The Bitcoin Futures Trap


Perhaps I am all-wrong about this. I actually hope that I am. In any case, it won’t be long before I (and we) find out. Given the significance of the subject matter though, I felt it important to share my perspective for those interested. If I look the fool then so be it.

On Monday, Bitcoin futures will begin trading and many Bitcoin enthusiasts are optimistic about the impact this will have on its price. As things stand right now, I think they will be sorely disappointed. Rather than the launch of a Bitcoin futures contract being indicative of mainstream financial markets’ acceptance, I believe that instead it represents a new method of control and price suppression.

I offer a few options which Bitcoin investors may consider at the end of the article (titled, Conclusions and Options). While this article is a bit longer and more technical than I wanted it to be, I nonetheless encourage you to not ‘drop out’ before reading that short concluding section.

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As discussed at length in The Power of Money: A Case for Bitcoin, Bitcoin represents a dire threat to the status quo monetary systems’ power structure.  Currently, the ability to ‘create money out of thin-air’ is held by a small elite (which I have colloquially dubbed the ‘Masters of Money’, or MoM)– the public face of which is represented by Central Banks. The prospect that the masses will adopt a form of money that is fixed in supply (for Bitcoin it can only ever be 21 million coins) would mean that this elite could no longer conjure up new units of money to be spent wherever they see fit –  in general to enrich those of their choosing at the expense of those ‘not in the club’. As such, they have gone to  extreme lengths to fight Bitcoin.

Their initial attempts to stop Bitcoin (and really Blockchain in general as an alternative to fiat currency) were crude – they tried to simply ‘kill it’. Attempts were made to break the encryption, disrupt mining and verification processes, and undermine the public’s confidence in it through methods ranging from threatened bans to a concerted effort to disparage Bitcoin in the media as a bubble, fraud, or ponzi scheme.

While these attempts are all still being pursued (just in new forms) there are additional subtler programs being deployed to undermine Bitcoin and more generally ‘blockchain-as-money’. These include attempts to control and neuter Bitcoin – some of which I discussed in my last piece, The Bitcoin Flaw: Monero Rising. The latest attempt, which we are about to publicly see in-action, is the launch of Bitcoin futures contracts. The launch of Bitcoin futures represents a method whereby the Masters of Money may be able to accomplish two of their key objectives:

1)    Suppress the price of Bitcoin
2)    Accumulate more Bitcoin for themselves, while critically not driving up the price (which up until this point has been impossible).

Suppressing the Price of Bitcoin

If Bitcoin were to stop going up in value (never mind go down in price!) – it could halt the progress that it has made towards globally displacing Fiat as money. Not only would investors and speculators (who are only ‘in it’ for the investment return) eventually tire of having their resources tied-up in an asset that doesn’t produce a return, but Bitcoin would seemingly not be able to assume a large enough percentage of global M3 (money supply) to constitute a real threat. $200-300 billion is of course a  fortune, but with regard to global money supply, the scale at which widespread practical roll-out occurs is in the trillions, not billions. Furthermore, the talking-heads who have called Bitcoin a fraud/ponzi/etc. until now will no doubt be all over the media with insulting ‘I told you so’s’.

Before we can understand how a Bitcoin Futures contract could be used to suppress the price of Bitcoin, we need to recognize one additional fact about the situation – the Masters of Money are willing to ‘lose’ unlimited amounts of money in the process of killing Bitcoin. After all – what  ‘losing’ money means to you or me means nothing to those who have the ability to create money out of thin-air. When this is combined with the realization that if Bitcoin is not ‘stopped’ their very ability to create money is at-risk, then we can see how whether a particular ‘trading-strategy’ generates a positive return or not is irrelevant. All that matters is whether the Bitcoin threat is defeated, thus defending the power of the MoM to create money.

