Bitcoin logo sits on a LL 1800W power unit supplying cryptocurrency mining machines. (Photographer: Andrey Rudakov/Bloomberg)

You Can Trade Bitcoin Futures. But Should You?: QuickTake Q&A

(Bloomberg) -- Trading in bitcoin futures opened today on Cboe Global Markets Inc. Its rival, CME Group Inc., will soon follow suit. It’s a milestone in the acceptance of the digital currency by the world of mainstream investing, spurred in part by bitcoin’s meteoric rise this year. Skeptics still abound, however, including executives at some of the world’s largest banks. For the doubters, at least there’s this silver lining: Futures trading may add an opportunity to burst what they see as a bubble.

1. How does bitcoin normally trade? 

On a network of unregulated exchanges, which have their own prices for the digital currency -- and a long history of problems that range from service crashes to hacks and thefts. Buying and holding bitcoin is essentially a bet that its value will rise further. Not everybody who wants to get involved in this market thinks so.

2. What does it mean to trade bitcoin futures?

Futures contracts -- which derive their value from some underlying thing like corn, wheat, or in this case, a digital currency -- oblige a buyer to pay for something at an agreed-upon price at a certain date in the future. They can be used to make a bet on which way the market for a product is going to move. They can also be used to short a market, or bet that prices will fall.

3. Who’s going to be offering futures contracts? 

Three of the largest U.S. exchange companies, all overseen by the Commodity Futures Trading Commission, are debuting bitcoin futures contracts. Cboe is getting its contract to market first. CME will begin offering a competing product on Dec. 18. Nasdaq Inc. is planning to introduce bitcoin futures next year. The other major U.S. exchange player, Intercontinental Exchange Inc., has not yet announced any plans to do so. “We may be stupid for not being first on that,” Jeff Sprecher, CEO of ICE, said at an investor conference this month.

4. Why are they doing it?

Exchanges want to offer what investors want to trade, and a lot more people want to trade in the bitcoin market than even a year ago. Coinbase, a large bitcoin exchange, was overwhelmed by heavy traffic as bitcoin soared toward $10,000 in late November. CME, which as recently as October hadn’t made a decision on how to address cryptocurrencies, ultimately decided the allure was too much to resist. For traders, bitcoin offers an entirely new landscape to navigate. One hallmark of bitcoin trading is unpredictable price swings, a stark contrast to the eerie calm that’s settled over other financial markets, including U.S. equities.

5. What are the risks? 

Not everyone thinks derivatives based on bitcoin are ready for prime time. One worry is the volatility that so far has been a key feature of the digital currency market. Just three days before Cboe’s product was slated to be introduced, bitcoin had one of its wildest sessions ever: On Coinbase’s GDAX exchange, prices zoomed up to almost $20,000 from $16,000 in only about 90 minutes, before crashing back down.

6. So are bitcoin futures a bad idea? 

Some big traders think futures may be premature. The Futures Industry Association -- a group of major banks, brokers and traders -- said the contracts were rushed without enough consideration of the risks. In an open letter to the exchanges, the group questioned whether they would be able to adequately police market manipulation in bitcoin. The group said the exchanges should have sought more industry feedback on margin levels, trading limits and stress tests for the system before beginning trading. Cboe and CME are requiring traders to set aside an unusually large pile of cash to serve as collateral to back purchases.

7. What is bitcoin, anyway?

This simple question draws a surprising amount of debate in the investing world. While bitcoin advocates call it a currency, the CFTC views it as a commodity. Skeptics view it as a commodity without any intrinsic value, with demand driven by novelty and the scarcity imposed by bitcoin’s software protocols, which will cap its production. Some analysts think it will trade more like a volatile stock, while others expect it to develop into a new asset class entirely. These arguments are being debated among trading desks at banks and hobbyists alike.

8. Is anyone betting against it?

Those who believe bitcoin is overheated have a chance to short the market with the introduction of bitcoin futures. Some hedge funds have been waiting for the chance to bet against the cryptocurrency.

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