Jason Potts and Marie-Anne Cam: With a new futures market, Bitcoin is going mainstream

The Chicago Mercantile Exchange will soon begin trading Bitcoin derivatives (futures contracts), signalling the cryptocurrency is now a mainstream asset class. Bitcoin has had limited use in the mainstream economy in part because the volatility of its price. The value of the currency might go up or down significantly between the time a deal is struck and delivery.

The introduction of Bitcoin futures contracts will allow investors to manage this risk, and make it safer to hold and trade in Bitcoin. This will make the cryptocurrency more accessible to individuals and businesses, and encourage developers to build more products and services on top of the technology.

Futures and other derivatives are contracts between two parties to fix the price of an underlying asset (currencies, shares, commodities etc.) over a period of time or for a future transaction. The buyer of these contracts commits to purchase the underlying asset at a set price and at a certain date, and the seller commits to sell.

There are two main uses for these contracts. First, to reduce price risk by freezing future prices. The second use is speculation. For instance, a speculator would commit to buy a commodity/share/currency at a certain time, hoping that the market price at the time of delivery is higher than the price set in the contract.

Airlines commonly buy long term oil future contracts to hedge against the potential increase in fuel price, or to take advantage of what they believe to be a low price.

Similarly, future contracts will enable traders to lock in the value of Bitcoin for a defined period of time. This effectively removes the risk associated with fluctuation in value. In addition, since these contracts will be traded on the Chicago Mercantile Exchange, the exchange effectively guarantees that both buyers and sellers will abide by the agreement.


Read more: Price hikes in Ether and Bitcoin aren’t the signs of a bubble


In 2010, one Bitcoin was worth less than one hundredth of an Australian cent. As of Monday the 6th of November, the price is near A$10,000.

The market capitalisation of Bitcoin is now well over A$160 billion, which is larger than the GDP of most small countries. As the price of Bitcoin has grown, so too have transaction volumes, showing an increasing use of the cryptocurrency.

As a result, Bitcoin is starting to look like a credible investment in any respectable financial portfolio.

Although, this is not the first futures contract for cryptocurrency. Futures contracts already exist for both Ethereum and Monero.

But the Chicago Mercantile Exchange’s futures contract is significant as the CME group manages not only the Chicago Mercantile Exchange, but also the Chicago Board of Trade and New York Mercantile Exchange and Commodity Exchange. Combined, these exchanges represent the largest derivative market in the world.

The decision to issue futures contracts on Bitcoin rather than another derivative is also significant. So far Bitcoin derivatives have mainly been swap agreements. A swap is a commonly used financial tool where two parties agree to swap financial instruments, such as interest or currencies. The key point is that the two parties, the buyer and seller, make a deal directly with each other.

As a swap agreement is not done through an exchange, the risk of a party not delivering on the agreement can be quite high. If one party decides to opt out, the agreement has to be terminated. This leaves the other party exposed.

Futures contracts eliminate this “counterparty” risk, as the exchange clears the transaction and guarantees delivery. And unlike swaps, futures contracts are standardised (in term of size, how much is going to be traded, and maturity date etc.). This means futures contracts can be traded at any time until maturity, making them very liquid and accessible.


Read more: Taking Bitcoin to the stockmarket won’t do much for its risky image


The lack of a futures market in Bitcoin was a significant barrier to it becoming a mainstream asset class. You can buy and sell forward contracts on the Fijian dollar, for instance, meaning that institutional funds anywhere in the world can hold Fijian dollars in their portfolio and manage the risks of that asset.

But they cannot yet do that with Bitcoin. Until now, there has been no way to offload the risks associated with fluctuating prices. An investor could always hold the cryptocurrency, but they would do so fully exposed to price volatility.

The introduction of Bitcoin futures contracts will allow traders to hedge against this volatility and eliminate the currency risk. This will make Bitcoin more attractive for both individuals and corporations.

As crypto-assets become a mainstream investment class, other products emerge around them (such as exchange traded funds). It will also have a similar effect to that of mainstreaming share ownership – enabling a much larger fraction of the population to diversify their asset portfolios and income streams.

