With much fanfare, regulated bitcoin futures were first introduced in late 2017, coincidentally, right around the time both bitcoin and the cryptocurrency market as a whole reached a peak. A senior executive working on futures at the time proclaimed the financial derivative would “tame” bitcoin into a “regular” investment instrument, referring to the dramatic levels of volatility both the cryptocurrency and the market as a whole had been experiencing.

To investigate the long term relationship between the launch of bitcoin futures and the intraday volatility of bitcoin, South Korean researchers Wonse Kim, Junseok Lee & Kyungwon Kang analyzed data from five leading cryptocurrency exchanges from the six months prior and post the first launch of bitcoin futures. Their findings were presented in the 2019 paper the “Effects of the Introduction of Bitcoin Futures on the Volatility of Bitcoin Returns.”

Bitcoin Futures

A futures contract allow traders to take a bet on whether the price of an asset will go up or down, with a set expiration date. Through such futures, speculators can short an asset, something that before the launch of bitcoin futures wasn’t possible for the digital asset.

In December 2017, the first step towards a more mature market for bitcoin was made as the Chicago Board Options Exchange (CBOE) allowed traders to enter futures contracts for bitcoin, a move followed a week later by the CME group. Recently, due to a lack of volume, CBOE has announced they are pulling the plug on bitcoin futures as soon as the last futures contract expires in June. However, future trading volumes for the CME group has been gradually increasing, and multiple renowned financial organizations such as Nasdaq (in partnership with Van Eck and the Intercontinental Exchange) are in the process of launching their own futures contracts.

Based on the timeframe for the dataset used in this research, only the CBOE and CME futures contracts are taken into account.

Prior Research

The effect of future contracts on their related markets has been studied considerably, and as has been found in the case of the stock market, there could be two conflicting explanations for the effect they have. The first one states that uninformed speculators are generally eliminated from the market quickly, after which the trading of futures by well-informed speculators stabilizes the market.

The second explanation is that the introduction of futures leads to trade volumes moving from the actual asset, bitcoin, to the futures market, reducing liquidity and effectively increasing volatility.

Previous studies on the effects of the launch of bitcoin futures have been conducted. Most notably by Hale et al. (2018), who suggested that the launch of bitcoin futures allowed pessimists to enter the market, effectively contributing to a rapid decline in the asset’s value after the launch of the derivatives. And Corbet et al. (2018), who showed that volatility increased around the time the bitcoin futures launched.

Kim, Lee & Kang set out to expand on these prior studies by analyzing the relationship between bitcoin price stability and the launch of the futures contracts on the longer term.

Methodology

To investigate this relationship, the researchers undertook two methodological steps. First, bitcoin price volatility after the introduction of the bitcoin futures was examined using a bias-corrected realized volatility analysis, findings of which were explored in more detail using the discrete Fourier transform.

The Fourier transform provides more realistic results as it allows for a model-free approach and adds robustness to the volatility analysis. Through the combination of the two techniques, detailed, robust and realistic results on the relationship between intraday volatility and the introduction of bitcoin futures were produced.

Data concerning one-minute price changes of bitcoin from the five largest cryptocurrency exchanges at the time of research, Coinbase, Binance, Bitstamp, Coincheck, and Bitflyer, was used to investigate this correlation. The data used is from between June 1, 2017, and June 26, 2018, hence six months before and after the first futures by CME and CBOE were launched.

Findings

The timeframe for the sample was split into 4 periods, with period 0 covering the pre-futures six months and the subsequent 3 periods comprising two months each, post-futures launch. Based on this, the researchers found that bitcoin’s volatility significantly increased in period 1, the two month period after the start of the bitcoin futures, compared to the pre-future period 0. However, over both periods 2 and 3, volatility gradually decreased, and the volatility in period 3 significantly decreased, compared to the post-futures period 0. These findings are confirmed by the different datasets from all five exchanges.

Additional analysis (focused on causality) indicated that while there might not have been a causal link between the futures and intraday volatility for period 1 and 2, the decrease in volatility in period 3 was found to be significantly linked to the introduction of the bitcoin futures. This indicates that in the long run, the bitcoin futures helped to stabilize the bitcoin market. Additionally, the researchers found that for a short period directly after the launch of the bitcoin futures, volatility increased compared to data points before the launch.

Concluding Remarks

With bitcoin prices currently on the rise and a multitude of bitcoin futures being rolled out over the coming months, the findings of the research conducted by Kim, Lee & Kang shed some light on how these newly launched futures contracts may affect bitcoin’s price volatility over a longer-term.

Based on the findings of the study, bitcoin futures contracts, while perhaps initially increasing volatility, seem to have led to an increase in the asset’s price stability over time. Not only is this an interesting finding because new futures for bitcoin are on the horizon, but also for the potential launch of futures contracts concerning other major digital assets such as Ether and XRP.

As confirmed by the research, futures contracts do seem to add a degree of stability to markets that have, to date, been temperamental and unpredictable.

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