Bitcoin’s future, and bitcoin futures

Bitcoin is going from strength to strength at the moment. Despite the legitimate concerns I’ve already discussed, it’s fair to say that the cryptocurrency’s meteoric rise has not skipped a beat.

My colleague, Sam Volkering, has been very bullish on the crypto sector for some time. Bitcoin’s recent run has seen his confidence vindicated. If you want to be able to profit like Sam, then you’ll need to get his guide to investing in cryptocurrencies .

Bitcoin’s had a record-busting run, recently – temporarily piercing the $7,500 barrier. But that’s not the subject of today’s piece. Instead we’re going to look at more strategically-significant aspects of bitcoin’s rise to power, as a global currency.

Back to the Futures

Recently, a new bitcoin futures market has been announced. This is a big change for bitcoin, and it requires a bit of explanation. The futures market is, by some standards, a relatively obscure part of the financial trading system.

Who am I to talk about futures? Well, I’ve published an academic paper on their use (D. Coffman and A. Lockley, “Carbon dioxide removal and the futures market”, Environmental Research Letters, vol. 12, no.1, 15003 (2017)). So I should be OK to give you a quick tour…

What exactly are futures?

A future is a type of financial instrument that executes on a specific future date. For example, Brent crude futures (executing Jan 2018) were trading just over £62 last Sunday, compared to a spot (real time) price of just under £61. This means a price rise is predicted by the market. You can trade futures – speculating on how attractively priced you think their current price is, relative to your prediction of expected movements in the spot market by the due date.

The future’s market is an example of a financial derivative – a range of instruments that got the economy into a right old muddle during the financial crisis. As such, the emergence of a futures market in bitcoin is interesting news. The brand behind this new market is CME, the Chicago Mercantile Exchange. This exchange has a very long history, going back to agricultural commodities markets in the 1800s. Futures themselves have a far longer history – with modern markets surviving in Japan from their founding in the 1700s. In fact, the first recorded futures contracts were from the ancient world – so bitcoin’s ultra-modern currency is adopting an ultra-ancient way of trading!

The emergence of a derivatives market tends to make it less likely that the long-term future for bitcoin will be one of collapse, or regulation into obscurity. Large blue-chip institutions like CME staking their reputation to this radical new kind of commodity lends a lot of credibility – in this case, to a sector which has often struggled to establish it.

The addition of a futures market in bitcoin is, of course, also directly interesting. It will give us some insight into the market’s view of what’s in store for the currency. That’s all the more important, as it has been a particularly volatile instrument.

The Future to Back

Bitcoin futures are a big deal – but the future is bringing something that could be even bigger. In mid-November, there will be a code fork. This is essentially “round two” of the squabble that recently created the newcomer cryptocurrency called “Bitcoin Cash”. This forthcoming event, known as Segwit2x, results from a disagreement over amendments to the technical standards behind bitcoin. An upgrade is necessary – to accommodate the rising demands on the network, which stem from the cryptocurrency’s popularity. The problem is that there is a fundamental disagreement over how this should be achieved – leading to a forthcoming fork, as the two warring sides huff off in their separate technical directions. It’s unclear which of the competing standards will prevail after mid-November’s split. Meanwhile, this confusion will keep both speculators and commentators very busy.

Three views of bitcoin’s fundamentals

Notwithstanding the forthcoming fork, there are three widely differing view on bitcoin’s future. Some view the currency as being worth hundreds of thousands of dollars – pegging it to gold, in terms of the ultimate size of the market. Others take the view that its price is fundamentally linked to the long-term cost of electricity – as power is a primary input, for bitcoin production. Others view it as an unstable, faddish commodity, with little underlying value – and long overdue a dramatic correction.

I must confess I have great difficulty reconciling these wildly different views. The electricity argument is compelling, medium-term. However, it says little about the fact that the total market is subject to an arbitrary limit – albeit one that may potentially be worked around. Could bitcoin replace gold, as a money-like store of value? I think that’s possible – but gold has other uses underpinning its value, so that’s not necessarily the best comparison. As well as not being much like gold, bitcoin is also a pretty awkward replacement for cash. Accordingly, I could imagine it’s due for a correction. Nevertheless, it appears not to be valueless – judging by its now-longstanding trajectory of increasing price. So, I’m remaining firmly on the fence. check out Sam Volkering’s new book.

Do let us know what you think of bitcoin’s future, and of bitcoin futures! andrew@southbankresearch.com.

Best,

Andrew Lockley
Exponential Investor

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Category: Blockchain

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