Did Bitcoin Derivatives Change the Institutional Investment Landscape?

The arrival of cryptocurrencies has resulted in varied responses from the traditional finance world. Initially thought of as a fad with little practical application, the sentiment surrounding cryptocurrencies have generally improved, with institutional investment rising notably in the past two years. Despite this, many parties still find investment difficult, as regulation is threadbare and infrastructure is still nascent.

The introduction of Bitcoin futures contracts, by the likes of the CME Group and Cboe Global Markets in late 2017, has changed this by offering an attractive investment vehicle. According to Investopedia, futures are financial contracts that represent an investor’s agreement to buy or sell an asset at a predetermined future date and price.

When the contract expires, the asset is bought or sold at the stipulated price, whatever the market rate may be. While this may appear to be a challenging investment vehicle, it is a highly lucrative derivative product, as it involves betting on the future price direction of the asset.

One of the significant ramifications of Bitcoin futures was that its announcement allowed investors who were on-the-fence about cryptocurrency to enter the system in a regulated and safe fashion. This includes hedge funds, endowments, and pension funds, which all began warming up to the idea of cryptocurrencies.

Why are Bitcoin Futures Important?

As evidence of the significance of Bitcoin futures contracts, we only need to look at the value and growth of the crypto market around the time. In December 2017, one Bitcoin reached $19,000 in value, and the market as a whole had a market cap above $700 billion. Naturally, such a large price change was accompanied by an influx of new investors and greater trading volume. Around $50 billion in daily trades was recorded on CoinMarketCap.

Although the market saw a decline following this bull run, institutions and high-profile investors saw the value in Bitcoin and cryptocurrencies. Morgan Creek Capital Management’s Mark Yusko opined that the market’s lull in 2018 nudged institutional investors, all “without the challenges of buying, storing, and safekeeping digital assets.”

Coinbase CEO, Brian Armstrong, also said that there was a noticeable rise in institutional interest, tweeting

“Whether institutions were going to adopt crypto or not was an open question about 12 months ago. I think it’s safe to say we now know the answer. We see $200–400M a week in new crypto deposits come in from institutional customers.”

What are the Ramifications of Bitcoin Futures?

Bitcoin Futures opened up the investment potential for large investors and institutions - the big players who wanted a suite of tools to make the most out of the asset class. Prior to futures, investors would have to buy Bitcoin from other investors or via an exchange - a method suitable for millions of retail investors, but not large investors. The latter wanted margin trading, leverage, and short selling.

Futures opened the floodgates of institutional investors, boosting liquidity and, more importantly, adding a sense of legitimacy to the overall cryptocurrency market. Futures contracts are also required to comply with regulations put down by the US Commodity Futures Trading Commission (CFTC), which further assuages any concerns about risk and legitimacy that professional investors may have. This, in turn, has spurred exchanges to offer specialized custody solutions so that traditional investors can invest in the crypto market even outside of derivative products such as futures.

Where does the Future(s) Go from Here?

Bitcoin futures are not the only crypto-based derivative product in the works. Several companies have been planning to launch a Bitcoin based exchange traded product for the past couple of years, often mentioned to as an ETP or ETF. All the proposals have so far been rejected by the United States Securities and Exchange Commission (SEC), citing concerns of manipulation. However, Bitcoin ETPs have been launched on the Swiss stock exchange SIX.

This should make investors optimistic, as such products are slowly entering the market and being approved by lawmakers. In due time, such products will win the SEC’s approval and ensure that it is ‘designed to prevent fraudulent and manipulative acts and practices’. This could very well bring a massive price push, similar to the first Bitcoin futures contract back in 2017.