Comment by josephagoss | Hacker News Reader

Comment by josephagoss | Hacker News Reader

Two interesting arguments the article discusses.

1) Will customers be able to sue JPMorgan Chase & Co. due to facilitating institutional trading customers access to these futures, when the CEO said that Bitcoin is a scam/fraud?

2) When the futures clear, you basically end up with dollars, which is odd to an extend as a future in oil will literally give you oil once it clears.

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On 1 I think that as long as those institutional trading investors are given a prospectus stating that Bitcoin could be a scam, invest in these futures at your own risk, it should legally shield JPMorgan Chase & Co.

The only time I can imagine JPMorgan Chase & Co. would be on the line is if they wrote an prospectus that said this is a good investment whilst the CEO is out in public talking about how much of a scam it is.

On 2, I would say this stops the CME Group Inc.'s futures exchange having to find a way to deal with actually running Bitcoin withdrawals that could open up hot wallet hacks, etc.. and in the long run this should bring down the overhead (fees) on the futures.

In addition what is the point of getting actual Bitcoin once the future clears? Obviously these customers do not want actual Bitcoin. I would say a future that ended with actual Bitcoins would scare away a lot of possible customers.

> When the futures clear, you basically end up with dollars, which is odd to an extend as a future in oil will literally give you oil once it clears.

Futures come in two types: physically settled and financially settled. Physical means the owner at expiration receives the product (in this case BTC). Financial means the owner at expiration receives the quote currency (in this case USD). Many futures contracts are financially settled, usually in the national currency where they are traded.

It would be possible to write physically settled BTC contracts, but that would be more complex for CME to implement (they'd need brokers to manage flows of cryptocurrency), and would be a less differentiated offering compared to existing cash exchanges.

Re: 2

Everything you say is true and acknowledged in the article, but as ML also points out they are also all arguments against bitcoin.

This is going to speak to my naivety around futures and how they work but if you're ending up with cash instead of bitcoin and there's no actual bitcoin wallets/bitcoins involved, what on earth are you actually buying when you buy a Bitcoin future in this manner? It sounds like the one, sure, answer is "not Bitcoin". Can anyone explain this to a neophyte like me?

There are two possibilities when buying a commodity-backed security like this.

You could buy a representation of the actual commodity, such that every $X you own represents $X of Bitcoin. That's known as a "cash commodity", or an "actual", or various other terms.

Or, you could buy what amounts to a bet on the future value of the commodity. Those don't need to correspond to any actual amount of the commodity. Those are called "futures", which are one type of "derivative" (because they're derived from the value of the commodity without directly representing an amount of the commodity).

Even oil futures are still settled with actual oil though. The distinction here is they are cash settled, which is pretty weird for an asset that is easily delivered.

Depends on the contract. Whine CL on CME is physically settled, WTI on ICE is financially settled. Both are contracts for the same underlying crude (I've traded them one for one in various strategies).

As one of the other commentators mentioned (and has been called out a few times), in the case of other futures, you are actually settling them with the commodity in question, but in the case of this product, you are settling with cash. I think I understand what you're saying, and I don't think I have any fundamental problem with it -- mainly because I don't invest in the futures market so it's simply "unimportant to me" how it works in this case -- but I'm curious: is this a normal practice?

Is it more common for a futures-based product to be settled with the product it's based on or is it more normal for it to be settled in this manner?

My curiosity, if the way they're executing on this is unusual, is "why"? I mean, take oil futures as a good example. It'd seem a whole lot easier to settle a BTC future with actual BTC than to settle an oil future with actual oil, so why isn't it the other way around? Heck, why wouldn't all of these futures-based financial products be handled in a cash-based manner -- what's the downside? (I'm not arguing for or against either method -- I really don't know).

My apologies if these are truly stupid questions -- I imagine I sound to someone who works/studies this sector like people sound to me who think "Facebook" and "The Internet" are interchangeable terms, but if you're willing to play along, here, I certainly appreciate it. :)

Keep in mind that most commodities futures contracts are never settled. They are closed before expiration (rolling into a new contract if you want to keep the position open). Many brokers will close your position before expiration, because they are not prepared to handle delivery, even if younwant to.

There are also some commodities futures that are cash-settled. Futures on financial indices, interest rates and such are usually cash-settled. But some futures based on financial instruments are “physically” settled, like US Treasury futures.

