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Bitcoin price declines driven by launch of fourth-quarter futures, Fed researchers argue

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Bitcoin's winter price spike and its subsequent decline coincide with the introduction of bitcoin futures trading on the Chicago Mercantile Exchange. A team of researchers did not think it was a coincidence.

Galina Hale, Arvind Krishnamurthy, Marianna Kudlyak and Patrick Shultz – economic researchers writing for the Federal Reserve Bank of San Francisco – claim in a research paper that the rapid rise and subsequent decline of the bitcoin price is consistent with commercial behavior which accompanies the introduction of futures markets for an asset.

The futures contract raised the price

After the launch of bitcoin in January 2009, the price remained below $ 1,150 until February 22, 2017, when it jumped about 10 months. This growth ended on December 17, 2017, when bitcoin reached its peak price of $ 19,511. This momentum was not caused by global market fluctuations, as indicated by the comparison with the Standard & Poor's 500 stock index, the researchers noted.

Instead, the summit coincided with the day that bitcoin futures began trading on the Chicago Mercantile Exchange (CME).

This price dynamic corresponds to the rise and collapse of the residential financing market in the 2000s. Researchers Fostel and Geanakoplos in 2012 suggested that the mortgage boom was caused by financial innovations in securitization and bundles of bonds that attracted investors. The collapse of mortgage credit was caused by the introduction of instruments that allowed pessimistic investors to bet against the housing market.

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Similarly, the introduction of the blockchain gave birth to a new financial instrument, bitcoin, whose investors proposed bitcoin until the introduction of future bitcoin would allow pessimists to enter the market, resulting in a change in bitcoin price dynamics.

Transactional or speculative claim

Researchers separate transactional demand, which relies on the use of bitcoins for purchases of goods and services, from speculative demand, which occurs when people buy bitcoins in the hope that their value will increase. The speculative demand is a bet that the price of the asset will increase because the investor does not need the asset himself.

For most currencies and assets, investors have the means to bet on the change in their value by using financial instruments based on the currency or the asset, called financial derivatives.

Prior to December 2017, there was no significant market for bitcoin derivatives, which meant that it was extremely difficult to bet on lowering the price of bitcoin. These bets typically take the form of selling an asset before you buy, futures or futures, swaps or a combination.

The speculative demand for bitcoin came from investors willing to bet that the price would rise. Until December 17, the demand for optimists has pushed the price up, stimulating more investors to join them. The pessimists, in comparison, had no way of wagering that the price of bitcoin would fall.

The futures contract gives pessimists an entry point to the market

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US Federal Reserve researchers estimate that the launch of bitcoin futures on CME triggered lower prices for bitcoin in T1.

This unilateral speculative demand ends when bitcoin futures begin trading on CEM on December 17th. While the Chicago Board Options Exchange (CBOE) opens a futures market a week earlier, trading remains rare until the CEM reaches the market.

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Pessimists could bet on lower prices, buying and selling contracts with a lower delivery price in the future at the spot price. They could sell a promise to deliver a bitcoin in a month at a lower price than the existing spot price and expect to buy a bitcoin during the month at an even lower price to make a profit.

With offers of future deliveries of bitcoin at a lower price, the flow of orders is also putting downward pressure on the spot price. Those on the market to buy bitcoins for transactional or speculative reasons and ready to wait a month have had a good deal. The new opportunity has resulted in lower demand on the bitcoin spot market, which has lowered the price.

Also read: $ 670 million: Bitcoin futures record record daily volume as the market recovers

Questions remaining

As to why the price of bitcoin has fallen steadily rather than fast is difficult to explain, the researchers noted. Pessimistic investors may not have entered the market on the first day or the first week of trading. CME's total trading volume in the futures market started very low, with an average trading volume of nearly 12,000 bitcoins during the first week of trading, compared with 200,000 bitcoins in the spot market.

The rapid rise in prices and its decline as a result of the issuance of futures contracts correspond to the price dynamics suggested elsewhere in the financial theory. While some of the factors that play a role in determining the long-term price of bitcoin are understood, understanding the transactional benefits of bitcoin is too imprecise to quantify its long-term price. But as speculative dynamics disappear from the market, transactional profits will likely lead to valuation.

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Pictures of Shutterstock

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