Saturday, December 23, 2017

First two weeks of Bitcoin futures

Bitcoin bears' path to killing the cryptocurrency industry and make a profit seems safe now

The Bitcoin futures as defined by CBOE have been trading since December 11th, 0:00 Pilsner Winter Time, and those by CME from December 18th, 0:00 Pilsner Winter Time.

Bitcoin price in the recent 7 days – picture will be updated.

We didn't know any numbers describing these new markets, especially the volumes and the ratio of bulls and bears. The volumes started at tiny values – roughly 3,000 CBOE contracts (=1 Bitcoin) and below 1,000 CME contracts (=5 Bitcoins). On the second day and a few more days, the volumes were even lower. But things got more vigorous yesterday, during the drop. The volumes at CBOE and CME show 12,500 Bitcoins a day – three times the previous, record-setting day – which shows some potential for rapid growth.

I think it's fair to say that during this period, the Bitcoin price volatility has stabilized a little bit. We saw the explosion of the altcoins' prices. The percentage of the Bitcoin in the cryptocurrencies' total capitalization dropped from over 65% to below 45%.

There are lots of potential explanations. The volumes themselves were so small at the beginning that they were unlikely to contribute much – even though, if they were "systematically bear-dominated positions", they could have competed with the daily trades of the real Bitcoin assuming that the latter is mostly random walk. During a day, 400,000 trades of order BTC 1 each get you some 1,000 average transactions worth of a deviation from the initial price (in a random direction) – recall the "square root" rules of the Brownian motion.

But I think that it's more likely that the mindless Bitcoin buyers have been disappointed that no institutional buyers started to buy hundreds of thousands of Bitcoin equivalents. Perhaps even more importantly, the very existence of the futures – two pages (linked at the beginning) that tell you "the price will be basically the same in 1 or 2 or 3 or 6 months from now" – has calmed down much of the irrational exuberance among the Bitcoin believers. Before the futures, all of them acted as a one-sided religious sect that only saw one direction. Right now, there are many who realize that there exist two directions on an axis and both of them are comparably likely.

At the beginning of the futures trading, the January Bitcoin futures were selling at a $1,000 premium relatively to the spot price that will be used to settle the futures. However, during a week or so, the premium dropped to hundreds, then to zero, and it was fluctuating on both sides of zero yesterday. Note that everyone who can trade both real Bitcoins and the futures has a "safe algorithm to profit [a lot]" whenever the spot price of the Bitcoin differs from the price indicated by the futures [by a lot].

Needless to say, the most interesting day was yesterday, Friday December 22nd, when all the cryptocurrencies dropped substantially – many of them by 40% a day. The Bitcoin has seen prices near $11,000 at the very bottom, over 40% below the peak of $19,500. Now, on Saturday, the Bitcoin price is back close to $15,000 again, a 25% drop from the peak.

No big whales of the conventional financial world have thrown their billions to the Bitcoin trading, in one way or another. But because we already know that the volumes seem rather tiny, there is a clear strategy for the whales to enter. Just start to short the Bitcoin whenever the price indicated by the futures is above $15,000 or something like that. And this threshold may be gradually decreased.

There is already a pretty good correlation between the futures and the spot price – some people are working on the arbitrage. So by keeping the futures below $15,000, one basically guarantees that the spot price won't be "too much above" $15,000. There were two main risks of the strategy: One of them is that the spot price may ignore the futures and they may diverge heavily, so suppressing the futures' price doesn't quite suppress the spot price. I think that we're close to the healthy market which "knows" that the prices should be close to each other although it's questionable how big volumes may be traded by those who use this arbitrage opportunity – the link between the spot and futures prices could break if the futures trading volumes were too high.

The second major risk was that there could have been some big whales making a bullish bet on the Bitcoin through the futures. I think that it's clear that no one seems eager to play such a role – no big banks and hedge funds are willing to "adopt" this silliness (Bitcoin). So it's a rather good time for someone big to start to systematically deflate the Bitcoin bubble and make the corresponding profit out of it.

Note that the Bitcoin price is undetermined by any fundamentals – it was changing purely due to mood swings of the naturally unstable Bitcoin traders. But that also means that someone may "fill the power vacuum" and just say what the Bitcoin price should be doing. The most sensible rule is to say that the Bitcoin price should be rather continuous and decrease by some rate – and just the very statement may become a self-fulfilling prophesy.

So far, the only available "investment guidance" were slogans such as "always HODL" and "to the Moon". And that's where the price was going – the only limitation was how much new money the "lunar astronauts" were capable of getting from their parents. ;-) In practice, it meant a doubling once or twice a month. But now, there may also be adults who provide the market with some more sensible guidance. Obviously, the direction has to be the opposite one, "back from the Moon", if the recipe is supposed to be sustainable.