The presence of a market-participant with unlimited funds and no concerns over losing money throws a massive wrench into the works of traditional investing and economic analyses. Indeed, most financial and economic theories are based on the notion that market participants act in such a way as to maximize their investment returns. When this is no longer the case, the usefulness of ‘normal’ exchange and trading functions can be turned on its head.

With that, we can turn to a demonstration of how Bitcoin prices could be suppressed. The picture I’m going to paint will undoubtedly be overly-simplistic and ‘off’ in details from how things actually play out. It is just one demonstration of how Bitcoin may be controlled through Futures contract trading. The key take-away of this though is that the MoM can sell as many futures contracts for Bitcoin as is necessary to drive that price down. The lower futures price may have an impact on the actual price for Bitcoin – presumably driving it lower. That’s really all there is to it. Will those contract sales (betting against Bitcoin) eventually make money for the MoM? Maybe, maybe not. But remember, it doesn’t matter. They care not one whit as to whether they lose money on the ‘trade’ – only that it succeeds in keeping the price down and thus neutering the Bitcoin threat.

Starting Assumptions

Let’s assume that Bitcoin is $15,000 a coin just prior to trading on the exchange (December 11th). Let’s also assume that the first contract ‘expiry’ date is exactly one month later (January 11th, 2018). Let’s also assume that Goldman Sachs (GS) is acting on behalf of the Masters of Money (this shouldn’t be too far a stretch to consider – especially as Goldman Sachs is being charged with clearing all the futures trades in Bitcoin). As such, let’s assume that GS has unlimited money (and no regard for profitability) in their quest to keep the price down. Finally, let’s assume that there is a hedge fund, we’ll call it BitFund, who owns 10,000 Bitcoin (currently valued at $150 million), and that this BitFund has the ability to trade on both actual Bitcoin exchanges, as well as the Futures exchange.

December 11th
Once trading begins, and in the face of any buying of contracts, GS sells as many contracts as they need to push the Bitcoin futures price down to where they want it to be. (Note, I will be using what I expect to be exaggerated price swings to more easily illustrate the theme). Whether GS has to sell $100 million worth of contracts to effect this price move, or $500 billion – it doesn’t matter. There is no limit to how much they can sell. (This could be achieved via the Federal Reserve providing an up-sizeable revolving credit facility for $10 trillion at 0.25% interest, and not maturing for 100 years. As the Fed is not audited, no one outside the institutions need ever know – so long as that GS subsidiary was non-reporting.) Let’s assume that after 5 minutes of trading, they have sold $10 billion of futures and this has dropped the Bitcoin futures price to $10,000.

Meanwhile, on actual Bitcoin exchanges, the price will not have dropped so quickly. After all, there hasn’t been nearly as much actual selling of Bitcoin as there has been of futures contracts. Nevertheless, traders will be looking to the price on the futures exchange, and will undoubtedly be made nervous by the movement lower. Some or many will sell ‘for a trade’. Let’s assume that the price on the actual Bitcoin exchanges are (also after this first 5 minutes) is $14,000 a coin.

Now the sophisticated BitFund sees a great trading opportunity – they call it ‘arbitrage’. BitFund sells all of their 10,000 actual Bitcoin on the exchanges, at an average per-Bitcoin price of $13,500 a coin. They simultaneously buy Futures contracts for 10,000 Bitcoin at $10,500 a coin. They know that when January 11th comes around (the day of the Bitcoin futures contract), the price of the Bitcoin futures contract and actual Bitcoin coins will converge on the same price (this is a technical feature of futures trading I won’t go into here).  They pat themselves on the back for being so clever.


January 11th

Nearly a month of significant selling by GS of the Bitcoin futures contract has had an impact. The opening price of both Bitcoin and the Bitcoin Futures contract (remember, they converge at expiry) is $11,500.  Along the way, GS has bought 50,000 worth of actual Bitcoin on the exchanges. While they were selling futures contracts, they were buying the actual Bitcoin on the exchanges! In other words, while pushing the price down, they have accumulated a strategic inventory of actual Bitcoin.

