Can price of Bitcoin be manipulated by Bitcoin futures? In the crypto market you will not only have different types of crypto coins with varied market caps, popularity quotient and prospects to trade with but you can also choose from different forms of it.
It can be options trading, short selling and more. The latest form to choose is Bitcoin futures contracts which have gained significant and rapid traction among the investors.
However, since the launch of Bitcoin futures in December 2017, both investors and critics are quite apprehensive about its future and the effect it would have on the Bitcoin price as well as the crypto market on the whole.
In fact, most of them believe that Bitcoin futures will have a serious impact on the price of Bitcoin.
And, in that case, your most natural question would be – what could be the best probable defense against such price manipulation.
Well, to find the answer to the question you, fortunately, are in the right place.
In this article, you will come to know about the futures and futures market, the reasons for such price manipulation to occur along with several other necessary things for a clear understanding of the matter.
Can Price of Bitcoin be Manipulated by Bitcoin Futures?
The futures market and the approval for it by the SEC or the Securities and Exchange Commission has been a hot topic of discussion among financial experts and crypto critics of late.
The primary concern of people is whether or not it can manipulate the prices of crypto just as the behavior of the crypto investors resulting in a paradigm shift towards Bitcoin futures from direct Bitcoin investment or vice versa.
The main problem that the futures market can face is in its operation which would be affected due to several external factors.
One such significant factor that may affect the smoother operation of the futures market is due to the problems created by the enemies of it with unlimited amounts of cash in their hand.
It can be the Board of the Federal Reserve or even the International Monetary Fund or IMF, for example, who can hold back the price of Bitcoin.
Such suppression from such powerful bodies can have serious effects, though mostly temporary.
However, there is also quite a possibility to create some long term effects due to such price suppression, though it is debatable how strong or long term these effects can be.
This is because such strategies usually do not work for an extended period.
Understanding the Futures Market
You can trade futures contracts in the futures market.
These contracts are made between two parties who agree to either buy or sell the underlying asset of the contract at the expiry of the contract.
These dealings are done at a predetermined price and size.
Through the futures contracts you can get exposure to the crypto space without needing to hold the actual coins.
You can also use these futures contracts as a hedge against the price volatilities and prevent your portfolio from incurring a huge loss.
The futures markets are however a little different from the crypto markets as such where you can buy, own, and hold crypto coins directly.
The stark difference between a futures market and a crypto market is that these futures markets do not operate on the weekend and on holidays as against the crypto markets that are open and operate 24/7/365.
This means that there are a lot of possibilities to manipulate the price of the underlying asset of the futures contracts by the participants of the market during the weekend.
Such type of price manipulation can be typically achieved via the cash-settled futures market.
This is how it happens:
Assuming that you have one Bitcoin, you can speculate what its price will be in the future and place a bet on it.
You can choose any time period to write a contract.
Assume that the price of the coin is $10,000 as of now and you enter into a contract for a year, though you can choose any period of time.
Therefore, in the futures contract it will be written that you will sell one Bitcoin after one year at $10,000, though you are allowed to set any amount.
What does this futures contract mean and what are the advantages of it, you may ask.
Well, for a person who buys such a contract can abstain from selling the coin at the spot price or current price now.
Instead, the person waits for a year after which they pay for one Bitcoin.
This means that the buyer of the futures contract will hold the value of the coin, $10,000 in this case, in cash for a year.
This will allow the person to earn additional cash because the money held will earn yield for that period of time, one year in this case.
However, the good thing about the futures contract is that the person will still be able to gain an exposure to the Bitcoin market and the price movements of the coin, and for that, there is no need to pay for the coin in full.
This is because, after signing the contract the person has entered into an agreement.
The person is therefore now legally bound to buy the Bitcoin effectively for $10,000 at the expiration of the contract no matter whatever happens to the price of the coin within a year’s time.
If there is an increase in the price, say up to $20,000, the person will have to buy it at that higher price.
However, if the person wants to sell it immediately for $20,000, a profit of $10,000 will be made right away.