Note that only if you make a bearish bet on the Bitcoin, you may be more or less guaranteed that you won't run out of money. If you made a positive bet on the Bitcoin and you would try to corner the market by pumping up the prices, you would ultimately run out of the money – just like the irrational Millennials who have been obsessively inflating the bubble would run out of money (or out of greater fools) at some moment – and then you might lose all the money along with all the other bulls and HODLers on the Moon, not to be confused with fiddlers on the roof.

But what happens if you decide to impose a negative trend on the Bitcoin price? Well, then your big bank or hedge fund only needs to fight in a tug of war against the Bitcoin bulls – mostly a disorganized movement of the Millennials collecting the last thousands of dollars in order to become trillionaires after some years by sitting on their lazy aßes (=hodling). Charlie Munger made the correct observation (around 39:00 in the video) that the Bitcoin is complete insanity – and also mentioned that it's run by bad people building on bad values. He is particularly annoyed by the philosophy that the right path to wealth is to sit on your aß (=hodl) without producing any values. I completely agree with that. It's a terrible lesson for the youth to learn. The mankind can't produce wealth by sitting on its aß. Those who get rich by the Bitcoin bubble – or any similar bubble – are parasites. Not all parasites get wealthy, of course, only the "leaders of the parasites" do. The remaining parasites came too late to the bubble and will be the losers.

OK, how strong do you have to be to win the tug of war against the Bitcoin bulls? Not very strong. The Bitcoin capitalization is over $250 billion at this moment but most of it is "hot air", not any actual money that someone has "invested" into this bubble. To count the money that was "invested", you need to calculate the total value of the Bitcoins at the moments when each of them was coined. Not surprisingly, this is basically equivalent to the total spendings by the miners – because they only have a small profit margin in average – and that's some $4 billion or so. Yes, the remaining 98% of the $250 billion is "so far unrealized profit"!

Most of this $4 billion flew to the Bitcoin bubble in the recent month or two – so the actual funds that have been paid are comparable to the money needed to buy the Bitcoins mined in recent 2 months (the previous months are negligible because the price was a negligible fraction of the current one). So it means that roughly (four billions over some fourty days equals) $100 million of new money is being sent to the Bitcoin every day. If you could push more than $100 million a day to the Bitcoin futures short positions, you would be guaranteed to push the price down in the tug of war and win the bet – you would probably break the Bitcoin so that its price would go strictly to zero at some moment and the mining would completely stop, too.

So assuming that no bigger player than the "Millennials throwing $100 million a day to this bubble" exists, and I think he doesn't really exist, the only question is whether the Bitcoin futures market would be capable of absorbing these $100 million a day – of your money that you would basically push to the short positions. Well, I think that the answer starts to be Yes. $100 million is just some 7,000 Bitcoins – that's less than the total daily trading volumes at CBOE+CME.

If I had a bank or a hedge fund that may afford to invest – and in this case, I would call it a genuine investment because the Bitcoin futures are a wildly undervalued asset (the short 1 Bitcoin futures position is undervalued by $15,000 right now because the Bitcoin's fair – and asymptotic future – price is clearly zero) – I would just try to suppress the futures price, perhaps even to $1,000 below the spot price. That could further stimulate the trend in the desired, negative direction, because lots of people would see that the "future is bleaker than the present".

Now, people like Jamie Dimon should be motivated to kill the Bitcoin just in order to preserve and strengthen their prestige. But if they also wanted to maximize the profit, they would probably want to make the death of the Bitcoin as slow as possible – to enter as big a total short position in the Bitcoin as possible. So maybe their interest would be to make the Bitcoin drop somewhat slowly. But you probably need a drop per month (to the next expiration date) that is significantly more radical than the possible difference between the spot and premium price.

On top of that, some other people could figure out that you're playing this game and they could start to compete with you and devour a part of the potential for profit. Maybe they need a confirmation so you want to kill the Bitcoin and push it to zero before others get all the permissions to join your game. OK, I would choose an approximate halving of the price every week, and I would close some of the short positions if the drop were too fast.

The elevated Friday volumes in the futures market could indicate that someone big has already started to play this game. A subtlety is that this market is closed on weekends and probably over the Christmas holidays, too. It means that during those times, the Bitcoin market may be ruled by the one-sided Bitcoin fanatics again. Well, don't forget that after Christmas, the number of working days exceeds the number of days in the weekends. ;-) But I find it plausible that there will be a more bullish price trend during the weekends which is why the big shorter may prefer to open the positions on Mondays or Tuesdays and close some of them on Thursdays and Fridays.

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