5 Reasons You Should Not Invest in Bitcoin Futures

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Bitcoin Futures

Bitcoin Futures

Bitcoin is a digital currency which is still in the process of revolutionizing the way people deal with currency. Bitcoin is also known as a peer-peer payment network which cuts off the middleman. Many call Bitcoin the "cash for the Internet."

Being a paperless, bank-less crypto-currency, it took only a short while of time for Bitcoin to become one of the most talked about crypto currency in the world. In 2009, the first Bitcoin proof of concept was published by Satoshi Nakamoto and a year later, the Bitcoin community started work on the crypto currency.

Since Bitcoin's birth, there have been many other wannabe digital currencies that came up, but none have managed to capture the awe of its users, as much as Bitcoin did.

Unlike fiat money, Bitcoin is unique because the currency is de-centralized and more importantly not under the control of bankers or financial regulators. An argument often used by supporters of Bitcoin calling the currency insulated to any kind of manipulation. Bitcoins originally started by individual computers also known as miners which earned Bitcoins in return for the computing power they contributed towards processing of the blockchains. Bitcoins work on the concept of distributed authority. Instead of having a central clearing house or an authority validating all the transactions, the Bitcoin transactions are validated and recorded on a public ledger. This makes it possible for the transactions to remain transparent, yet anonymous and less susceptible to fraud.

The Bitcoin Economy (Source - Bitcoincharts.com)

The Bitcoin Economy (Source - Bitcoincharts.com)

While up until a point, anyone with a decent configuration computer could have thought about earning some Bitcoins, but that has since eroded. What's unique about Bitcoins is that it is finite in its creation. At the time of writing, the total count of Bitcoin or BTC was 16,187,113 BTC, which in dollar denominated terms comes to 19,165,541,200 USD.

What are Bitcoin futures?

While Bitcoin’s popularity has been growing over time, Bitcoin futures, a derivative version of the crypto currency isn’t far behind. Bitcoin futures operate similar to how the futures markets work. These are derivative products, which tracks the prices of the underlying asset, Bitcoin (BTC).

Similar to a regular futures contract, when you trade Bitcoin futures, you are in essence, fixing the price at which you want to buy or sell the Bitcoin at a future date. The purchase or selling in the futures is not outright initially and therefore the position is leveraged. So you do not have to put up the full price, but rather only post a small percentage of the full value of the Bitcoin.

Bitcoin futures are ideally suited for those who already have invested in large sums of Bitcoin. Instead of selling their Bitcoins for fiat money, these same Bitcoin holders can short the Bitcoin futures and make a profit from the price volatility, thus not having to touch their Bitcoins in the first place.

Bitcoin chart, priced in U.S. dollars (Source - Coindesk.com)

Bitcoin chart, priced in U.S. dollars (Source - Coindesk.com)

Trading Bitcoin futures might seem like fun, but there is a lot more to it than what meets the eye. Although, do not be mistake that Bitcoin futures work similarly to many other commodity futures. Except for the term futures, Bitcoin futures are very different from the rest.

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While it might seem compelling to trade Bitcoin future, there are certain aspects that a trader needs to bear in mind. Here are a few reasons why you should not invest in Bitcoin futures trading.

1. Bitcoins are yet to be widely accepted as a medium of exchange

When trading Bitcoins, there is still a certain level of awareness among the masses that is required. Furthermore, with the crypto currency limited to the digital world, it makes it impossible to be accepted as an alternative form of currency in the real world. Although more and more transactions are now conducted digitally, the acceptance of Bitcoin as a form of payment is still in its nascent stages.

Another factor that is limiting the acceptance of Bitcoins as a form of payment or a medium of exchange is that not many people have still heard about Bitcoin. This makes the scope of this alternate currency limited in its use and thus liquid instrument in futures trading. Because a commodity or a currency is only as much as it is valued, Bitcoin still has a far way to go before it is widely recognized as a medium of exchange or an alternative currency. While there are numerous businesses that continue to add to the list of businesses where Bitcoins are accepted, it is still small in comparison. Furthermore, most of the Bitcoin accepting businesses are still Internet-only stores, which is also limited. You obviously cannot, at least at the time of writing, pay on Amazon using Bitcoins.

The limited acceptability for Bitcoins also means that they are less widely recognized, thus it leads to factors such as liquidity, volatility which can make the Bitcoin futures trader vulnerable to adverse price movements when trading, which in either case is not something new to the Bitcoin industry.

2. Bitcoins are volatile but for different reasons

Besides the part about Bitcoin still yet to be widely accepted, the crypto currency is also very volatile than one might think. There are numerous instances when the price of Bitcoin, relative to the U.S. dollar has turned erratic for a number of reasons.

Volatility is not something new to the investing world and any type of market has undergone extreme volatility. One of the fundamental reasons why an instrument turns volatile is because when some news or information is released which is not discounted by the markets already.

The volatility that follows later, which can result in either a sharp appreciation or deprecation of the security’s price in question is simply a result of price adjusting to the new piece of information. In the Bitcoin world, volatility is for the same reasons, but also additional factors such as regulatory warnings from agencies, a hack into an exchange and so on.

For example, earlier in January 2017, Chinese authorities warned on implementing new rules on Bitcoin market. This sent volatility to 4.13% on the day, while Bitcoin prices itself continued its decline. Between January 4th and January 11th, price of Bitcoin fell from $1129 to $776.

