What is the effect of Bitcoin futures on Bitcoin price? It is a common belief among people that the prices of the Bitcoin futures contracts usually do not affect the price of the underlying asset, Bitcoin in this case, directly.
This does have some logic behind but it is not always true. There are times when the prices of the Bitcoin futures do weigh down heavily on the price of Bitcoin in the open market.
Yes, it does so indirectly even though the Bitcoin futures contracts trading does not actually involve buying and selling of actual Bitcoin by the investors.
In this process, the investors gain exposure to the Bitcoin space and for that they do not need to hold the crypto coin actually.
The price of the Bitcoin futures contracts at that time will largely depend on the spot price or the prevailing price of one actual Bitcoin in the open crypto market.
Often referred to as spot BTC, this price swings wildly depending on a large number of external factors such as:
- The trading volume
- The usage and
- The adoption.
In addition to that, there may be other catalysts as well that may affect the current price of Bitcoin in the open market in some other manner.
It may not seem right to you because you may not know the details regarding this specific phenomenon.
If you want to gain some valuable insights on it, you are in the right place.
This article will have it all covered for you including a brief about the Bitcoin futures contracts.
With such enhanced knowledge about Bitcoin futures contracts and its effects on the price of one Bitcoin, you will be able to make more productive investment decisions in the future.
What is the Effect of Bitcoin Futures on Bitcoin Price?
Bitcoin futures contracts is typically a contract between two parties who promise to one another to buy or sell the Bitcoin, as the case may be, at a specific price, quantity, and time in the future.
The Chicago Mercantile Exchange or the CME offers Bitcoin futures trading products that are cash-settled which are arguably considered to be the vastly referenced indirect elements that influence the direction of the price of one Bitcoin.
These Bitcoin derivative products offered by them are considered to be the simplest instruments that allow the qualified investors to place risk-balancing and complicated trades that would have been inaccessible to them otherwise.
This results in a significant impact on the price of one Bitcoin, both in the short term as well as in the long term.
The CME is one exchange that offers monthly new contracts to the investors for cash settlement.
This provides the investors with an opportunity to take cash when their Bitcoin futures contracts are settled instead of the actual coins.
On the other hand, there are other exchanges such as Intercontinental Exchange and Bakkt that offer such contracts both monthly and daily but these are settled on maturity with physical delivery of Bitcoin instead of cash.
Since its launch in December 2017, several companies are opening up now to the idea of offering Bitcoin futures contracts.
Therefore, with such an increase in demand and supply of it, there is bound to be some effect on the price of one Bitcoin in keeping with the demand and supply principle of economics.
Here are a few specific conditions and reasons that may cause a significant effect on the prices of Bitcoin due to the Bitcoin futures contracts.
In the short term, if there is a significant amount of purchase of Bitcoin futures contracts made due to some notable price impact on the futures market, it will be arbitraged away very quickly in the spot market.
This will result in the convergence of the prices. However, this may also happen if there is an increase in demand and purchase of coins in the spot market first.
On the other hand, Bitcoin may be traded at different prices at times on different exchanges.
The reasons for such price variance could be many and include order book demand, big events, and others.
If there is a large price discrepancy existing, a trader may be tempted to buy Bitcoin at a lower price on one crypto exchange and sell it on another at a higher price and make some profits. This process is known as arbitrage.
Arbitrage can affect the price of Bitcoin futures when someone buys several of these contracts.
However, this will not move the spot price of the Bitcoin immediately even though the more enthusiastic traders will start buying and selling Bitcoin at a lower price.
Nevertheless, this will surely result in the rise in the Bitcoin spot price in due course of time.
Now, if you consider long term, the Bitcoin futures trading products will cause a more significant effect on the price of one Bitcoin in the spot market more quickly.
This is because these products will create an increased stability in the price by reducing the risks involved in it.
Stability and Liquidity:
Over the years, Bitcoin has become easily available and accessible to the large players which is a result of the provision of the Bitcoin futures which is much greater than before.
This, needless to say, will drive a huge amount of money into the Bitcoin market.
The primary reasons for the larger players to become more interested in investing in Bitcoin futures much more than investing in the coin directly include:
- They do not need to own a Bitcoin wallet or address to trade Bitcoin futures and
- They can trade with much less risk.
The increased demand from the more seasoned investors or hedge funds results in a rise in prices of Bitcoin in a bull market and lowers it in a bear market.
This is due to the given fact that conventionally managed assets dwarf the current assets of the crypto companies.
This means that a handful of people will have a say in this matter.
This will cause a bullish effect for Bitcoin because it will eventually drive the large investors to get involved with such trades with grown confidence in the market.
These large investors and mainstream traders along with them will add more money to the market which will allow every participant in the market to hedge their portfolio along with their trades.
This means that the market now will have more stability as well as liquidity.
Shorting Bitcoin is another factor that affects the price of the asset in a very interesting way.
Shorting Bitcoin is a process where you can sell the crypto coin at a high price and then buy them back when the price falls due to the correction in the market.
This correction is caused by the excessive selling of the coin in order to regulate the finite supply of Bitcoin in the market.
In the process, you make a significant profit due to the price differences at the time of buying the coins and at the time of selling them.
When too many traders start shorting Bitcoin, it is considered to be a negative signal of massive selling with respect to the futures market.
And, most people monitor the futures market in order to determine the sentiment.