There's a pretty decent explanation from the article

> If you buy an oil futures contract on the CME, and you hold it when it expires, then someone hands you 1,000 barrels of oil, and you have to find a place to put them. If you buy a bitcoin futures contract, and you hold it when it expires, nobody hands you the 5 bitcoins underlying the contract. Instead, CME computes a daily "Bitcoin Reference Rate," "which aggregates the trade flow of major bitcoin spot exchanges during a calculation window into the U.S. Dollar price of one bitcoin as of 4:00 p.m. London time," and if the Bitcoin Reference Rate at the expiry of your futures contract is higher than the Bitcoin Reference Rate when you opened the contract, you get paid the difference ... and vice versa. In dollars.

If you have any specific questions related to that paragraph, I'm happy to try and explain what I know.

So you nailed down the specific part that I wasn't grasping in that paragraph: the "Bitcoin Reference Rate". Again, this is an area where I'm horribly naive and wouldn't imagine investing in (partly because I don't have enough knowledge around how futures markets, in general, work/behave and partly because I do understand Bitcoin). However, if what they're trading in is the "Bitcoin Reference Rate", isn't this really a future trading in this "Bitcoin Reference Rate" rather than Bitcoin? Does that even really matter, here, or is that an irrelevant detail? While Bitcoin isn't treated like an actual "currency" (outside of those of us who think of it as one, it appears the financial powers-that-be think of it like a traditional security/commodity-like instrument), are other currencies handled in this manner -- or any other futures product for that matter (i.e. is this common or is this something that is very unique)?

Oh, and thanks for the offer to explain -- it's much appreciated. :o)

The one takeaway from futures trading is that you probably don’t have enough risk capital to do it right. Professionals use large risk capital bases and have access to better information. Retail traders who don’t know better sign disclosure forms then overutilize the generous performance bond requirements, mathematically ensuring most will perish.

This is probably the most practical takeaway that I can share with you, and it’s why they’re considered so risky. Leverage can kill.

Any cash settled future is going to have to have a reference rate. The Brent Index is an example for a certain type of crude oil: https://en.wikipedia.org/wiki/Brent_Crude#Brent_Index

I'll prefix by saying this is my best understanding and that I'm not an expert by any means. Hopefully someone can correct me if I make any mistakes

My understanding is that a "cash settled" Bitcoin future essentially conducts an exchange from USD to Bitcoin with the exchange on the Seller's end, and then from Bitcoin to USD on the Buyer's end.

So, imagine a normal future's market where the Seller and the Buyer both want fiat, and are willing to do their conversion from Bitcoin to fiat with the same exchange that conducts the transaction. So, when it's time to settle the futures contract we see the following transactions:

Seller Buys a Bitcoin

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Seller -> Exchange: $10,000

Exchange -> Seller: 1 Bitcoin

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Seller settles Future contract

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Seller -> Exchange: 1 Bitcoin

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Buyer receives delivery of Future contract

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Exchange -> Buyer: 1 Bitcoin

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Buyer exchanges bitcoin to fiat

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Buyer -> Exchange: 1 Bitcoin

Exchange -> Buyer: $10,000

The Exchange, however, doesn't want to be in the game of holding bitcoin or exchanging bitcoins. So they modify their contract to say that the Seller will pay them in USD (whatever the conversion rate of Bitcoin to USD is), and the buyer will receive USD (again, with the same conversion rate). Then we condense those transactions above:

Seller settles Future contract

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Seller -> Exchange: $10,000

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Buyer receives delivery of Future contract

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Exchange -> Buyer: $10,000

Now the Seller, Buyer, and Exchange are only dealing with a fiat currency that they're familiar with. However, through the "Bitcoin Reference Rate", or the computed conversion rate, the Buyer and Seller are being exposed to the Bitcoin market.

So, you're right that what's really being traded are USD pegged to the "Bitcoin Reference Rate". However, since the Bitcoin Reference Rate should be a fairly transparent conversion into Bitcoin market conversion rates, it should exactly track if a Buyer and Seller traded Bitcoins and then immediately convert them to fiat dollars.

Futures have something called open interest and an expiration. They come into existence because both a buyer and seller are willing to take opposing positions. When this happens, open interest increases correspondingly.

Let’s say you believe btc will rise and you bid to buy one CME futures btc contract at 42000. I am willing to sell (short since, let’s say, I don’t have any contracts to sell) at 42000 and we have now created the future contract out of thin air. Upon expiry money has changed hands between us daily (mark to market pricing) between our futures trading accounts (customer segregated funds at our respective clearing firms to be exact), and price was tied to the underlying (spot — the real btc market) price at all times.

