The meteoric rise of Bitcoin, as well as the cryptocurrency asset class as a whole, has brought the concept of digital money into the mainstream. The relative ease of entry and the possibility of realising large gains has led individuals around the world to engage the cryptocurrency markets on a daily basis. If you have a computer, internet connection and risk capital, trading these products via an exchange or CFD provider can be a routine endeavour.
As of December 2017, the launch of standardised Bitcoin futures made participation even easier for traders and investors. Restrictions facing Bitcoin CFDs and tax concerns surrounding trades executed on cryptocurrency exchanges served as formidable barriers-to-entry for many. Products now listed on prominent futures exchanges give U.S. traders in particular the opportunity to engage Bitcoin using the many advantages specific to derivative products.
Bitcoin Futures Products
In consideration of the public interest surrounding cryptocurrencies and the growth potential of blockchain technology, several globally reputable futures exchanges initiated plans to offer standardised Bitcoin futures contracts. Two prominent U.S.-based exchanges, the Chicago Futures Exchange (CFE) and Chicago Mercantile Exchange (CME), launched Bitcoin futures in December 2017.
The first of these products to hit the open market was the CFE's XBT contract. Upon it becoming available, the spot price per Bitcoin spiked by £1500 for the 11 December 2017 session. There were extreme levels of participation during the launch that led to intermittent CFE system outages and a 20% rally in Bitcoin pricing.
Below are the contract specifications for Bitcoin futures on the CFE:
Name: Cboe Bitcoin (USD) Futures
Listing Date: 10 December 2017
Contract Size (Quantity): 1 Bitcoin
Denomination: U.S. dollars and cents
Tick Size: 5.00 points
Tick Value: US$10
Platform: CFE System
One week after the CFE launch, the CME Group proceeded with its own Bitcoin offering.
As the world's largest futures exchange, it was widely publicised and anticipated. However, only moderate volatilities were observed in BTC, with the price falling 2% for the opening session.
The following are the contract specifications for CME Bitcoin futures:
Name: CME Bitcoin Futures
Listing Date: 17 December 2017
Contract Size (Quantity): 5 Bitcoin
Denomination: U.S. dollars and cents
Tick Size: 5.00 points
Tick Value: US$25
Platform: CME Globex
Both products provide traders and investors with a means of engaging the Bitcoin derivatives markets. Nonetheless, there is a considerable difference between the two offerings: size. The CFE contract is based on an underlying asset of one Bitcoin, while the CME instrument is valued in terms of five Bitcoin. This led to the CME BTC's US$25 per tick value in comparison to the CFE XBT's US$10.
The discrepancy in contract size has a significant impact on the pool of participants that regularly interact within each market. The CME offering is much larger in terms of value, making it a more attractive alternative to institutional or high-net worth investors. For the initial six months of BTC trade, institutional participation is credited with boosting volumes in the neighborhood of 50%.
Due to its moderate tick size, smaller retail traders find the CFE Bitcoin contract more suitable. While retail demand for the XBT contract is far from constant, some online brokerage firms have attempted to capitalise upon its popularity. By providing clients with trading options in tandem with equities and ETF instruments, many brokers are positioning themselves to accommodate coming demand.
Will Bitcoin Futures Be A Success?
The success of a new futures contract is far from a certainty. Many fall by the wayside when a lack of public interest negatively impacts traded volumes and levels of liquidity. The eventual result is a delisting of the contract itself.
According to academia, there are three inherent qualities that a futures contract must possess to achieve longevity as a financial instrument:
Demand For Hedging: Commercial producers or financial institutions must have a need for the product when executing their risk management strategies.
Attraction of Speculators: There must be incentive for traders interested in profiting from pricing fluctuations to participate in the market. A broad pool of speculative interest ensures adequate market liquidity and efficient price discovery.
Governmental Cooperation: The regulatory environment must be supportive of derivatives trading in order for a new contract to flourish.
Traded volumes, open interest, institutional participation and speculative opportunities are the typical calling cards of a viable futures contract. These components can be hard to come by, even if the underlying asset class is popular. Failure of futures products based upon global cotton, certified debt obligations and even snowfall are modern examples of new listings falling flat.
Ultimately, the success of the XBT and BTC futures contracts will depend on public interest and trading activity. In order for speculative opportunities to exist, there must be adequate market liquidity and consistent volatility—two characteristics that attract higher levels of participation.
Bitcoin pricing is subject to extreme fluctuations, thus consistent volatility is accounted for. The big question facing its lifespan as a futures product is whether or not there will be enough day-to-day volume to make it a viable trading alternative.
It is a circular concept, but traded volumes attract more traders, which in turn boosts activity and brings more volume. Volumes have been limited for the first six months of trade, but they have also shown signs of growth.
In April 2018, XBT experienced a period of heavy participation measuring almost three times that of normal levels. During the same period, BTC action featured a dramatic upswing, trading two-and-a-half times the normal daily handle. While it remains to be seen if these levels are sustainable in the long-term, the expansion of public interest for the first six months is perceived to be a positive sign.
Although cryptocurrencies are in their infancy, many financial industry professionals view the asset class as being much more than a passing fad. Aside from Bitcoin, products such as Ethereum, Litecoin and Ripple have piqued the interest of not only retail traders but institutional investors.
Upon going public, initial coin offerings for new cryptocurrencies commonly raise investment capital in the tens of millions of pounds. Bitcoin itself has a market capitalisation of over US$117 billion, more than 80% of the companies included in the S&P 500.
With growing popularity and acceptance, cryptocurrencies are projected by many to become the new standard for money in coming years. Financial institutions around the globe have begun integrating blockchain technology into operations. Household names such as Overstock.com, Dish Network, Microsoft and Expedia.com already accept payments via Bitcoin.
In the event that Bitcoin becomes a staple of global commerce, then retail and institutional demand for related futures products will likely do the same. If this is the case, then Bitcoin offerings are poised to remain part of the futures landscape for years to come.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…