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Bitcoin Derivatives: A Case for Investor Caution

Liz Louw
21 November 2017

For the past few months, Bitcoin news has been abuzz with a wave of financial products launch announcements. The latest came at the end of October, when CME Group published a press release on its intention to launch bitcoin futures in the fourth quarter of 2017.

If you have seen the headlines and read the reports of the market responding with bitcoin surges, you might be under the impression that the move is unequivocally positive. The flow of institutional money into bitcoin most certainly allows for greater awareness of the cryptocurrency, and for some will represent a ‘credibility’ of sorts.

What is, however,  perhaps lacking from the discussion at this point, is the failure to consider the chaos that derivatives (more specifically, the institutions that sell them) have repeatedly caused in the traditional investment market, and what impact this may have on bitcoin. Let me explain.

Derivatives, Futures, and Market Manipulation

While big banking institutions’ adoption of bitcoin can be viewed as a bullish indicator for bitcoin, it may put the market at risk of the pitfalls of the traditional financial markets. Future markets, in particular, are vulnerable to manipulation by big institutions. Earlier this month, Credit Suisse’s foreign exchange business was fined $135 million for market manipulation. In December of 2016, regulators ordered Goldman Sachs to pay a civil penalty of $120 million to settle charges that it often tried to manipulate a global dollar benchmark. And in 2013, an Italian regulator fined the world’s biggest money manager, BlackRock 150,000 Euros ($204,600) for market manipulation. These events raise valid concerns about these businesses’ imminent participation in the bitcoin market.  

Earlier in October, Blackrock CEO, Larry Fink told a Bloomberg interviewer that he’s a “big believer” in cryptocurrencies and sees “huge opportunities” ahead for this market. UK-based hedge fund Man Group also stated their intent to invest a portion of their $103.5 billion assets under management (AUM) in Bitcoin, if CME’s futures exchange is approved by regulators.

Opening Bitcoin up for mainstream financial products opens the doors to market manipulation by institutions whose collective market capitalisations (market caps) outweighs that of Bitcoin by miles. While cryptocurrency market cap has certainly grown rapidly, it is presently at $172 billion, with bitcoin alone at around 54%, or $94 billion of the total. Compare that to $4,5 trillion AUM for Blackrock, JP Morgan’s $1.8 trillion, and $1.41 trillion for Goldman Sachs, and the power imbalance is easy to comprehend. By putting even a minimal percentage of their funds into the game, each of these organisations has the capacity to cause a tsunami in the bitcoin market.

Manipulation of Cryptocurrency Markets

We have already begun to the see a level of this manipulation in the bitcoin market from popular figures in the community, taking to social media to promote or deride trade movements or assets. Some comments seem contrary, illogical or misleading, leading one to suspect that the person in question may have an involvement with futures, and could be pushing a personal agenda. For lay investors, it is of utmost importance to be astute and apply discretion when considering these messages from bitcoin ‘celebrities’.

Other scenarios to be cautious of is ‘pump and dump’ schemes. As big institutions with enormous pockets enter the bitcoin market, we may expect these to  occur with greater frequency and exponentially higher levels. If not recognised for what they are, investors might find themselves investing in crypto at an inflated price, and  at a loss when the price retracts to stabilise at  lower levels.

The Importance of Being a Discerning Investor

How can a cryptocurrency investor benefit from growth spurts without getting caught in artificial ‘pump and dump’ cycles? In a market that is sensitive to hype (trading is 24/7, open to everyone with access to a wallet) it is difficult to tell the difference between the legitimate growth of price to match value.

What complicates matters is that day traders see these growth surges as an opportunity to make quick money. The first week of November was an example of this, as the Bitcoin Cash price rose to an all-time high, mainly as a delayed reaction to an influx of positive news about developments in the Bitcoin Cash arena. At the same time, day traders in South Korea jumped at the opportunity and pushed the price up to over $2,000 per coin. Just as quickly, once they had dumped their coins, the price dropped back, stabilising at around $1,000. While the consolidated price delivered impressive growth of the Bitcoin Cash price (from $340 to $1,000 in 1 month), we can safely (yet, sadly) assume that many ill-informed investors were caught holding a wallet of overpriced coins at the end of the day.

If you’re a HODLer (a nickname for an investor who elects to hold for the long-term), the safest option is to enlist the services of a specialist crypto investment firm. The value of cryptocurrency investment advisors becomes especially clear during irregular market movements, as can be illustrated by Michael Hudson, Bitstocks CEO’s public declaration during the past Bitcoin Cash growth spurt:

@bitstocks concluded our research on the viability of bitcoin cash 3 months ago. We’ve been incredibly bullish on BCH irrespective of naysayers. Fundamentals are king (especially) in #crypto

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