Last December’s introduction of Bitcoin futures, which gave investors an opportunity to bet against the value of the coin, played a large role in the late-2017 and early-2018 price decline, according to the U.S. Federal Reserve.

Bitcoin’s Connection With Futures Markets

In the economic letter from the Federal Reserve Bank of San Francisco, published today May 7, the authors conclude that the rapid run-up and subsequent fall in the price of Bitcoin after the introduction of futures is far from a coincidence. Rather, it is consistent with trading behavior that typically accompanies the introduction of futures markets for an asset — a situation comparable to the securitization of bonds in the early 2000s.

“The subsequent bust was driven by the creation of instruments that allowed pessimistic investors to bet against the housing market,” the Federal Reserve wrote. “Similarly, the advent of blockchain introduced a new financial instrument, Bitcoin, which optimistic investors bid up, until the launch of Bitcoin futures allowed pessimists to enter the market, which contributed to the reversal of the Bitcoin price dynamics.”

Federal banking policymakers have been dismissive, especially in recent months, of Bitcoin as an alternative currency to the dollar or other central bank-backed money. San Francisco Fed President John Williams, who next month will move to New York to run the Fed there, has been particularly critical: “One of the problems they have is the values are extremely volatile,” Williams said in April of Bitcoin and other cryptocurrencies.

CME Group & Cboe Global Markets

On December 17, CME Group Inc. became the second exchange — behind the Cboe Global Markets Inc. — to list Bitcoin futures. This date coincided with the all-time high (ATH) price of Bitcoin, which at the time was trading at around $20,000.

The authors of the report, Galina Hale, Arvind Krishnamurthy, Marianna Kudlyak, and Patrick Shultz, said the introduction of futures ended the ‘one-sided speculative demand.’ That said, the lack of capitulation was down to the early limited volumes in the futures market, something futures analyst Bob Fitzsimmons believes to be a valid argument:

“Firms were very cautious. They didn’t want it going from 10,000 to a 100,000. So, there wasn’t what I would call wild speculation,” Fitzsimmons, managing director and head of Wedbush Futures, a financial services firm that publishes reports on cryptocurrencies, said.

Moving Forward

Moving forward, the Federal Reserve argue that real-world applications of Bitcoin as a border-less, low fee medium of exchange — which they call ‘transactional benefits’ — will be the biggest factor in determining the coin’s price. They write:

“While we understand some of the factors that play a role in determining the long-run price of Bitcoin, our understanding of the transactional benefits of Bitcoin is too imprecise to quantify this long-run price. But as speculative dynamics disappear from the Bitcoin market, the transactional benefits are likely to be the factor that will drive valuation.”

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