All we did was bet against each other with the “score” being the actual btc price. The “cash settled” part means we don’t touch btc at all, we settle the bet between us in cash. If it sounds too obvious or if it seems like you’re missing something, you probably get it. It’s simple, and there are a lot of complexities underneath the surface (expiration months, cost of carry, contango and backwardation), but at the core it’s just a bet on the price with one party believing price will rise and other believing it will fall. Nothing less or more.

In practice there is interplay between futures and spot markets’ prices, and this opens up a can of worms about liquidity and how futures could be used to “stabilize” a commodity (read up on hunt brothers cornering the silver market for an example of govt intervention into a futures market)

On a very basic level, I get most of that. But in the cases you mention, you're actually buying a contract based in the actual asset/security you're targeting. In this case, it sounds like you're buying an asset that is priced based on the asset/security (BTC) but that outside of that price doesn't involve actually doing anything with BTC. Is my assessment here completely insane or am I somewhere near understanding what I've read in that article?

No your assessment isn’t insane; instead you’re visualizing how they’re related and it’s important to understand it.

CME does daily mark to market pricing so the futures price will always fall back in line with the “bitcoin index” which is based on the actual spot market.

CME futures typically close once daily for a brief time (each market has its own schedule) and price settlement (the price adjustment) occurs around that downtime. This is distinct from most btc exchanges which as far as I know, operate round the clock (could be wrong on that point, I don’t actively use various btc exchanges).

If someone were to sell a whole lot of futures and drive the futures market price way down relative to the spot market, another participant could then come in as a simultaneous buyer of the futures and seller of the spot market, pocketing the difference knowing the price will be marked to market daily. Such a natural force helps to keep the prices correlated in soft real time.

Beyond that you’re correct it’s just a way to gamble on the side :) nothing to do directly with real bitcoin

I'm going to try though I'm a neophyte myself. So if we take the example of oil, if you need to buy oil in 6 months time and don't want to be affected by market volatility you can pay a small premium on today's prices to guarantee the price in the future. People that don't actually need oil but think that it will go up in value can also use the futures instead to bet on oil being more expensive and cash out the difference between what they paid and what the future price ends up being. Speculating on Bitcoin vs oil isn't so different, the only difference I can see is that where as there is use cases for hedging and one for speculating traditional futures there only exists the speculating use case for Bitcoin futures.

It is not necessarily a premium.

I don't agree that people having some investment in Bitcoin without ever holding Bitcoin is a disadvantage.

Once of the things we used to talk about years ago with Bitcoin was that by the time Grandma owns Bitcoin in some way, it would be via several layers on top.

And we were not talking about technology layers like LN, we were discussing that eventually financial products would be built on top of Bitcoin.

I see this as the market maturing and even die hard Bitcoin fans should see this as a good thing.

It's unrealistic to expect everyone that interfaces/holds value in Bitcoin to actually use the raw layer itself.

But futures aren't like that; futures are supposed to be one of the lower layers of the financial "abstraction stack", not the top layer.

Grandma doesn't buy futures; grandma invests in a mutual fund that buys futures. But Harold the wheat farmer does buy wheat futures directly, because his whole business is delivering wheat down a manufacturing pipeline, and the wheat future delivers wheat just like his own fields will, so either can be used as an input to said manufacturing pipeline. That's the original point of [commodities] futures, after all—to let Harold hedge his wheat-growing risk. The fact that they can be traded like any other instrument to make money without ever coming into possession of any commodities at all, is just a weird side-effect.

Shorting bitcoin, whether as a hedge or in speculation, seems like the killer app here. And because of the ability to short, a successful futures market should reduce BTC's volatility. I'm personally uneasy with long-only futures funds, because it does seem that they might be able to distort the market. Oil is a great example.

I wouldn't short crypto, ever.

The bitcoin futures contract is worth 5 BTC. So if you own 5 BTC, you can short one BTC futures contract and lock in your current value. In fact, until you've done that, BTC are a highly uncertain store of value with a history of extreme volatility. To me, bitcoin's greatest weakness is its wild price swings.

