At some point this month (probably sooner rather than later), the Chicago Mercantile Exchange has promised to launch a platform for futures contracts trading on Bitcoin. There are quite a few advantages this offers to Bitcoin over other cryptocurrencies, and it offers new opportunities for investment – either bullish or bearish – on Bitcoin, as well as hope for a new era in cryptocurrencies in general.
The first thing potential investors will notice is the ability to sell Bitcoin to another investor at some point in time in the future at a particular price. That’s a futures contract.
In selling this contract, you give yourself a hedge against downward movement in the market, because you already have your currency sold at a future date.
Conversely, the investor you’re selling to is assuming the currency will go up, and he is leveraging that position by paying a premium to you for the contract rather than having to lay the money out for all the currency involved in the contract. He’s only buying the right to purchase Bitcoin from you rather than buy the Bitcoin itself.
So now, there are three new mechanisms for pricing efficiency in the currency. Investors can buy Bitcoin outright, they can hedge against potential future losses, and they can leverage a bullish position in the currency in a way that costs less money to lay out.
The net effect of this on Bitcoin is that the volatility and vast rapid price swings will begin to smooth out a little bit as greater volume in trading enters the market place, and as investors can take both sides in order balance the market better.
The volatility brings up yet other trading opportunities.
Wherever there are futures markets, there are also options contracts traded on those futures. Options contracts allow investors to further leverage their trading positions with either an option to sell futures contracts (a “Put” option contract) for a given price at some point in the future, or an option to purchase futures contracts at a given price at some point in the future (a “Call” contract).
Options contracts on futures contracts are useful to traders to build a whole host of very complex trading schemes that allow the potential to profit from almost any type of movement in underlying futures. This also allows investors to trade on the actual volatility of the futures contract, therefore by extension, in a less connected way, the ability to trade the volatility of Bitcoin.
In other words, rather than focusing on Bitcoin in either a bull or bear position, investors will now have the opportunity to focus only on how far up or down prices move in either direction. An investor trading on upward volatility doesn’t care if the price is moving up or down. He only hopes that the futures he has options on moves in a large direction one way or the other.
For example, an investor might buy a call on a particular futures contract, and simultaneously buy a put on the same contract. This type of trading position is called a straddle. In so doing this, the investor gains most from a large move in either direction. He wasn’t sure which direction it might go, only that it would move in a big way. That is just one type of position, and there are tons more. The fact that investors can trade on this volatility further stabilizes prices by investors efficiently trading the volatility.
So, we will have a market with more stable and efficient price movement than Bitcoin has ever had before, and we will have more investors attracted to Bitcoin than there ever has been before. This does not by any means signal a further bull market in Bitcoin. It means that there will be more interest and less wild swings.
Furthermore, it means that a highly respected exchange, and one of the best recognized in the world is now trading cryptocurrency in the form of Bitcoin. Suddenly, Bitcoin has an entirely new air of credibility and respectability as a legitimate and safe form of investing. This encourages use of the currency and will attract new users along with new investors.
This does not mean that Bitcoin has now won the cryptocurrency battle and will take over all other currency. What it does mean is that other cryptocurrencies are likely to begin trading futures contracts of their own. Bitcoin has only just opened the door. The CME is interested in anything that can attract large volumes of investors, and they will offer other popular cryptocurrencies at some point. We just don’t know for sure when, but the regulatory hurdles are already out of the way.
All of this does mean a new era for cryptocurrencies in general. It will take a little time for cryptocurrencies to move away from the idea of a speculative investment vehicle and begin actual significant widespread use.
There are, by far, more hurdles to use than there are to investment. Try using crypto in any large capacity and you’re probably asking for an annual audit from taxing agencies for the rest of your life, if they take notice. But, at some point, the critical mass needed to overwhelm regulators and taxing agencies will create general acceptance of these currencies as a common form of legal tender trade. How long that will take is anyone’s guess.
This post was written by Danny Chabino.
The views expressed here belong to the author and do not necessarily reflect our views and opinions.
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