Will investors use futures markets to put money in Bitcoin?

With so much happening around the Bitcoin, many experts defined the coin as an illusion, a mass hallucination just like a soap bubble.

Representational Image: Photo: Pixabay

As Bitcoin sparked global craze, many stock exchanges have decided to regulate this digital currency either in the form of commodities or futures.

The trend started from November 2017, when Bitcoin continued to touch new highs on multiple occasions. It was trading around $1000-mark in February 2017, jumped to $10,991 by end of November 2017, and further touched a new high of $19,694-level in first three weeks of December 2017.

With this blockbuster performance, Bitcoin surged by a whopping 141198.21% or 1412.98 times between 2013 and December 19, 2017.

Bitcoin remained only cryptocurrency till 2011 holding 100% market capitalisation. After 2011, over 1300 cryptocurrencies have come into existence so far with a total market cap of over $300 billion.

Bitcoin, however, dominates with 55% market cap, and has emerged as the second most trending global news as per Google's 2017 data.

It got a further boost when two Chicago stock exchanges, CME Group CME and CBOE Holding, launched their own version of Bitcoin futures. Global investment banker Goldman Sach is also stated to be gearing up for trade in the cryptocurrency.

In another development, the Commodities Futures Trading Commission proposed to regulate this cryptocurrency as a commodity like gold and oil.

With so much happening around the Bitcoin, many experts defined the coin as an illusion, a mass hallucination just like a soap bubble.

The Securities and Exchange Commission warned investors to be careful while investing in Bitcoin and other digital currencies. Similar warnings were also issued by the Financial Industry Regulatory Authority.

If you are planning to invest in Bitcoin futures ahead, understanding of few facts in necessary. Firstly, let's have an overview of futures contract and how does stock exchanges trade in this market.

Generally, futures contract allows a trader to buy or sell a particular commodity or financial instruments at a fixed price for a specified time in the future. It mostly acts as a gamble, as a trader bets whether the price of the underlying asset will either go up or down before the expiry date.

Now that bitcoin has been launched as futures. In CME, the contracts will be equal to 5 Bitcoin. The price of one Bitcoin will be the CME Bitcoin Reference Rate, which is averaged from several cryptocurrency exchanges.

Similarly, CBOE contracts will represent 1 Bitcoin, and the price of Bitcoin will be XBT used by the US-based cryptocurrency exchange Kraken.

The settlement in Bitcoin will be cash-based. This means no bitcoin will actually change hands when the contract expires. Just like other contracts, traders will have closed out positions, collecting gains losses on Bitcoin before expiration.

Winklevoss twins in Incrementum report said, "We believe that derivatives are the logical next step in the evolution of the Bitcoin market. In case of Bitcoin to continue to grow, you need to incorporate it into the existing market system."

Dave Kranzler of Investment Research Dynamics thinks that futures can be used to manipulate the price of Bitcoin.

CoinDesk, which tracks the performance of cryptocurrency, explained that the Bitcoin market seems to be excited at all the institutional money that will come pouring into bitcoin as a result of futures trading.

It further highlights that it is possible that the institutional investors, who are negative on Bitcoin's prospects, might utilize futures markets to put money behind their conviction.

Coindesk states that these investors may well send signals to the actual Bitcoin market that sends prices tumbling. Also, the leverage arising in futures contract, especially when they are settled in cash, may increase the volatility in a downturn.

Observing the existing scenario, a thorough study is needed prior to even think of investing in cryptocurrencies.