Why do people say that Bitcoin futures have burst the Bitcoin bubble?

Source: Zero One Finance

Christopher Giancarlo, former chairman of the U.S. Commodity Futures Trading Commission (CFTC), revealed in a recent interview that the Trump administration of the United States had burst the Bitcoin bubble in 2017 by allowing the introduction of Bitcoin futures products.

“One of the things that has not been widely known over the last few years is that the CFTC, the Treasury, the SEC, and then-National Economic Council Director Gray Cohn all believed that the launch of bitcoin futures would burst the bitcoin bubble, and that’s exactly what happened,” Giancarlo said.

After nearly a year of skyrocketing, the price of Bitcoin has risen from $1,000 at the beginning of the year to around $17,000, and the market is in a frenzy. Many Bitcoin believers even believe that Bitcoin breaking through $100,000 may soon become a reality.

At the end of this carnival, the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) entered the market. On December 1, 2017, the U.S. Commodity Futures Trading Commission (CFTC) officially approved the listing requests of CME, CBOE and Cantor Exchange for Bitcoin futures. (Note: The CFTC committee consists of 5 members with a term of 5 years, and all previous CFTC members are directly appointed by the President of the United States.)

Subsequently, CBOE and CME announced the launch of Bitcoin futures contracts within a week of each other. This was seen as the recognition of cryptocurrency, which has always been in the gray area, by some mainstream institutions, which undoubtedly gave another shot of stimulant to the enthusiastic market.

Source: CoinMarketCap, 01 Finance Chart

On December 11, CBOE took the lead in launching the Bitcoin futures contract XBT. "These derivatives are real game changers that will revolutionize the traditional financial sector and increase the acceptance of cryptocurrencies. In the next 10 years, the cryptocurrency market will explode in terms of the assets and currencies involved," said CBOE Global Markets COO, commenting on the significance of Bitcoin futures.

The hot scene on the first day of listing seemed to verify people's previous expectations. Due to the fact that the speed of increase far exceeded expectations and the large fluctuations, the circuit breaker was triggered three times that day, closing at $18,545, a surge of nearly 20%. More than 4,100 contracts were traded on the first day, and the excessive traffic even caused the CBOE website to crash. At the same time, the spot price of Bitcoin approached $18,000, with a cumulative increase of nearly 79% in early December, setting the largest increase in four years.

Then on the 18th, CME officially launched Bitcoin futures trading, and the opening price exceeded US$20,000.

But after the carnival, what often comes is infinite desolation. What many people didn’t expect at the time was that just on December 17, the spot price of Bitcoin had already hit its highest point in history to date - $19,142.

In 2018, the price of Bitcoin began to fall sharply, and both spot and futures trading volumes showed a significant decline: spot trading volume shrank by more than 80%, and the trading volume of CBOE Bitcoin futures contract products did not exceed US$1 billion.

On December 17, 2018, exactly one year after reaching its highest point of $19,142, the price of Bitcoin was only $3,280, a drop of more than 83%.

The listing time of Bitcoin futures contract trading highly coincides with the time when Bitcoin price reached its historical high, which can hardly be described as just a coincidence.

Many people have always recognized that the greatest value of futures lies in value (price) discovery and risk hedging. Although volatility is the essence of the trading world, futures can allow an investment target that is out of its current value to gradually return to its value, and the two-way trading market also gives investors more investment options.

But in the Bitcoin futures market, this does not seem to be obvious.

When Shaen Corbet et al. studied the impact of Bitcoin futures contracts in 2018, they found that the Bitcoin futures market increased the volatility of Bitcoin prices. The results showed that since November 29, 2017 (two days before the announcement of the launch of Bitcoin futures), the volatility of Bitcoin prices has increased significantly, and the distribution of price returns has also changed significantly. In addition, the price discovery function of the Bitcoin futures market is significantly weaker than that of the spot market, which is completely contrary to the feelings of many people.

Source: "Bitcoin Futures - What Use are They?"

Bitcoin futures contracts do not seem to have played the role expected before. On the contrary, after the launch of Bitcoin futures contracts, the Bitcoin market began to enter a long bear market.

A report released by the Federal Reserve Bank of San Francisco under the Federal Reserve in May last year showed that the decline in Bitcoin prices since December 2017 is closely related to the launch of Bitcoin futures.

The report believes that futures provide Bitcoin investors with an easy and liquid channel, which has largely robbed funds from the Bitcoin spot market. Before the launch of Bitcoin futures, the Bitcoin market was just a "believer market" composed of optimists. Optimistic expectations are the only reason for the surge in Bitcoin prices, but pessimists have no suitable way to short Bitcoin and bet on the price to fall to make a profit. Therefore, after the launch of Bitcoin futures, pessimists can exit the Bitcoin market and short Bitcoin in the futures market, resulting in a decline in spot demand and a drop in Bitcoin prices.

The remarks made by the CFTC chairman this time are basically consistent with the views in the report, both of which believe that the emergence of Bitcoin futures contracts has curbed the Bitcoin spot market dominated by optimists.

The Trump administration burst the Bitcoin bubble at the end of 2017 by allowing the introduction of Bitcoin futures products, which may not be a bad thing from the perspective of Bitcoin's long-term development. But Giancarlo's statement itself reveals a lot of information: on the one hand, it shows the political power behind the launch of Bitcoin futures contracts, as well as the close attention and huge influence of the United States on the cryptocurrency market; on the other hand, it also shows the fragility and immaturity of the cryptocurrency market represented by Bitcoin. Even today, the price of Bitcoin lacks real value support and is easily affected by market expectations.

Of course, it is not sensible to attribute the sharp drop that began in late 2017 entirely to Bitcoin futures trading. Various factors, such as stricter global regulation and the rise of other cryptocurrencies, may have contributed to the bursting of the Bitcoin "bubble".

How can we explain all this now?