To date the cryptocurrency frenzy has largely been driven by retail investors from Asia. Approximately 40% of bitcoin trading is yen-denominated, and by the end of November, Japan, South Korea, and Vietnam accounted for nearly 80% of the global bitcoin trading, with the US accounting for just 20% of the total volume. That means that U.S. institutions have largely been on the sidelines while bitcoin and its progeny have experienced parabolic returns. Since Wall Street isn’t exactly known for letting money-making opportunities just go by, the dearth of institutional participation in the cryptocurrency market begs the obvious question – why is this happening?
There are several possible explanations for the absence of institutional capital. For starters, there’s very little regulation or oversight by the Securities and Exchange Commission, which means there’s a greater opportunity for malfeasance. Additionally, the currencies are extremely volatile, and there’s a lack of reliable price discovery. Bitcoin trades on over 100 exchanges around the world, and there’s usually some level of price discrepancy on many of the exchanges. There’s also insufficient liquidity in the market, so large traders can’t easily get in and out of trades. Finally the cryptocurrency market has historically been long-only, meaning only people that love crypto, buy crypto. All of this results in a conclusion shared by many, that the entire cryptocurrency market is a giant bubble. Any one of these factors could be enough to discourage meaningful institutional investment from entering the market in a real way.
Earlier this month however, the Cboe Futures Exchange (Cboe) launched a bitcoin futures product. The launch of bitcoin futures marked a significant milestone of sorts for the currency, as futures allow investors to bet either long or short on the future price of the underlying commodity, and use leverage to do so. Ostensibly this would open the door to larger investments, because the futures market is long and short, and using leverage allows investors to place larger bets.
Like many others, I was expecting the bitcoin skeptics in the U.S. and around the world to step in with full force and attempt to drive down the price of bitcoin. Since the futures market can impact the spot-price of the underlying asset, if enough capital were wagered on a bitcoin price decline in the nearest month, the spot-price of bitcoin would likely also go down. And if people like JP Morgan CEO Jamie Dimon believe that bitcoin is a “fraud”, what better way to profit than to bet heavily on its demise?
But when the CBOE market opened, that didn’t happen. In fact, nothing really happened, as the price of bitcoin (on Coinbase) stayed relatively flat after the futures launch. Then history repeated itself this past Sunday, when the worlds largest futures market, the Chicago Mercantile Exchange (CME), launched its own bitcoin futures product. Once again the price of bitcoin held steady, and as of this writing, the price for bitcoin is $18,7090 on Coinbase.
So what happened?
In short, Wall Street is still predominantly on the sidelines. The muted response from institutional investors wasn’t due to lack of conviction on the buy or sell side, but rather a lack of access to the futures market. Many brokerages like Bank of America Merrill Lynch and Citigroup would not allow their customers to trade bitcoin futures. The reason is because if a customer defaults on a futures obligation, the broker is on the hook for the payment. By and large, the brokers felt that the bitcoin futures were rushed to market without sufficient testing, and were therefore too risky and unstable to support. One reason is that the cryptocurrency market trades 24/7/365, while most trading desks take off weekends and market holidays. So what happens if a customer buys a bitcoin futures contract on Friday night, and the price of bitcoin craters over the weekend as happened with Mt. Gox? Every long contract would be significantly under water when the exchange opened on Monday morning, and some of the holders might not be able to buy back their position to cover. It could be a complete disaster.
The concern from the brokerage industry was so pronounced that the Futures Industry Association (FIA), which represents brokers from around the world, actually wrote a letter to the Commodity Futures Trading Commission urging the agency to stall the release of bitcoin futures until the Commission could further test the futures product. However the FIA’s plea was ultimately unsuccessful and bitcoin futures launched on the CBOE and CME as scheduled.
In addition to the paucity of brokers willing to accept a trade, the select brokerages that are willing to do so had astronomical margin requirements, presumably to hedge against so much potential risk. Bitcoin futures have margin requirements of 35% and 40% at the CME and CBOE respectively, and one futures trader with whom I spoke, told me that many brokers are requiring 100% – 200% margin. By contrast, the margin requirement for an S&P futures contract is approximately 5%.
So with institutions still playing the role of spectator, retail investors traded approximately $40 million of bitcoin futures within the first 8-10 hours of trading on the CBOE. Under normal circumstances, that amount of volume would be considered a strong opening for a new futures product. However had institutions been able to more readily participate in the market, one would have to assume that trading volume would have been exponentially larger.
For most mature commodities, the trading volume in the futures market outpaces the trading in the traditional cash market (also known as the “spot” market), thanks in part to the leverage available to futures traders. However during that same 8-10 hour period of time after the CBOE bitcoin futures opened, roughly $1 billion of bitcoin traded on the spot market. That means that without institutional capital driving the market dynamics for bitcoin futures, the liquidity and price stability that should have come to the spot market, didn’t.
A healthy and robust futures market doesn’t happen overnight, especially for something as disruptive as cryptocurrency. But as the worldwide market for bitcoin continues to grow, we expect the uncertainty associated with the futures products to work itself out over time. Once brokers are able to ease into the market we believe institutional investors will be willing to participate in a more meaningful way.
If and when that happens, we expect the price of bitcoin to correct fairly significantly because it appears as if the skeptics on Wall Street still outnumber the advocates. However, even if the price does correct, we believe that a healthy and robust futures market could ultimately prove to be a good outcome for bitcoin and cryptocurrency as a whole. A thriving futures market should create more liquidity for the currency itself, and better price discovery since there would be investors both long and short. In addition, futures could mitigate (or to a large extent eliminate) the price discrepancies on the dozens of exchanges around the world, creating a more consistent price for bitcoin.
Were this to happen, the net effect could be a more stable price for bitcoin with less spot-price volatility. This in turn, would make it easier for the currency to gain widespread adoption, as buyers may feel more comfortable using bitcoin as it was originally intended (as currency or store of value), instead of a speculative “get rich quick” investment.
 CryptoCompare research
 Coinhills – a cryptocurrency tracking firm
Disclosure and Declaration
Greg Harrison, the author of this article is an independent contractor. Greg was compensated by Sylva to author this article. He owns, or his family owns, bitcoin, etherium, and litecoin.
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