No matter how good it seems to be, shorting Bitcoin is not free from risks.
The most significant risk is of losing a lot of money in a bull market when the price doubles while shorting.
This means that shorting Bitcoin can only work in your favor if you do it in a bear market.
The ability to hedge their portfolio and trade is another significant reason why more and more people are now inclined towards Bitcoin futures.
This helps them significantly to do away with the risks quite considerably in trading Bitcoin due to its extremely volatile nature.
It is also due to the fact that as and when the people enter into the futures market they immediately know what they are getting into, what they are risking, and how much they can gain or lose.
Even the Bitcoin miners can decide to sell futures as well. This will eventually make their income much more predictable.
There is no doubt that it is really good to have a cash flow that is more predictable given that the miners need to foot large bills on electricity and machinery for mining.
As and when the futures market grows more than ever, there are larger possibilities of more changes in prices of Bitcoin as a result.
What do the Regulators Say?
Looking at things from the standpoint of the crypto regulators, things can be explained in an entirely different way.
A regulator, such as the FTC or Futures Trading Commission, would consider the derivatives trading markets for products as the primary reason that may affect the particular core spot markets.
And, these derivatives products include Bitcoin futures trading contracts.
They say that according to the futures contracts, there should be a specific amount of coins per head, and, therefore, the price should be stable and uniform in the real market.
However, there may be a few instances in the commodity futures market when contracts may be settled physically.
In such situations, however, the underlying asset that is involved in the transfer after the expiry of the contract may differ from the prices of the Bitcoin futures trading products.
Therefore, after conducting several tests and researches especially on CME-BTC futures, the regulators conclude that the Bitcoin futures contracts contribute significantly more to the Bitcoin price discovery as compared to the price of it in the related spot markets.
Closing the Price Gap
Therefore, without any doubt or dispute, you will agree that there is a notable gap existing between the prices of the Bitcoin futures contracts and the spot prices of Bitcoin.
This gap is the result of the shifting of the spot price of Bitcoin on the futures chart when the Bitcoin futures markets are closed on holidays or for the weekend due to the big move from the coin.
This gap on the chart between the price of Bitcoin when the exchange opens and the listed price of the futures when the exchange closes is noticed later when the Bitcoin futures market opens for trading.
The crypto space gives these gaps a significant weight. It expects the price of Bitcoin to return to normal levels which will ‘fill’ such gaps existing on the futures chart.
However, ‘filling’ or closing this gap does not necessarily mean trading in both ways through such gaps.
Instead, the gap is considered to be filled or closed only when it matches the price of the asset when it was traded prior to the gap came into existence.
While making such trades, it largely is about probabilities and it is these probabilities that fill these gaps between the spot price and the futures contracts price.
Also, the likelihood of the participants in the market to open or close their positions at the price of the previous trades can also help in closing the gaps. However, this will largely depend on the type of the gap in the first place.
However, it is not always necessary for the gap to be filled, as some crypto experts suggest.
This is because these gaps exist just as they do in some other types of chart patterns in the same category.
Now, to interpret these price gaps between the previously traded and currently traded futures in the best way the fair market price of Bitcoin is taken into consideration.
There are a few market strategists and financial experts who opine on the contrary to the common market sentiment that favors filling these price gaps.
They say that it is quite unlikely that these gaps will be filled easily simply due to the lack of trading volume of Bitcoin futures in comparison to derivatives that are native to the traditional crypto exchanges.
They substantiate their opinion with some statistics and facts that show the low yield of the Bitcoin futures contracts for a specific period of time.
The average daily volume of these futures contracts is pretty low as compared to some popular crypto derivatives across different crypto exchanges.
Moreover, the trading volume differs even more significantly for the Bitcoin perpetual swap futures product across exchanges.
The most significant reason for such difference in trading volumes, the expert points out, is the availability of several other crypto-native derivatives exchanges that have high daily trading volumes.
Add to that, the fact that these exchanges trade all through the weekend as opposed to the CME Bitcoin futures widens this gap even more.
All these results in such a wide gap that is inconsequential as compared to the price of Bitcoin in the spot market filling the gap.
Typically, the price movements of one Bitcoin are often higher than the CME Bitcoin futures contracts price.
In some other situations, these prices are even a wage on where the futures market may open after the weekend.
Experts also point out that trading CME futures contracts through the weekend is very much similar to Bitcoin options trading wherein it is essential to place a ‘put’ or ‘call’ during the weekend on the gap so that the spread can be captured.
In fact, option trading is seen as another type of derivative in the crypto space.
Therefore, it can be concluded that in order to close the gap between the Bitcoin futures contracts price and the spot price of one Bitcoin it will need a lot more trading volume both from the bids and offer side of the Bitcoin futures contracts.
This is certainly required before the weekend, and also on Sunday, if possible.
Also, when the futures market reopens and resumes trading, it is required to maintain the same level of trading volumes all through the day, if not the entire week.
This will ensure that the gap between the spot price of Bitcoin and the price of the Bitcoin futures contracts is normalized in a much smoother and in a more effective way just as it should be.
In the end, after discussing all the necessary aspects, it can be said that, as of now, it is the CME Bitcoin futures that affect the spot price of one Bitcoin significantly more in a number of levels.
Given the fact that the impact on the price of Bitcoin depends on a large number of forces, it is probably difficult to conclude which specific driver causes how much impact. However, this article has tried to draw a reasonable conclusion.