This will unlock some of the value currently being built on cryptocurrencies and blockchain technology – new products and services – that are currently only accessible to a relatively small number of the early enthusiasts and those helping build the technology.

The ConversationThe increased flow of investment funds into Bitcoin will likely push prices up further, but it will also incentivise more work to build products and services on the technology. Bitcoin just went mainstream.

Jason Potts, Professor of Economics, RMIT University and Marie-Anne Cam, Senior Lecturer in Finance, RMIT University

This article was originally published on The Conversation. Read the original article.

This entry was posted in Guest Post. Bookmark the permalink.

32 Responses to Jason Potts and Marie-Anne Cam: With a new futures market, Bitcoin is going mainstream

  1. hzhousewife

    Have any limits been placed on the number of cryptocurrencies to be created? Bitcoin may be one of the earliest, but many many others are now available, to my mind each new one dilutes the value of the others.

  2. Oh come on

    It used to be that the energy required to power the computers that mine BTC cost far more than the value of the coin mined – Bitcoin mining was only a profitable enterprise if you stole power from the grid or stole processing power from other computers. However, when I read that, the BTC price was well under USD1000/1. Now that it’s gone through the roof (and processing power has similarly increased), I wonder if it’s again profitable to mine BTC.

  3. JC

    As a result, Bitcoin is starting to look like a credible investment in any respectable financial portfolio.

    Why?

  4. Back Burn

    Have any limits been placed on the number of cryptocurrencies to be created?

    No

    https://dev.cryptolife.net

  5. Mak Siccar

    Remember the old business adage: when you can’t see who’s being screwed, it’s you. Hi

  6. Mak Siccar

    Ignore Hi. Fat finger syndrome.

  7. J.H.

    I always tend to look a these kind of financial things this way….. The moment that something becomes available to the Ma and Pa investor, is the moment to sell…. Because she’s goin’ down.

    Plus I keep getting this horrible feeling that all currency in general, not just Bitcoin, is going to become worthless… Current World Debt is at 200 Trillion…. The bureaucratic economy is devouring the real economy and making money worthless. The State is just going to “own” everything anyway and dole it out via the Welfare State…. The Socialists probably can’t believe their luck.

    To be honest, I think Bitcoin is still worth one hundredths of a cent…. It’s just that all our money has devalued to the point that Bitcoin’s old value is now a freakin’ fortune. It hasn’t changed, but our money has…. and that’s just really sad.

    My hard earned savings and money is already worthless.

  8. ar

    I’m only trading it if it’s open outcry

  9. ar

    Limit down bitcoin will be fun!

  10. ar

    Finally, an instrument to short crypto!

  11. Tel

    The Chicago Mercantile Exchange will soon begin trading Bitcoin derivatives (futures contracts), signalling the cryptocurrency is now a mainstream asset class.

    To me it signals that there are people out there for whom Bitcoin is just not volatile and exciting enough, so they want the additional leverage that derivatives can provide to make it really, really, risky.

    Good on them for that! We need people willing to take risks and speculate.

    Don’t think I’m discouraging anyone, but it’s a whole new level of crazy that I just don’t feel comfortable going anywhere near.

  12. I’m with Buffett on this. Don’t invest in anything you don’t understand.

  13. Nato

    Reading publications out of the blockchain innovation hub always make me wish I was involved in the research… If only I knew stuff. Need an administrator? I’d file the chit out of this paperwork.

  14. Sinclair Davidson

    Need an administrator?

    Actually yes. Send me a CV.

  15. ACTOldFart

    So, one of the great positives of Bitcoin was supposed to be that it allowed you to transact directly, without an intermediary. And now it’s going to be made even more fabulous by having its futures traded through …. an intermediary?

  16. Oh come on

    Short BTC all you want – I wouldn’t as you’ll probably lose your shirt or at least your collateral. That’s not to say BTC’s value won’t collapse at some stage, but who knows when? You’d have to be very lucky to short it at the right time. And it really is down to luck. Currently, there seems to be a need for this kind of currency throughout the world.