Yes, the person can also hold on to the coin thinking that it was a cheap bargain.
However, if the price of Bitcoin falls at the end of one year, the party to the futures contract will still need to pay $20,000 even if this price is much higher than the prevailing market price of one Bitcoin at that particular time.
Though the futures market determines the value of the contracts, assuming that it has a premium of $5,000 over the spot price, this will be the price that you will need to pay for enjoying the benefits as mentioned above.
At this premium, the price of the futures contract would have been $15,000 on the market – $10,000 for the price of the Bitcoin and $5,000 for the premium for one year.
In such a hypothetical situation, this will mean an annual premium of 50%.
However, in reality, in the futures contracts such details are not written so clearly. It is the exchange that sets the terms of these contracts.
This is why these contracts are fungible which allows them to be traded on an open market.
While trading a futures contract, all you have to do is visit a futures exchange and go to their homepage and look up a one-year contract.
Examine the chart displayed there and decide whether you want to buy or sell.
If you choose to sell it, you are actually selling the specific deal with a few specific terms and not the coins in particular.
You will be able to see an order appear in the order book.
In this case, there may be a person who will be interested in buying it and when they do so, it is then and only then, a new and live contract is created.
Also, it is at that time when the open interest, which is the total count of open contracts, will be added to it by the size.
This happens on the basis of the number of units that are traded.
If you want to come out of the contract, in such situations, there is no need to wait for that contract to expire.
You are also allowed to buy back the contract either at a profit or at a loss at any point of time if you wish to end the contract.
This actually means you will exit the position which will, in turn, decrease the open interest.
Reasons for Price Changes
There are a few specific reasons for the price of the futures contracts to change. These are:
Time Premium Decay:
First, the time premium may decay as time runs out because time has some value and over time this value reduces.
Even if the premium is high and the price of one Bitcoin stays dead-steady for the one-year period according to the above example, the high premium amount will reduce to zero as the date of expiry of the contract comes near.
This means, in the above hypothetical example, the value of one Bitcoin will be $10,000 in total by the end of the time mentioned in the contract which is one year.
This means the value will come down to the spot price of the coin at that time.
If you hold on to the coin at the end of the futures contract, then the profit you will make will be $5,000.
This is because you will sell it for $15,000 when it is about to expire at $10,000.
In short, the time premium of the futures contracts will be lost no matter whatever happens to the spot price of Bitcoin till the ultimate moment when the worth of the contract will be the same as the Bitcoin spot price.
Time Premium Volatility:
A major component of the time premium is volatility which has a significant influence on the time decay of the time premium.
Due to the volatile nature of the spot price of Bitcoin, there may be wide fluctuations in the cost of the remaining time premium.
This is pretty similar to an insurance policy.
There will be an increased likelihood of wilder price swings in highly volatile situations which will make the insurance premium much more expensive.
Changes in the Spot Price of Bitcoin:
The spot price of Bitcoin may also change apart from the time premium.
If the spot price of Bitcoin rises, it will also signify a rise in the price of the futures contract.
This rise will be seen across all the components of the futures contracts apart from the time premium.
How Price Manipulation Crop Up?
Price manipulation can crop up in several different ways as such. One of the most significant ways in which the price of Bitcoin is manipulated, in fact driven down, is by selling the futures contracts at a much lower price than the actual price of them.
This is done heavily and easily because it does not need any Bitcoin as collateral for this. All that is needed is cash collateral.
This collateral is however required to protect them in the event when the trades go in the wrong direction.
In such a situation when the trade goes in the unexpected and in the wrong way, the entire collateral is confiscated by the exchange to liquidate the futures contract and to recover the amount that is owed.
This is another way in which the price of Bitcoin can be manipulated by Bitcoin futures.
It is usually believed that the futures prices do not move away from the spot price of Bitcoin due to arbitrage.
Assume a situation where there is heavy selling of the futures contracts and the prices of it drop significantly from a high but the spot price of the underlying coin of the contract does not move away from its current position.
In such a situation an experienced crypto trader would consider it to be a good opportunity to make profit and see that the price of the futures is much too cheap.
