there are 1-2,000 quant trades on a daily basis,” adding “at most prices for this year, BTC futures form too small a portion of the total market to influence price to a large extent”.

That is not to say that bitcoin prices won’t be impacted by futures contracts at a later date, however.

In fact, these contracts may even have a place in bringing bitcoin to its ultimate destination; a usable currency.

Though a point of controversy in many markets, the role of futures contracts is to reduce volatility and allow traders to utilize a highly liquid investment vehicle. Traders are able to take ‘long’ or ‘short’ positions, making bets on the future prices of different commodities. In turn, these bets allow investors a means of hedging against drastic price movements and finding a fair price for their commodity.

For instance, someone who is majorly invested in the idea of bitcoin as a currency and needs, say 100 bitcoin to get through a six month period, can buy a bitcoin futures contract in order to hedge against the possible increase or decrease in the price of bitcoin, effectively minimizing their potential losses. The same can be said about a business that operates using bitcoin. And because these hedgers own and rely on the cryptocurrency, its in their best interest to aim for less risky bets.

As always, however, it’s not so black and white.

While futures contracts could effectively help hedge against rising or falling bitcoin prices, there is another player in the game: the speculator.

Speculators aren’t looking to reduce risk or volatility. In fact, they may actively encourage it through risky bets. This is where big money can actually move markets for the worse. Either through pumping the price of the commodity or shorting it, essentially betting that it will lose value.

Though speculators pose a larger problem in small markets, they are still a necessary force in determining the true value of a commodity. The closer a contract gets to expiration, the smaller the spreads become and the more information a market has to realize a ‘truer’ price for that commodity.

Where does bitcoin go from here?

There’s wild predictions heading in every direction. Some say to $1,000,000, others say to $0, but no one really knows. With as much hype there is around the price, the one thing that will finally make it acceptable in the mainstream is a reduction in volatility.

Though bitcoin futures are not the only answer to this dilemma, they’re not the evil financial instrument that they’re made out to be… mostly.

By now, most can agree that bitcoin will do both: Rse and fall. With futures contracts, investors and spenders alike can at least mitigate their losses if they play their cards right.

Please note: This isn’t investment advice – always do your own research, and remember that this is still a brand new market, and a brand new idea.

Image from Pixabay.

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Texan living in Mexico, new tech enthusiast, decentralization fan, cryptocurrency enthusiast, geopolitical junkie, digi-explorer, and music lover. I believe that we are on the cusp of a new frontier in how we will view the government, money and energy. Let’s be a part of it, together.

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