  17. alexnoaholdmate

    Go away for a few weeks, come back – and everyone has a new avatar, and the site’s flooded by newbies.

    Cool.

  18. Zatara

    $300m in cryptocurrency accidentally stolen and lost forever due to bug

    Could someone explain how safe cryptocurrencies are again?

    This $300 million wasn’t even hacked and stolen, it was fat fingered and lost forever.

  19. GD

    I’m waiting till ‘Bitcoin For Dummies’ is published. Does Coles accept bitcoin? Can I use it in a vending machine? So many questions.

  20. Gbees

    Ooh. Sounds like I should accept the Bitcoin offer I got via mobile SMS. I was offered $14,343.10 worth of Bitcoins if I hand over my account number. Bitcoin, just another scam and there are plenty of takers as per usual.

  21. Bad Samaritan

    Hmmmm. There seems to be plenty of very ignorant, very anti-Bitcoin commentary on The Cat….based on nothing but fear of new technology….All so baseless. As an antidote, consider the following…….

    My brother-in-law was recently contacted by a Nigerian Prince who has 100 billion Bitcoins he needs to blockchain out of his homeland. Already, with his house remortgaged, and his superannuation prematurely withdrawn to help this Prince, my usually gullible loser of a B-in-L is making me look rather stupid as his crypto fortune heads for the stratosphere. Thus, not wanting to become the laughing stock of the family,I too have joined the Nigerian “Building the Bitcoin Revolution” bonanza and sent all my old-fashioned fiat currency savings to Lagos.

    Only a dope would not jump aboard this train, I tell’s ya. Do not dally a second longer, fellow Catses!

  22. Speedbox

    Have any limits been placed on the number of cryptocurrencies to be created? Bitcoin may be one of the earliest, but many many others are now available, to my mind each new one dilutes the value of the others.

    There are currently about 1100 crypto currencies with new issuing occurring at about 1-2 per day.

    Important note: Most of the current crop of crypto currencies will fail (and take the money invested with them). As a guide, I reckon about 90% of the current crop will eventually fail. To be fair, there are a number of “pump and dump” scams out there but the greater truth is that the majority of failures will be due to the cryptos never raising the amount of money necessary to undertake the (blockchain or other usage) research and implementation they aspire to. (or, they will spend all the money before producing anything of real value to the market).

    Therefore, selecting cryptos to invest in is a minefield.

  23. Diogenes

    An international group of quantum boffins reckons Bitcoin could be broken by the year 2027.

    The researchers from Singapore, Australia and France say that scenario represents the worst case, and would see a quantum computer able to run Shor’s algorithm against the cryptocurrency’s protective elliptic curve signature quicker than the 10 minutes Bitcoin needs to record a transaction in the blockchain.

    Cough cough
    https://www.theregister.co.uk/2017/11/09/quantum_computers_could_crack_bitcoin/

  24. Speedbox

    It used to be that the energy required to power the computers that mine BTC cost far more than the value of the coin mined – Bitcoin mining was only a profitable enterprise if you stole power from the grid or stole processing power from other computers.

    Mining occurs all over the world but a lot now occurs in China (and Asia more generally), Russia and a number of other countries that have cheap power. (As an aside, I understand that North Korea has a growing program to mine (and steal if possible) Bitcoins or dominant altcoins such as Etherium).

    There are also substantial operations in the USA and parts of Europe.

  25. Speedbox

    This $300 million wasn’t even hacked and stolen, it was fat fingered and lost forever.

    The coins were not stolen and they are not lost – everybody knows exactly where they are – they just can’t be accessed by their owners (or anyone) at the moment. There is a solution to unlocking/returning the coins to their rightful owners but it is messy and a headache. But, I expect we will hear this matter will be resolved in a relatively short period of time and the new code will prevent this from happening again.

    Remember that cryptos and the blockchain is evolutionary (revolutionary?) technology. Mistakes happen. But, mistakes are good in that they highlight the flaws that need fixing.

