There has been much speculation on the effect CME and CBOE bitcoin futures will have on bitcoin. Some fear bitcoin futures will give institutional investors the ability to short bitcoin at volumes the community has never seen before and will cause a massive price crash. Others think that the massive inflow of institutional money will push bitcoin prices to heights beyond the community’s imagination. In response, Andreas has come forward with a presentation on how bitcoin prices are determined on CME futures.
The Andreas Connection
Andreas Antonopoulos is a Greek-British, bitcoin thought leader who has been an early advocate of bitcoin since 2012. Around 9 months ago, Andreas took a position on the oversight board of the Chicago Mercantile Excange & Chicago Board of Trade (The CME Group Inc.) for bitcoin reference rates. The CME Group is an American financial market company operating an options and futures exchange that is listing bitcoin futures on December 18th. Andreas’s role in the oversight committee is to oversee which bitcoin exchanges are used to pull pricing data that will be used to determine the current bitcoin price on the CME futures.
The Process Bitcoin Goes Through to List on CME Futures
Andreas explains that prior to listing bitcoin on CME futures, two kinds of bitcoin reference rates (price) need to be formed: The bitcoin Reference Real Time Index, which is a spot price that updates every 30 seconds and is published on traditional platforms like Bloomberg and Reuters. The other is a Point Price or moving average price that is measured every day at 2pm Central time. The point price is considered the price of bitcoin for the day.
Both bitcoin Reference Real Time Index and the bitcoin Point Price are used to underpin the legal contracts that are part of the futures exchange, or to resolve disputes between two parties who disagree on the price of bitcoin at the time the agreement was made.
Inner Workings of bitcoin CME Futures
Andreas explained the two different criteria CME uses to determine whether a bitcoin exchange is eligible as a source for bitcoin pricing data. First, the bitcoin exchange has to publish a price consistently or it will not be a reliable source of data. The bitcoin exchange also needs to have trading fees and cannot be a zero trading fee platform. This is important because platforms with no trading fees are susceptible to trading bots that can create fake volume.
Also, CME futures are a cash settled market, that means nobody holds actual bitcoin. For the CME to operate bitcoin futures, every short position has to have a corresponding long position. Both positions have to be capitalized in US dollars against the CME. The CME customers need to have collateral deposited and audited on a daily basis. This entitles CME customers to take long and short positions that do not go over collateral.
Lastly, the CME also has circuit breakers that halt trading if bitcoin prices drop or rise by more than 7%.
Who Will Short bitcoin
Traders or investment bankers will short bitcoin at great risk and so this is an unlikely scenario. Instead the most active short participants will be bitcoin miners. This is because miners have the ability to short bitcoin with the least amount of risk. Miners hold the underlying asset (bitcoin) and can make good on short bets without loss.
A miner operating a bitcoin mining business has to pay electricity prices month to month without knowing what the price of bitcoin will be. If the price collapses suddenly, miners may have to close shop because of a lack of cash flow. Andreas foresees miners taking 10% of their bitcoin to put in a short position. If bitcoin collapses in price that month, it gives miners the ability to recover losses from price drops to pay for their running costs.
Even if bitcoin prices increase tremendously, miners who short will lose on their 10% short position but gain on their 90%. Thus, miners stand to gain the most from calculated short positions and are the most likely to participate in shorting bitcoin futures to hedge their risk.
Currently, bitcoin is volatile because traders cannot take a short position against it. The introduction of CME futures will bring massive increases in volume and the liquidity will lead to an overall reduction of volatility for the price of bitcoin.
How do you think CME futures will affect bitcoin? Do you think Andreas is right? Are you glad there will be less volatility in bitcoin? Let us know in the comments below.
Images courtesy of Shutterstock and Wikipedia.
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