Bitcoin volatility 2011 – 2017 (Source - btcvol.info)

Bitcoin volatility 2011 – 2017 (Source - btcvol.info)

The limited availability of Bitcoins means that just a few transactions can quickly and significantly impact the price of Bitcoin. Although proponents of Bitcoin claim that volatility will settle as the technology matures and Bitcoin becomes more widely accepted, for the current scenario, Bitcoins are still volatile and can create liquidity problems for the Bitcoin futures trader as the futures contracts are traded on leverage. Although, if one looks close enough, you can see that the volatility in Bitcoin has been steadily falling over the past couple of years.

3. There are nearly 10 Bitcoin futures exchanges

Unlike futures exchanges for the regular markets, there are more than one settlement places for the Bitcoin futures. This brings some additional complexity to a crypto currency which is already complex itself. For example, if you were to trade Index futures, you know that you can trade with the CME Group which is the exchange where the trades are managed and booked. For some exotic index futures such as the Nikkei or the NIFTY futures, you know that trades can be settled either at the CME group or with the exchange in Singapore or Japan.

However, with Bitcoin futures there are nearly 10 futures exchanges, which can complicate things for the average futures trader. Furthermore, trading Bitcoin futures means that you are only speculating on price. There is no underlying delivery of the Bitcoins, which makes Bitcoins futures trading a speculative, leveraged based trading on Bitcoin prices.

Each of the different Bitcoin futures exchanges has their own rules and trading requirements. Among the different futures exchanges, BitMEX is a name that comes up often. BitMEX offers Bitcoin futures trading with a 100 times leverage, making it extremely risky. Furthermore, to trade Bitcoin futures with BitMEX, you must have Bitcoins as fiat currency is not allowed. And if the above reasons haven't put you off already, U.S. traders are restricted from trading on BitMEX and a couple of other Bitcoin futures trading exchanges as well.

4. Bitcoin futures exchanges are not regulated

While each of the Bitcoin futures exchange claims to offer something unique, a common factor among them all is that they are not regulated. Which is kind of ironic as a crypto currency such as Bitcoin which calls itself as an alternative form of currency would be looking at seeking regulation in the first place.

Therefore, for traditional investors or speculators who want to trade Bitcoin futures, you cannot expect to see the same regulatory oversight that is common to other futures markets. Also, the fact that U.S. residents are barred from trading at most of the Bitcoin futures exchanges makes is difficult, if not challenging to find a credible Bitcoin futures exchange to trade with.

While regulation may be frowned up on by the Bitcoin community whose very purpose of coming up with the crypto currency was because of breaking the monopoly of the governments, regulation can help especially in containing bubbles or supporting an industry or a market. Because of the unregulated framework in the Bitcoin industry, it is very easy to get scammed.

The SEC has also published several publications warning the general public and the investment community about potential Ponzi schemes involving Bitcoins while also highlighting the risks of dealing with a crypto currency that prides itself in being anonymous.

5. Different types of Bitcoin futures contracts

When you think about futures contracts, you know that they are standardized contracts. Therefore, one standard contract of crude oil is 1000 barrels of oil, no matter which way you look at it. This uniformity is however lost when it comes to Bitcoin futures contracts, because there are just too many.

One would think that a standard Bitcoins futures contract would be certain number of Bitcoins per contract. While this may be true, there are many other futures contracts for Bitcoins and the contracts change from one futures exchange to another.

For example, at a Bitcoin futures exchange such as Crypto Facilities, you can trade multiple futures contracts, from the standard Bitcoin/Dollar futures to Turbo, Ripple/Dollar futures and many more. The standard Bitcoin/dollar futures have a contract size of 1 Bitcoin with a leverage of 1:6. They also come with maturities from 1-week and contracts far out as a quarterly cycle.

However, when you look at another famous Bitcoin futures exchange such as BitMEX, the leverage can go as high as 100 times on some contracts. The existence of many different exchanges and the different type of contracts makes in non-uniform with liquidity concentrated to that particular exchange alone. For example, you cannot buy a futures contract from Crypto Facilities exchange and attempt to sell it at BitMEX, which is impossible.

While there are obvious shortcomings when it comes to Bitcoin futures trading, the reader should know that this is still an industry that is developing and there are many questions that are yet to be answered, which only shows that it takes time for the Bitcoin industry to mature to the point that it becomes a serious contender as an alternative to the fiat currency.

Besides Bitcoin futures, ETF’s are also likely to make push for seeking acceptance in the mainstream investing community. More recently, supporters of Bitcoin have been eagerly awaiting the Securities and Exchange Commission (SEC) verdict on the Bitcoin ETF. The Winklevoss brothers, known for their dispute with Facebook's Mark Zuckerberg and career Olympian rowers have been staunch supporters of Bitcoin and filed with the SEC to offer a Bitcoin exchange traded fund called the Winklevoss Bitcoin Trust with the ticker COIN. The SEC has been constantly seeking updates to the proposal for the ETF and more recently after seeking public comments; the SEC is expected to announce its decision by March 11, 2017.

While there are apparent drawbacks to trading Bitcoin futures, the fact remains that it is still too early to consider Bitcoin futures investment as serious as investing for the sake of making credible money for the long term. However, things are likely to change over time as the wider acceptance for the crypto currency continues to grow.

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Al Hill Administrator
Co-Founder Tradingsim
Al Hill is one of the co-founders of Tradingsim. He has over 18 years of day trading experience in both the U.S. and Nikkei markets. On a daily basis Al applies his deep skills in systems integration and design strategy to develop features to help retail traders become profitable. When Al is not working on Tradingsim, he can be found spending time with family and friends.
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