Comment by mdip | Hacker News Reader

Comment by mdip | Hacker News Reader

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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

---------------------

Seller -> Exchange: $10,000

Exchange -> Seller: 1 Bitcoin

------------------------------

Seller settles Future contract

------------------------------

Seller -> Exchange: 1 Bitcoin

------------------------------------------

Buyer receives delivery of Future contract

------------------------------------------

Exchange -> Buyer: 1 Bitcoin

---------------------------------

Buyer exchanges bitcoin to fiat

---------------------------------

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

------------------------------

Seller -> Exchange: $10,000

------------------------------------------

Buyer receives delivery of Future contract

------------------------------------------

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.

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