It's interesting to say that you'd never short crypto. That means, in effect, that you'd never borrow money in BTC -- so no crypto credit. Why? Borrowers are effectively short the currency, lenders long. If BTC goes down, borrowers owe less (in dollars, for example). If BTC goes up, they owe more dollars (must buy the bitcoin back at a higher price, just the same as if they'd gone short futures). Because BTC can go up without limit, borrowers of bitcoin are exposed to limitless risk. This is true if you borrow in any currency, and makes exchange rate risk important in credit. With bitcoin you're almost guaranteed a wild ride -- so for now, credit markets based on bitcoin are practically impossible. So, borrowing five BTC from a bank is the same as going short one futures contract.

We have yet to see if the Chicago Mercantile Exchange contracts will become popular. If they do, the CME will likely create options on the futures contracts. Then, as a speculator, you could much more safely buy put options to short bitcoin, and be guaranteed of never losing more than you'd started with.

> So if you own 5 BTC, you can short one BTC futures contract and lock in your current value.

Wouldn’t it be much easier to sell?

You could just sell the BTC, yes, but a futures contact might be faster, easier, and cheaper, though I don't trade BTC so I don't know, and we don't yet know if these contracts will be liquid. Many futures contracts never take off, so we'll see.

If you sell the 5BTC you’re done. If you short one contract and BTC doubles next week you will be $40k down on that position. It looks a bit risky... Of course your BTC will now be worth $80k instead of $40k so the math works out. But you will have to come with collateral to keep the position open (or get it closed and take the loss).

If you don't actually have the BTC you can't sell.

For example you are a miner and trying to lock in the correct BTC price or if you are expecting payment in BTC and don't want exposure to BTC price moves.

The put hedge is a fraction of the cost of the total BTC you currently hold. It's basically insurance on your current BTC holding and you're willing to pay the "premium" to dampen the volatility of BTC.

Shorting using futures has nothing to do with buying puts. You can think of buying puts as buying insurance (you pay now for the option to sell your BTC at a guaranteed price later), but buying/selling futures is esentially giving you the same exposure as buying/selling the underlying asset.

The meme of crypto is HODL. So yes, I wouldn't short it or borrow btc for USD and today in btc. Definitely not now

> I'm personally uneasy with long-only futures funds, because it does seem that they might be able to distort the market.

What do you mean? It´s not just that there is an ability to short, each contract has necessarily someone standing at each side.

Yes, each contract has someone on each side. With long-only futures ETFs and so on, large numbers of investors can get exposure to the futures markets, for example in physical commodities markets like petroleum and agricultural products, in the attempt to create diversity in their portfolios, and they usually want to go long, as if they were buying stocks, typically when the trend is up in the first place. Many economists believe that they then can help to exacerbate trends beyond a rational price (think, "bubble"). Hard evidence for this is inconclusive, but I personally tend believe it is quite possible.

So, for example, the price of oil may rise because of fundamentals (supply and demand for actual use), but this new source of passive, paper demand (trend-chasing long-only investors) can push the price farther than it could have gone otherwise. For example, $147/barrel West Texas crude oil was clearly impossible to sustain (and may have been the needle which finally made the financial markets go pop), but very possibly froth in the markets had helped pushed it up that far, because everyone wanted to get in on this amazing commodities super-cycle, and of course they wanted to be long. The supply and demand fundamentals were indeed bullish, but not up to $147, or, at the same time in 2007, $18/bushel of soybeans, a price that would imply widespread hunger.

Excuse me for going on like this, but it could be interesting to note that the justification for having speculators in futures markets at all is to provide liquidity to the markets and help in price discovery. That means, to me, that participants should go long or short with equal proclivity. Instead, many ETFs encourage stock and bond investors to take long-term, buy-and-hold style positions in the futures markets. There are short commodity ETFs, but they aren't popular like the longs. Therefore this class of speculator introduces too many longs, not enough shorts, often with the effect of distorting market movements, especially during trends.

Still, these aren't likely to be issues with bitcoin futures.

I cannot say that I disagree with what anything you wrote. I really don’t know how things are going to play out, it will be interesting to watch. Futures can create a disconnect between fundamentals and prices because they provide a way to get exposure to an asset that was not available before. But in the case of bitcoins it is already possible to buy them and there is no fundamental value to diverge from anyway... The demand for bitcoins is clearly high before futures are available and maybe having a new way to get the exposure will in fact relieve the pressure on prices (the notional long exposure can go up without pushing prices up as long as there are enough shorts). I don’t know and I don’t really care: I have no dog in the race, I’m just watching it for fun.

> Harold the wheat farmer does buy wheat futures

Presumably you mean he sells wheat futures.

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