Bitcoin futures have already been introduced last year on the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOE) last year in December. Even though these contracts were seen to be used for hedging and controlling risks, one can make a case that they are being used for speculation.
Bitcoin has already become a highly speculative underlying asset. In this article, we will explore some of the most fundamental problems with having bitcoin futures Brokerage Definition.
Bitcoin futures contracts in Chicago are denominated in terms of the cryptocurrency. But they need to be settled in cash. This may not seem to be a huge problem at the surface. However, it is quite a crucial matter.
When the price of the underlying asset increases sharply, a lot of people rush to buy it, and this increase in demand causes scarcity in supply. Thus, the market will not be able to exert downward or upward pressure on the price of the digital currency. The price of bitcoin will be independent of the movements of the futures market.
With the tremendous rally in bitcoin prices, governments all over the world are imposing restrictions on bitcoin trading. The exchanges and the traders are being brought under the ambit of tax duties.
To avoid the government regulation, many investors are willing to pay some premium. This is the reason why they buy bitcoin contracts rather than just actual bitcoin. In case they wish to go long on their investment, they merely open another contract when the current one expires. If they want to unwind their positions, they simply just avoid rolling over their contracts Top Financial Brokerage Firm.
There is no liquid market for determining the price of bitcoin at any point in time. The contracts that are being sold in Chicago are largely dependent on certain bitcoin exchanges. The price that is used by CBOE is determined based on the price quoted by Gemini, which is a small bitcoin exchange.
In a similar manner, the price quoted by the CME is the average of 4 small size bitcoin exchanges. Their smallness makes them susceptible to financial and cyber-related attacks and hazards. There is no standardized price being followed for Bitcoin futures.
The price quotes that are acquired from different exchanges could differ by as much as 25 percent. This is what adds to the volatility and instability of the market.
Usually, the brokers require about 10 to 15 percent of the asset price as security. This happens in the case of assets like stocks and bonds. This margin money prevents the brokers from losing money because of the client.
As the price begins to decline, the broker issues a call to increase the margin money in a process called margin call. If the call is met by the investor, the contract will still be supported. However, if the investor fails to put up the required margin money, the contract is sold in the market and the losses are booked on the account of the investor.
Since rallies in bitcoin are wild and volatile, brokers usually need more than 35 percent of the price of the contract as margin money. To some extent, this is good for the market. Higher margin money puts down the leverage that brokers can provide to their client. This puts a limit to the amount of money that speculators can borrow and invest, keeping prices in check.