For the better part of the year, we didn’t think we could find anything more volatile than bitcoin. On Sunday, we did just that.
It turns out, bitcoin futures are more volatile than bitcoin itself.
During the first few hours of bitcoin futures trading, which saw a 26% rise, there were no less than two ‘circuit breakers’ triggered. Have a look:
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What are circuit breakers?
Circuit breakers are automatic triggers that halt the market when it rises or falls too fast. Yet most of time they’re intended for crashing markets, not rising ones.
The idea of circuit breakers is simple: In the aftermath of Black Monday — when the US stock market crashed 508 points in one day in October 1987 — authorities felt that there should be something in place to calm panics.
In other words, it was a complete distrust of traders; the circuit breakers were set to curb panic selling. Regulators were pretending to give the market makers and institutional investors the chance to make rational decisions.
These enforced timeouts (two minutes for the first circuit breaker, five for the second, and 15 for third) are designed to give traders a chance to think about their behaviour.
But do they actually work?
In my view, no. If anything, they create an illusion of safety for outsiders — everyday people like you.
Think about it like this: As a trader, you already know what will trigger a circuit breaker. If you want to dump your position, you will do so anyway. But you’ll place your orders through as the first breaker is approaching. Then, when the second breaker is approaching, you’ll do the same thing.
The point is that any trader looking to offload a position is going to sell into the circuit breakers.
Staying calm will be the last thing on anyone’s mind. Each time a breaker triggers, traders will be working to sell faster in order to avoid the market closing on them. If anything, these breakers encourage investors to sell at a quicker pace than they might otherwise.
A particularly horrible scenario for a trader is if the market closes early for the day. If the first or second of these breakers trigger after 3:25pm, markets close and everyone is left out in the cold until the next morning. When you get to a level three breaker, it doesn’t matter what time of day it is, the market closes for the day.
Arguably, anything that interferes with the market is something that you can’t trust.
Make no mistake; circuit breakers aren’t there to protect the smaller participants. I have no doubt they were put in place to appease a select group of people who lost a bucket load of money during Black Monday and want to prevent it from happening again.
However, these circuit breakers also tell us something important.
There is a risk that the bitcoin futures price will drive the underlying bitcoin price in the years to come. The sudden rush into cryptocurrency futures means that the demand for derivatives is strong. But because more investors and larger piles of money can access bitcoin futures, chances are we could see bigger price surges in the futures market than in bitcoin itself.
It happened to gold. The gold spot market was once the driver of the value of gold. Nowadays, gold takes its price direction from the futures market.
Then there is the rumour that a thousand people own 40% of all bitcoin in circulation. Maybe the futures market will allow these guys the chance to escape the crypto. Selling bitcoin futures enables them to lock in a price, knowing exactly what their profits are. They can then sell any actual bitcoin into the crypto market without worrying too much about the bitcoin price.
Which means they may crash the futures market if they don’t plan their moves carefully.
What we do know about bitcoin futures is that, from here on in, the big money is likely to be heavily involved. Which is perfect for you. It means that you can focus on how bitcoin and other cryptos can help grow your wealth.
If you want to begin investing in bitcoin, click here for everything you’ll need to know to get started.
Editor, Markets & Money