This strategic inventory is very important as they can do lots of things with it… but most importantly, they can use it to ensure that buying pressure for actual Bitcoin that occurs on this day (from those such as BitFund) doesn’t push the price all the way back up to $15,000 a coin.

As it happens, BitFund isn’t so keen to replace all the Bitcoin they sold. After all, they sold it at a great price, and locked in an arbitrage profit. But in the month since that day, the price and prospects for Bitcoin have gone down. They decide to only place an order for half their original inventory of actual Bitcoin: 5,000 coins.

Knowing that demand for actual Bitcoin is coming, GS decide to sell a portion of their strategic Bitcoin hold all at once – 25,000. This is more than enough to not only satisfy actual demand from BitFund, but to further drive both the cash and futures price even lower.

At day’s end, Bitcoin actual prices are $11,000 a coin. Bitcoin futures prices for expiration on February 11th are $10,000 a coin (GS has of course continued to sell those futures). GS walks away from the month with a net gain of 25,000 actual Bitcoin while having also kept the price down. That they actually made money on their futures trade is icing on the cake, though as we’ve discussed, not that important to them.


A Few Extra Thoughts

Many people have argued that Bitcoin has not been amenable to institutional buying – after all, if a large mutual fund like Fidelity wanted to buy $1 billion worth of Bitcoin, they couldn’t do so without pushing up the market price significantly – something that most traders are loathe to do. While this is true, what is not true is that instituting a futures market for Bitcoin (or any other asset for that matter that has limited liquidity) can somehow ‘magically create liquidity’. When it comes to buying the actual Bitcoin, there is no shortcut to going out and actually buying Bitcoin. Institutions can delude themselves into believing that by going ‘long’ Bitcoin futures, they are going long Bitcoin. This is nonsense. At contract expiry, they will own nothing but a profit or loss that has been determined by a market participant who has an enormous capacity to suppress the price of Futures, along with the actual ‘set prices’ on expiration day.

By my reckoning, there are only 2 natural seller of Bitcoin futures. The first would be miners, who want to use the contract to lock-in sales prices. I think this is extremely unlikely. Most miners are well funded (and certainly strategically oriented) to not need forward monetization. They haven’t needed it thus far, and not selling their Bitcoin at anything other than ‘spot’ prices has been enormously profitable for them. That they would now seek to sell their Bitcoin via a cash-settled futures market seems unlikely to me in general. The other natural seller of the futures we have already discussed – the MoM who are seeking to use this mechanism to control the price. If there is another selling market participant for whom the futures market would benefit, I ask that someone point this out to me.

Conclusions and Options

This could be a very challenging time for Bitcoin holders. Some options are (a painful) HODL, or using the lower prices to add exposure to actual BTC coins (ie, not bothering to try to buy the futures contracts). To the extent that  deep-pocketed investors still believe that Bitcoin will maintain its status as the standard-bearer for blockchain-money, then this could be an opportunity to accumulate a large position at lower prices. After all, the process to drive the bitcoin price lower only works if holders of actual Bitcoin sell their actual Bitcoin. If holders of actual Bitcoin don’t sell, (or even buy), then eventually the futures price (which may begin the month much lower than the actual price of Bitcoin) will be forced to rise to price of actual Bitcoin. The MoM will have failed in their attempt. Of course, the MoM are betting that enough of the average Bitcoin holders will sell to move the market significantly lower, and for long enough to achieve their aims.

Another option is to migrate into a coin that doesn’t have a futures market associated with it. As I am currently of the belief that Monero is the Bitcoin successor, I personally see migration into that coin as reasonable. After all, while Monero (or any other coin for that matter) might ultimately be vulnerable to the same types of Futures-Market manipulation, if/as that time comes the coin community will have had time, information and resources with which to effect a neutralizing response. Nonetheless, first and foremost i would personally like to see this attempt to kill Bitcoin fail, and fail quickly.

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