I know little about the technology behind Bitcoin or Blockchain or Crypto Currencies but I can tell whether an investment tool is purely for speculation or serves a more useful purpose. I can’t define exactly what a purely speculative instrument is but as Supreme Court Justice Potter Stewart said in his threshold test for obscenity “I know it when I see it”.
The Chicago Mercantile Exchange, CME (Futures Exchange), introduced the Bitcoin Futures back in December, 2017, as you might have guessed, at the very top of the bitcoin speculative frenzy.
Bitcoin price dropped nearly 65%, since the listing of bitcoin futures, and then rebounded 50% from the lows. Now it is still more than 50% off its highs. That is some extraordinary volatility in a contract that is cash settled – there is no delivery of actual bitcoin but only settlement of gain/loss. The initial margin for Bitcoin futures is about 50% of futures contract value, which is much higher than say an equity index futures contract where the initial margin would typically be around 10%. So the exchange and the regulators have recognized the inherent price volatility in this contract and set the initial margin extremely high. That still provides a 2X leverage on an “asset” that is extremely volatile.
Before bitcoin futures were available there was no way to take a short position in the value of bitcoin or use leverage to participate in bitcoin price movement. But today someone can do exactly that using the bitcoin futures. Perhaps this is one of the reasons why bitcoin price has dropped precipitously since the listing of bitcoin futures. Now some speculators can put their money where their mouth is. This may be a good thing as investors can now fight it out and set the right price for bitcoin. However this argument only holds true for assets with cash flows or some other fundamental measure of value. Bitcoin doesn’t seem to make the cut. The price is simply based on what the other person is willing to pay. All this lends to the thesis that Bitcoin Futures is a purely speculative instrument.
I actually think that Bitcoin futures may provide some counter balance to the irrational price movement in Bitcoin, precisely because now someone can short Bitcoin using the futures contract and impose some price stability.
There are far worse instruments out there such as Bitcoin funds that trade at a 50% premium to NAV (price of Bitcoin) and a 2.0% expense ratio. I wonder what investors get for that 2.0% expense ratio and why would anyone want to pay a 50% premium on the underlying price. If someone wants to buy Bitcoin for whatever investment merit that they see in the crypto currency that is fine. But regulators should not make it easy to speculate through the proliferation of trading instruments or provide easy access to leverage.
Now it looks like the regulators themselves want to get in on the speculative action as Bloomberg reports.
Speculator beware or should it be Regulator beware! Let’s see who is wearing shorts when the tide goes out.