Let’s go back a couple of years and remember what it was like when Bitcoin was surging to new highs and people were selling their houses and taking out loans to buy Bitcoins. Obviously, in hindsight it’s easy to say it was a bad decision but I am more interested in the future and what is going on with the digital gold now.
The only way to get a piece of the action was to buy Bitcoin itself back then. Now due to financial innovation, we have fractional investments, futures, options, CFD’s and even perpetual contracts. What impact did this have on Bitcoin?
When you trade derivatives, it doesn’t move the actual price. So regardless of how many futures contracts or spread betting positions you have, it will not change the price of the underlying asset.
Bitcoin Futures – These are contracts to purchase at a future value. If you buy a 1-month futures contract you are betting that the price will be higher in 1 months time. This is a margin traded instrument and unless you redeem your contract at the end of the month you will not own any real Bitcoin. The futures price is actually governed by supply and demand but it still will not directly affect the physical Bitcoin price.
Bitcoin Options – Again this is the option to buy or sell at a point in the future. With a 1 month Bitcoin options contract you can buy a put (bearish) for a call (bullish) position. If you buy a call you pay a premium to be able to purchase the Bitcoin at the expiry point (in this case 1 month). If you buy a call and the price falls you pay the premium to earn the difference between the price at the time and the price if it falls to the level you want in the month. When the trader is bearish on Bitcoin, he/she can purchase put options to profit from a slide in asset price. The price of the asset must move significantly below the strike price of the put options before the option expiration date for this strategy to be profitable. Now you can get to own the Bitcoin if you take physical delivery of the asset at the end of the contract term but traders rarely do this.
Contract for Difference (CFD) – This is another margin related product where you do not need to own the underlying asset. In this case, a broker will ask you to have a certain percentage of the value of the asset and you can buy or sell to profit or go long or short. Again when trading CFD’s you do not affect the underlying price. Sometimes the broker will actually own the asset for you if you go long or short.
Spread bet – With this asset, you do not actually own the asset at all. You simply just made a bet with the broker about the direction you think the asset will go. It’s as simple as buying when you think the price will rise and selling if you think the price will fall.
Perpetual or Swap contracts – This is very similar to a futures contract. This is an agreement between counter-parties to buy or sell an asset at an explicit price but with no expiry or settlement. The buyer is obligated to buy the underlying asset a specific price once the contract expires, and the seller is required to furnish the asset at the time of expiry. This is all margin-based to so it can be very volatile.
What does this all mean for Bitcoin?
Back in the day when you wanted to buy or sell Bitcoin you had to do it physically via your exchange. Now there are all these options and as you can see from the information above not many of them actually affect the underlying price. I have done some analysis on the exchanges that offer the services and they have taken away a lot of volume from the old physical exchanges.
So if you are bullish on Bitcoin now you have soo many options other than just buying it physically like before. Is this changing the dynamic of the market?. Of course, it is, part of the reason for the euphoric rise was the flood of volume. Bid upon bid pushing the price higher. Now some of those large funds and deep pockets are moving into more regulated spaces like ICE’s Bakkt futures and options or CME’s Bitcoin futures.
All in all, the market is now more sophisticated and that means more stable and less volatile. The days of the price pump may be over as lots of volume has moved into crypto derivatives.