Big Banks Hack Regulation To Bet On Bitcoin

Mining bitcoin

Some commentators, like those at CoinTelegraph, CNN, USA Today and elsewhere, point out that bitcoin’s recent run-up may coincide with the debut of futures markets on the Chicago Mercantile Exchange. Since the announcement, a bitcoin futures market launched on the Chicago Board Options Exchange (CBOE) on Sunday, December 10th. One week later, CME’s bitcoin futures market launched.

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And in the last week or so, paperwork for two new bitcoin ETFs have been filed with the SEC, despite recent cautionary messaging and looming regulatory crackdown on crypto-driven funding schemes.

So what bearing does this recent interest by Wall Street types have on the price of bitcoin? It’s tempting to chalk all this up to a fairly simplistic explanation of “it’s more demand.” And in broad strokes, that’s correct. And we’ll get to the why on that in a moment.

But first, let’s get a renewed understand of just how wildly Bitcoin has exploded.

Hockey Sticks Are Back

When markets are doing well, investors like to say “it’s all going up and to the right.” But in the case of many blockchain-based assets, the direction is more straight up.

This rocket-like trajectory is clearly evident in a one-year chart of bitcoin’s price, which we’ve plotted using data from CoinDesk’s Bitcoin Price Index (BPI), which averages the price of bitcoin across a number of exchanges.

In just the past six months, the average price of bitcoin has grown nearly sixfold.

Between mid-December 2016 and the CoinDesk BPI’s all-time high on December 16, 2017 – a staggering $19,661, bitcoin’s price has increased by around 2,360 percent. A $2,500 bitcoin investment made last year would be worth over $61,400 at recent peak prices. As a reminder that this kind of return is not normal, that $2,500, if invested in a popular S&P 500 exchange-traded fund in mid-December of last year, would be worth just shy of $3,000 today—a comparatively paltry 20 percent return.

But in the world of bitcoin and other cryptos, traders with a resistance to whiplash and strong stomachs can see 20 to 30 percent swings within the same week. As the chart below shows, again using data from the CoinDesk BPI, the last week alone has been something of a roller coaster for average bitcoin prices.

In just the past ten days, bitcoin’s price broke out of a comfortable channel in the $13,000-$15,000 range to reach as high as $20,000 on some exchanges. To put the rise into some perspective, bitcoin was trading at around $8,000 just months ago.

It really is a remarkable rise. And one that isn’t driven by racks of fancy computers crunching math equations.

The Open Arms Of The Old Guard

New York has the NYSE and NASDAQ. And Chicago, the so-called Second City, is second to none when it comes to trading in financial derivatives.

Chicago is home to the Chicago Board Options Exchange (CBOE) and the CME Group, which runs a number of markets trading everything from agricultural commodities to Federal Reserve credit spreads. Among the most popular derivatives traded on these exchanges are known as futures contracts. And as we alluded to above, both exchanges have recently launched bitcoin futures contract markets. Announcements and the ultimate launch of these markets coincided with the uptick in bitcoin prices, so let’s see why.

Bitcoin: The Way Of The Futures

Put simply, a futures contract is a legal agreement to buy or sell a certain amount of a commodity at a predetermined price at some known point in the future. Typically, futures contracts can be traded from the time they’re created up until the settlement date, meaning that these contracts can change hands many times.

In the case of agricultural commodities, that might be 5,000 bushels of soybeans delivered in June 2018 at $9.50 a bushel. If by next June the market price of soybeans climbed to $11.00, the holder of the futures contract would have saved $1.50 per bushel on the deal.

In the case of these bitcoin futures, they’re settled in cash. No actual bitcoins trade hands here.

In short, bitcoin futures contracts serve as a vehicle for regulatory arbitrage—a clever and entirely legitimate “hack” around the rules—that allows institutional investors to get in on the crypto action. Gabor Gurbacs, director of digital asset strategy at VanEck Associates Corp told Bloomberg “one of the biggest issues when it comes to investing institutionally in digital assets is banks and larger institutions can’t hold an unregulated instrument in their balance sheet, and a futures contract is something they can hold.”

Jeffrey Carter, a former trader and current angel investor based in Chicago, told Crunchbase News “futures on an established regulated exchange that are cash settled does solve the ‘holding’ problem since it’s a pure speculation on price, without exposure to the actual asset.”

In other words, these new futures markets allow institutional investors to hold something that kind of looks like bitcoin, (random) walks like the price of bitcoin, and quacks like bitcoin, without actually having to hold bitcoin itself. This opens up bitcoin to a new set of investors – ones with very deep pockets – that didn’t previously have access to the asset class.

The Big(ger) Short

Bitcoin futures also provide a way to bet against the cryptocurrency, something investors haven’t been able to do easily in the past.

Although institutionally-traded bitcoin futures have been available for a very short time, contract prices had demonstrated some stability. That is until Interactive Brokers, a large online brokerage that was among the first to lets its customers trade in bitcoin futures contracts, announced on December 13th that it would begin to accept short sales on the CBOE contract. According to coverage by CNBC, that announcement coincided with a near-immediate ten percent decline in futures prices before recovering to close at five percent lower for that trading day.

Remember, bitcoin futures have only been “a thing” for a little over a week at this point, so the full effect of traders’ bets on the future price of bitcoins on the price bitcoin trades at right now hasn’t been clearly established yet. It will be interesting to see how (or if) short sellers of futures contracts are able to move bitcoin’s spot price lower if and when market sentiment turns negative for the world’s most valuable cryptocurrency.

It Takes A Village To Inflate

Of course, this adoption of bitcoin by the stodgier side of the financial ecosystem is only one factor in bitcoin’s dramatic price appreciation. After all, it’s not just professional traders bidding up the price of crypto. Crypto mania has also extended to Main Street as well.

Joseph Borg, a regulator at the SEC, observed in a CNBC interview that some Americans are taking out home mortgages to invest in the volatile asset.

Recently, published an article outlining the “3 Easy Steps” to “Getting Bitcoin Onto Grandma’s Android Phone.” This kind of consumer-focused exuberance has led many, including Bloomberg columnist Matt Levine, to publicly state that we may now be in some sort of bubble.

But if there’s one thing to be sure of, hews and cries of “bubble!” have been ignored in the past, and most folks calling market tops have been incorrect as prices kept marching upward.

Illustration: Li-Anne Dias

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