Today is the day that many Bitcoin enthusiasts have been waiting for. The release of the Bitcoin futures contract at Cboe Global Markets Inc.’s exchange. As I am writing this trading has been halted three times already as of 12 p.m. CST. So, the volume is heavy on the first day. Many thought that traders would wait to see how the futures contracts would play out for a month before making any significant moves.
What are Bitcoin futures?
Bitcoin futures is a financial tool that will allow you to bet on the future price of Bitcoin. Supply and demand sets the prices of futures contracts. They do not set the price of the commodity itself. This tool is used by people who want to hedge a bet on a commodity or speculators who think they know what the future price of a commodity will be.
It is another way to make money off of a commodity, but futures can also insure against devaluation of a commodity you already own. In the past at the expiration of the contract, an actual commodity would be exchanged. Now, contracts themselves are being traded.
In theory, if the price of Bitcoin today is $15,000 and you think the price of Bitcoin will go up in a month, then you purchase a futures contract on Bitcoin. In a month if Bitcoin is $19,000 then the contract is paid out at $19,000 since these futures contracts are dealing in cash settlements.
The Bitcoin price that is being used is the Gemini auction price. This may be different than what coinmarketcap.com reflects. The majority of people will not take place in the futures market anyway because of the high margin requirements. The futures contracts are no doubt going to increase the volatility around Bitcoin today and moving forward.
Eventually, the volatility should decrease once there is an established futures markets. We should understand the futures market was intended for commodities. Is Bitcoin a commodity? No, this is why I believe the party will end in a magnificent crash.
Why Bitcoin will crash
One day Bitcoin will crash and everyone left holding a Bitcoin will lose any value they have stored. When Bitcoin was invented it was to be used as a currency. A currency is used to exchange goods and services. For a currency to be successful it has to be accepted by the businesses providing the goods and services.
The dollar is used as the USA currency because the government backs this currency. When a business sells you something valued in dollars, they can then take the dollar to another vendor and buy services. Businesses within America accept the US Dollar. This makes the US Dollar a successful currency.
Bitcoin is not accepted by most vendors. I cannot go to Starbucks and pay in Bitcoin. I cannot walk into a gas station to buy gas with Bitcoin. I will never be able to do these things because the system is too slow. It would take too long to process these transactions.
What does this mean? It means that people are only buying Bitcoin and barely using it. People are not using the Bitcoin, they are buying and holding it hoping the price goes up. At some point they will sell the Bitcoin, but they will not buy a good or service with it.
It will end
At some point the buying will end and the selling will begin. There is really no argument against this statement. Because Bitcoin has little use, the buying will have to end. Bitcoin is a digital commodity, so this makes it very risky to store value. Exchanges were they are traded can be hacked. Last week an exchange was hacked for $65 million dollars in Bitcoin. If you store it on your hard drive, that can be phished or ruined in another way.
This is not really like the Tulip bubble because in the Tulip bubble the contracts were tied to actual bulbs that became actual flowers. These flowers could be rare and worth a lot of money. Sometimes bulbs became flowers that were not so rare, so the bet was on the bulb becoming a rare flower. Still, this market crashed as Bitcoin will.
Futures contracts are just tied to the future price of Bitcoin, this is why the fact that Bitcoin can scarcely be used to purchase anything becomes a problem. Why do you want a Bitcoin? People want to buy Bitcoin today, but why? The value in owning a Bitcoin is what?
Gold is a scarce commodity that you can hold, most people who invest in gold do not own the gold itself. They own contracts on the gold, but it is still tied to a scarce resource they can touch and feel. If you give someone a gold coin, they will agree that it has value.
The value in Bitcoin is derived solely based on what people are willing to pay for it at any given time. Gold has a history of thousands of years. The Bitcoin history is very short. It is only natural that Bitcoin will have a volatile price discovery period because it is in its infancy.
Greed and Fear
Driving the Bitcoin price up during the initial discovery phase is Greed and Fear. People are greedy by nature, they want to be rich. Bitcoin is seen as a way for people to get rich by doing nothing. The stories of people becoming rich after paying $5 for 1,000 Bitcoin are getting news coverage. This is driving people to Bitcoin because they see it as an easy way to get rich. For some it might be, for others they will lose all the money they invested.
Fear of missing the boat is driving more people to the market as they hear about it. It is irrational, but it is the common human response to something like this. Market crashes don’t happen on their own, humans create market crashes with their irrational behavior.
How many times have we seen this in products? The furby, the beanie babies, tickle me elmo, all of these products had amazing price increases on secondary markets because of scarcity. The scarcity lead to an increase in demand which lead to an increase in price. This is Bitcoin in a nutshell. People didn’t want to buy a Furby for their child. They wanted to make money off of it once they saw it was scarce. Bitcoin is scarce as well and just like people were left with over priced furbies, people will be left holding the bag with over priced bitcoins.
When will it happen?
Who knows when this will happen? No one knows, and you shouldn’t believe anyone that acts like they know. The panic can start at any moment. Since their is margin involved now, it is inevitable that a crash will happen as borrowed money is being put at risk.
You can listen to any economist that says it isn’t going to crash because of X or Y or Z, in the end it will crash. They have never predicted a crash at any point in history. The year before the Mortgage crisis, economists were saying there was no danger of a crash. In 1929, they were saying the stock market would continue to go up. At some point the fear of missing out turns into the fear of losing money. This happens when the buyers don’t want to buy and the sellers feel they need to sell.
I don’t know when this will happen, but I do know it will happen. Be careful out there.
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