  26. Speedbox

    Does Coles accept bitcoin? Can I use it in a vending machine?

    Not yet. But Bitcoin ATMs already exist.

  27. Zatara

    From my previous link:

    “Some are pushing for a “hard fork” of Ethereum, which would undo the damage by effectively asking 51% of the currency’s users to agree to pretend that it had never happened in the first place. That would require a change to the code that controls ethereum, and then that change to be adopted by the majority of the user base. The risk is that some of the community refuses to accept the change, resulting in a split into two parallel groups.

    Such an act isn’t unheard of: another hack, two years ago, of an Ethereum app called the DAO resulted in $150m being stolen. The hard fork was successful then, but the money stolen represented a much larger portion of the entire Ethereum market than the $300m lost to Parity.

    The lost $300m follows the discovery of bug in July that led to the theft of $32m in ether from just three multisignature wallets. A marathon coding and hacking effort was required to secure another $208m against theft. Patching that bug led to the flaw in Parity’s system that devops199 triggered by accident.

    Parity says that it is unable to confirm the actual amount lost, but that the $300m figure is “purely speculative”. The company also disputes that the currency is “lost”, arguing that “frozen” is more accurate. But if it is frozen, it appears that no-one has the ability to unfreeze the funds.

    “The Parity vulnerability was the result of an incorrectly coded smart contract used by the Parity wallet to store tokens on the Ethereum network,” said Dominic Williams, founder of blockchain firm DFINITY. “The vulnerability made it possible for anyone to ‘freeze’ the tokens held by that smart contract, making them immovable. At this time, the only method we are aware of to ‘unfreeze’ tokens held by the vulnerable smart contract would be to create a new ‘hard fork’ Ethereum client that deploys a fix. This would require every full node on the Ethereum network to upgrade by the date of the hard fork to stay in sync, including all miners, wallets, exchanges, etc.

    Yeah, until the next time it gets hacked or “an incorrectly coded smart contract” gets deployed.

    No thanks.

  28. Speedbox

    What corporation or person who makes, grows, mines or transports tangible things actually accepts bitcoin for payment?

    No major corporation that I am aware of – at the moment. It is possible to buy a cup of coffee and cake at some of the trendy type stores in Brisbane’s West End and, I understand similar style stores in most capital cities around the country.

    But this usage availability is irrelevant – who cares. What is vastly more important is that UPS, Amazon, Shell, BP, a host of global banks (including all major Australian banks) and others are devoting significant resources to examining how the blockchain technology can benefit their businesses. Those major companies are not necessarily developing the technology per se, they are investigating its development, potential use and alignment with their own requirements. (this is a huge subject!)

    Anyway, to be fair, blockchain and cryptos are different – although they share a common thread. In fact, many cryptos are created to raise money for the research into blockchain technology whilst pursuing their goal of implementing their particular coin.

    For example, there are coins that their designers (hope) plan will be used as a uniform global currency for travel; others for eLibraries; others for purchasing legal marijuana; others for trading excess solar power……..the list is as varied as it is, in some cases, bizarre. The one common link is utilizing blockchain technology.

    It is obvious that many of the coins will fail but, I believe that cryptos in general and blockchain in particular, will forever transform the way we do business. The trick is being able to pick those cryptos that have a viable future and simultaneously, invest in those companies that are directly engaged in developing either the blockchain or ancillary services.

    I have said on other threads that this is the “wild west” of investing. It is late stage 1 or early stage 2 of the investment cycle meaning that the risks are very high. Don’t put your house or superannuation on it, but the returns could be once-in-a-generation if you research and understand the market before investing.

  29. OneWorldGovernment

    Sinclair,

    Could you put all these blockchain posts onto an accessible dedicated website, either at RMIT, or elsewhere.

    I see that the original presentation has generated a lot of global interest and it would be nice to capture all that interest and thought.

    Cheers.

Leave a Reply

Your email address will not be published. Required fields are marked *