Bitcoin Futures Are No Bubble Bellwether

(Bloomberg) -- Bitcoin just passed its first major Wall Street test, but cryptocurrency bulls shouldn't read too much into it. 

Bitcoin futures began trading Sunday evening on the Cboe --the first "Wall Street" exchange to list the digital currency -- and the direction was straight up. By 11:30 p.m. New York time, the contract had already been halted twice because the price was rising too fast. Early Monday morning, the contract was at $17,700, or $2,700 above where it started trading 12 hours before. Bitcoin rose, too, up $831 to  $16,475.

Bitcoin Futures Are No Bubble Bellwether

It makes sense bitcoin bulls would cheer. Trading was mostly smooth in both the futures market and on the traditional bitcoin exchanges. The two trading halts on the Cboe, which mandates the contracts take a pause after 10 percent and 20 percent rises, were by design and resolved quickly. Based on prices for bitcoin futures contracts settling in January, Wall Street's best guess is that the price of the cryptocurrency will rise another $1,225 in the next six weeks or so. That's not as fast as it has been rising recently, but it suggests at least for now the market experts, bank CEOs and Noble-prize winners who have been predicting bitcoin's bust will continue to be proven wrong.

But while bitcoin has entered Wall Street's established futures market, don't expect trading on the Cboe, or on a rival exchange owned by the CME Group, which will start in a week, to literally tell you the future -- like when the bubble will pop, or if it is a bubble at all.

First of all, futures prices almost always trade above their current prices. There's even a name for the phenomenon, contango. Oil, for instance, which few look at with the same rosy eyes as bitcoin, is frequently in contango, and sometimes even super-contango (though not now). It's not exactly clear why that should be.

Economist John Maynard Keynes, who might have had a thing or two to say about bitcoin had he been alive to see it, frequently argued that the natural state of affairs in the futures market should be the opposite of contango, something called backwardation. But we've seen 70 years of futures markets since Keynes died, with far more liquidity than the economist ever saw, and contango has won out more than the opposite. The reason in the oil market is likely that there is a cost to store oil, which is reflected in the higher futures price. But bitcoin, other than say hacking, doesn't really have storage costs. Still, even with things that aren't physically stored, like say the VIX, we normally see upward sloping futures prices. And sure enough, that's what's happening with bitcoin.

Bitcoin Futures Are No Bubble Bellwether

Second, it's not clear that trading in futures on the Cboe reflects where the market will actually settle. Since it was the first time that Wall Street traders could easily short, or bet against bitcoin, some thought the futures price would plunge at the open. Instead, it rose. But the Cboe might not be a good test of this. Some brokers like Interactive Brokers Group Inc., which caters to individuals, said they wouldn't facilitate short-selling.

Professional traders could have been kept away by the structure of the Cboe contract, which is only based on the price of bitcoin on a single exchange -- Gemini (recently, bitcoin prices have varied widely between the numerous exchanges on which it trades). Meanwhile, futures traders at the big banks seemed to be in a wait-and-see mode before the contract started trading. The CME's contract, which will be based on the average price across four different markets, is seen as a better structure. Also, just jumping in first shows a certain faith in bitcoin. So it makes sense that the initial trading of the Cboe contract might naturally draw more bulls than bears.

Lastly, futures, despite the whole madness of crowds thing, are rarely predictive of the actual future. Instead, they are typically haunted by the past, which could be what is happening here. Crop futures markets typically trade with the seasons. They're high in the spring when crops are just being planted, and low at harvest time. Oil futures tend to follow supply, or expected supply. And that works pretty well. But futures markets almost never predict shocks like heavy rains or droughts. Futures on non-physical assets haven't worked any better. In March, VIX futures predicted that the volatility of the stock market would rise by a third. Instead, share prices continued to head straight up, and the VIX has declined.

All this is to say, it's nice that bitcoin futures didn't blow up in the first 18 hours that they started trading. But don't look for bigger takeaways.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Stephen Gandel in New York at sgandel2@bloomberg.net.

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