- The introduction of futures trading should mean that volatility in the Bitcoin spot market will come down over time.
- Bitcoin (BTCUSD) is more than -14% off last week’s high but +24% off of last week’s low; the CBOE saw two trading halts overnight.
- Unfamiliar with the cryptocurrency market? Familiarize yourself with the Introduction to Bitcoin trading guide.
The arrival of Bitcoin futures marks the beginning of a new era for cryptocurrencies. The perception of legitimacy that comes with trading on the futures market – a regulated market, mind you, unlike the unregulated spot market for Bitcoin and other cryptocurrencies – means that otherwise disenchanted institutional and professional investors will be more comfortable engaging with Bitcoin.
The introduction of the futures market should also have one important impact on Bitcoin longer-term: reducing volatility. When traders look to exploit the difference between where they feel where prices will be over time and where the futures contract is priced – arbitrage, or trading against the forward bias in FX markets – volatility tends to be dampened in the spot market.
As a result of the process of price discovery with the new futures contracts, the dampened volatility may ultimately provoke a positive feedback loop that sees confidence in Bitcoin’s stability grow. In turn, this should result in greater institutional flows into the cryptocurrency space. As observed in equities, bonds, commodities, and FX markets alike, greater liquidity tends to mean lower volatility. Perhaps this means that the explosion of volatility seen in recent weeks won’t be repeated that often in the future.
ORIGINAL: Chart 1: Bitcoin (BTCUSD) 2-hour Timeframe (December 1 to 11, 2017)
UPDATE: Chart 2: Bitcoin (BTCUSD) 2-hour Timeframe (December 1 to 18, 2017)
Through the price discovery and liquidity infusion process that come along with the introduction of futures, we’ll also learn more about whether or not Bitcoin can be classified as being in a bubble (the current market cap of the entire cryptocurrency space is just north of $450 billion). At the end of the day, more liquidity, particularly with the introduction of two-way trading via futures, shouldn't necessarily just inflate prices.
Here are a few different scenarios to watch for as the ‘bubble litmus test’ over the coming weeks now that futures are operational and Bitcoin begins to take on characteristics of a more traditional asset:
1) With new buyers coming in now, one could argue that a further uptick in volatility, regardless of direction, would suggest that the market is unstable, and that a bubble is present.
2) If volatility falls but price falls with it, then implicitly this would also be evidence of a bubble as the underlying fundamentals ultimately proved relatively disappointing prior to price discovery.
3) If volatility falls but prices stay stable or rise, then this would suggest that Bitcoin and cryptocurrencies in general are not in a bubble.
After discussing whether or not Bitcoin was in a bubble back in October, my colleague Nick Cawley and I will be back on Tuesday, December 12 at 7:00 EST/12:00 GMT for the next webinar in our special series on Bitcoin trading and strategy – you can register here. We’ll dig further into the implications of the introduction of Bitcoin futures and what it means for the cryptocurrency market in general.
This note was originally published on December 11, 2017.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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