It is highly likely that the trader would take full advantage of this situation and think that it would be a good bargain to buy the future contract at a price which is lower than the spot price of the underlying asset of the contract.
In order to make the most out of the situation, the trader may buy one future contract at a lower price than the spot price and sell one Bitcoin from his own holding at the spot price which is higher than the price of the futures contract.
This way he will make a profit immediately through arbitrage.
In this process, though the trader would have his number of Bitcoin holding reduced by 1 unit, he will still be exposed to the same number of Bitcoin in terms of price and not in terms of his actual number of coins held.
Since this remains unchanged the trader will still be able to make profits if the price of Bitcoin increases, though in fiat terms.
And, of course, the trader can always exit the position and end the futures contract after taking the profit in fiat.
He can buy back the Bitcoin at the current market price but still be better off and make profit.
This is because it is earned from the money of someone else that was not as prudent as the trader and sold the futures contract off at a far too cheap price.
The best part of it is that such profits would come for FREE. It sounds pretty good and most alluring.
Conversely, if you look into it more closely you will see that the spot price of the coin would also be driven down in the process due to the selling pressure.
However, this fall in the spot price will be till it reaches the lower prices of the futures contracts and not more.
This is because an arbitrage will be profitable only up to that specific price point.
This, though, is excluding the time premium component.
If you take the premium aspect into account, then selling the coin at a much lower price than the price of the futures contract would be quite rational and it would not result in significant losses.
Whatever loss that you will incur apparently by selling the coins at a price lower than the futures price will be compensated by the purchase of the futures contracts which are extremely cheap at the moment.
However, if you want to make more profits, you should make the best use of the time premium for free.
This is a good and more reasonable move because you are not someone who can print unlimited quantities of fiat money or want to push the price of Bitcoin further down all by yourself.
Reasons Why Manipulation in Bitcoin is Unsustainable
However, the good news about manipulation of Bitcoin prices by the futures contracts is that it is not sustainable.
But, before you understand why it happens temporarily, you must understand how exactly it works.
It is also worth noting at this point the success of this strategy followed to suppress the price of gold.
This will help in understanding things in a much better way.
As far as gold is concerned, the number of futures claims for it is much more than the total amount of gold available.
Then how is it sustained exactly you may ask.
This is mainly because the delivery of these futures contracts is made in terms of fiat money and not in actual gold.
And, there is literally no limit to the existence of fiat money, which is controlled by the government.
Add to that, there is no commitment to deliver gold as well.
Apart from that, people also do not want to accept gold physically as a payment for several reasons such as the costs involved in it, the storage requirements, and the security and carrying issues.
It is for these reasons that everyone seems to be willing to accept and trade with ‘paper’ gold and this type of gold is not scarce at all since there seems to be no limit to the amount to which this type of gold can be created.
Therefore, the scam (if at all it can be called so) continues and in the process the supply of gold is increased effectively.
This eventually leads to the suppression of the price of gold.
Though it sounds pretty similar, this is not the actual case with Bitcoin.
In this specific space, the solution to manipulation of Bitcoin and sustaining it is provided in two specific ways.
As you may know Bitcoin is easy to accept, carry, and take into custody or hold.
It is easy to spend and transfer directly to anyone living anywhere in the world instantly as it can be made from peer to peer.
And for that you do not need any help or interference of any third-party intermediaries.
This is much unlike gold which you can take custody of but cannot make an international trade without a central party taking custody of it.
This increases the chances of market manipulation of the price of gold.
Bitcoin , which is intended for self-custody, is easy to store in a wallet that you own to hold the private key.
You can amass more and more Bitcoin and it can be done in a number of different ways such as:
- By converting your fiat money to it
- By buying them directly from a crypto exchange
- By accepting it as a form of payment for the goods provided or services rendered by you and
- By buying more of it from arbitrage proceeds from people who are trying to manipulate the price of Bitcoin down.
Irrespective of the way in which you do it, when you accumulate more of these coins, you will want to do it in actual coins especially if you want to hold them for a long term and not as a term paper promise for it or in fiat as it is done in the case of gold.
