Place Your Bets on the Future of Money

This time of year, many people start counting the days until Christmas.

Here at Markets & Money, we are counting down the days until Sunday.


Because the biggest news story of the year is about to get even bigger.

There have been plenty of big stories in 2017 — missile launches on the Korean Peninsula and Russiagate, to name but two.

But the parabolic rise of bitcoin trumps them all.

The future of money is here. And global markets are getting ready to place their bets.

This Sunday, bitcoin’s legitimacy will soar to a new level.

The CBOE Group Inc. launches the first cryptocurrency futures contract on Sunday night.

A week later, the Chicago Mercantile Exchange (CME) will have its own bitcoin futures contract for trade.

This is clearly something the broader market is looking forward to.

On 31 October, a single bitcoin was trading at around US$6,100 (AU$8,080). When CME confirmed bitcoin futures were imminent the following day, the price shot up past US$7,000 (AU$9,272).

Yesterday, bitcoin was trading at US$14,058 (AU$18,621). That’s a 130% increase in just over a month. And a 1,310% rise in the year-to-date.

What’s more, it’s looking like it’s going to break through $15,000 mark any moment now. All bets are off on where the price will be come Monday morning.

Bitcoin USD price 8-12-17

Source: CoinDesk
[Click to enlarge]

However, it’s easy to understand the bitcoin scepticism when you look at that chart. Someone that didn’t know anything about bitcoin might go as far as saying that it clearly resembles a bubble.

And where have we seen a chart like that before? During 17th Century tulip mania.

Take a look below:

Tulip bulbs price chart 8-12-17

Source: Silver Doctors
[Click to enlarge]

The price rises for bitcoin and tulips look eerily similar.

Tulip mania got a little frothy around 1636, galloping up in a straight line. Towards the end of the tulip craze, flowers cost more than houses.

Interestingly, in 1636 — smack bang in the middle of tulip mania — the first ever ‘cash’ settlement for a futures contract was introduced.

The tulip bubble market crashed less than a year later. Crashing so quickly that physical delivery of tulips didn’t take place.

Even though the tulip market tumbled, though, the idea of payment in lieu of delivery remained.

Most futures contracts today have two settlement options: take delivery of the physical commodity, or receive fiat dollars. Meaning you could have 10,000 barrels of oil show up at your door, or you could take the cash.

This crypto futures market will be revolutionary

The crypto futures coming to the market are different. There will be no physical delivery option. If you want your profits, you can only receive fiat dollars.

Because of this, the crypto market is about to get a whole lot more interesting.

Between Wednesday and Thursday morning, bitcoin rose by over US$1,958 (AU$2,592), to US$14,058 (AU$18,616).

I have no doubt the 16% gain in 24 hours is down to many investors piling into the currency ahead of the futures launch.

Which is interesting.

The naysayers are suggesting that, with a futures contract, people will be able to short-sell bitcoin for the first time. That is, people will be able to try and profit from a falling bitcoin price.

Yet the market appears to have shrugged this off.

With the futures market launch, more people will be able to access the bitcoin market. Fund managers can invest for their clients. Pension funds in the US may look at adding some crypto holdings to their portfolio.

However, the biggest concern for some is that futures on cryptos will give ‘big money’ the chance to manipulate it.

At present, the total value of crypto markets sits at around US$300 billion (AU$397 billion). The arrival of futures contracts could easily turn it into a trillion-dollar marketplace. 

Now, some people are excited to see crypto futures. Many are even rooting for the price to fall, so they can ‘buy the dip’ if the bitcoin price happens to tumble.

There’s every chance the bitcoin price will fall at some point. But I’m not convinced that will last for long.

Here’s why:

There are two key reasons why investors use futures:

  • To hedge their portfolio positions; and
  • To speculate.

Let’s start with the speculators. Right now, we know how bullish the market is on bitcoin. In fact, while writing this, there was a US$300 price rise in less than an hour. That’s an incredible gain for a nascent and tiny market.

In other words, we know demand for bitcoin is strong.

What we don’t know is how many bearish bets there are out there waiting in the wings. Insane price rises mean many will be keen to find ways to profit from falling crypto prices.

More importantly, though, is the hedging group. Investors will generally use futures contracts to limit any falls in commodity prices. That way, when they sell the commodity at a lower price, they’ll have made up the loss by using futures to profit from the price fall.

With normal futures, any short-seller must hold the physical asset. If you’re placing money on falling pork belly prices, you must own the pork bellies to begin with.

As mentioned, the key difference with crypto and other commodity futures is access to the physical asset. But because cryptos use a reference rate, no one holds the physical asset…except the bitcoin miners.

Here’s where it gets interesting:

Bitcoin miners naturally like higher bitcoin prices. Mining the remaining five million or so bitcoins is expensive. Exact estimates are tough to calculate. But bitcoin mining now consumes more electricity than 160 countries combined, if you can believe it.

Rising power consumption means rising costs for bitcoin miners. So they have an incentive for the price to remain high.

However, if the bitcoin price falls, that’s fine by them. They can simply use a futures contract to hedge their position. Meaning that, if they suspect the price will fall, they’ll short-sell a bitcoin futures contract and profit that way.

They get to keep the windfall from a falling price AND the recently-mined bitcoin as well.

In other words, they can hoard the asset…profit even when the price falls…and then sell newly-mined bitcoin when the price rises once more.

What does this mean?

The bitcoin market is about to get a whole more interesting.

Kind regards,

Shae Russell,

Editor, Markets & Money

Shae Russell started out in financial markets more than a decade ago. Working with a derivative brokering firm, she helped clients understand derivative markets, as well as teaching them the basics of technical analysis. Since joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications. She holds the record for the highest-returning stock recommendation, in which a microcap stock returned over 1,200% in six months. Ask her about it, and she won’t stop yapping on. For the past two years, Shae has worked alongside Jim Rickards as his Australian analyst, translating global macro trends for Aussie investors, and how they can take advantage of these trends. Drawing on her extensive experience, Shae is the lead editor of Markets & Money. Each day, Shae looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

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