Such an activity adds to the fiat inflation and in turn strengthens both the awareness as well as demand for Bitcoin.
In short, such types of activities may be active and feasible temporarily but in the long run it will result in an equal and opposite reaction which will add to the demand for Bitcoin.
Apart from that, people who gather Bitcoin also tend to extract as much of coins as possible from them out of whatever supply of fiat money they have with them when the price of it is driven lower.
This reduces the chances of price manipulation as well.
At this point, it is imperative for you to know that buying Bitcoin simply on the spot market is not enough to do away with the price manipulation.
You will also need to make withdrawals. You must know that any Bitcoin that is remaining in the custody of the exchange is not a real Bitcoin necessarily.
Also, if you are told that you hold only one Bitcoin, you may not be sure that there is or will not be more than one claim for the same Bitcoin.
And, you may not be able to check whether or not the Bitcoin even exists with the exchange until you withdraw it even though the balance on the readout page of the website of the exchange shows that it still exists there.
In such situations, there are all the chances for the crypto exchanges to replicate the fractional reserve practices that are typically followed in the banking sector.
Therefore, you are not really breaking the price manipulation if you simply demand spot Bitcoin and leave the coins on the exchange.
If you are confused, here is an explanation that will make things clear to you.
Assume that there are millions of holders of Bitcoin who are trying to accumulate more Bitcoin and this number is increasing continually.
When these holders put in their fiat money to the spot market they have to bid for it which they do at a suppressed price.
In such a situation, there may not be enough Bitcoin available for delivery.
However, to gain access, these holders raise their bids even further which may be much more than the actual price of the futures contracts which, as such, is much lower than the spot price of the coin.
When such a situation prevails where bids continue to increase there may be other Bitcoin holders who may be interested in selling their holdings off, probably to buy some other goods with the fiat money they might get.
Therefore, in such conditions, the coins get transferred from the weaker holders to those with stronger hands.
This drives the spot price of the coin further up because they want real coins to gamble on instead of paper Bitcoin future contracts.
Moreover, due to the bids getting higher and the price continuing to rise, someone wanting to use an arbitrage strategy will now need to have actual Bitcoin in hand to carry out the plan.
However, there will be no Bitcoin left in hand since he will only have either fiat money or hold futures contracts.
This eventually drives the spot price of Bitcoin back down to the price of the futures contracts. This will put an end to the price manipulation.
Another significant reason that the manipulation is broken and cannot sustain for a long time is that there are lots of people who are allured by the arbitrage profits and want to make some themselves.
This is a situation when you sell off your Bitcoin holdings in lieu of future contracts that are priced low.
This may help you a lot when you want to reload your Bitcoin stock at a later date.
During these times you may want the futures contracts to expire or close them and collect the fiat money irrespective of making any profit or loss.
You can use this money received in the process to buy back your Bitcoin from the spot market again directly.
This will push back the price of the coin further up.
Therefore, with all these activities, the component that resulted in the fall of price of Bitcoin just as the manipulator wanted becomes irrelevant for the time through which the futures contract of Bitcoin was held.
To summarize and after comparing the price manipulation of Bitcoin with the gold analogy as mentioned earlier, it can be said that the results of Bitcoin price manipulation will never be the same as that of gold.
This is because the attributes of Bitcoin, as such, are simply not like gold in terms of relevance as well as in utilizable weaknesses.
Instead, one can demand for Bitcoin easily, store them easily when they get them, and transact them easily and instantly across the globe.
This demand for real Bitcoin by the investors and holders will simply disconnect the price of Bitcoin futures contracts from real Bitcoin.
Finally, it is safe to say that you cannot use a Bitcoin futures contract as a mode of payment for buying any goods or services.
You will need actual Bitcoin for it. This is the primary reason that the price manipulation of Bitcoin by the Bitcoin futures contracts is essentially temporary.
In the end it can be said that price suppression is not an impossible event in the futures market but it cannot really sustain for a long period. Going through the article now you surely know the answers to all your whys and hows related to it.