Let’s talk about bitcoin derivatives. I’m not an expert, and need to do more research on the actual figures, but my main worry has been this:
PoW supporters talk about the consensus working because “breaking” the bitcoin network would make participants’ holdings worthless. Miners won’t collude because they would lose not only the value of their bitcoin holdings but also the investment in the mining equipment (which is considerable). So, bitcoin is safe.
But what about short positions? A big enough short position could produce enough of a profit to make colluding to “break” bitcoin worthwhile.
My worry has been that bitcoin derivatives weaken the consensus incentives.
Now, I need to check into the volumes required, and the mechanism (can you even short that much, or are there limits?). So this is the beginning of a thought exercise rather than the sounding of an alarm.
My concern has (so far) been largely offset by a fascination for what bitcoin derivatives can tell us about sentiment. I thought that open positions could point to where the price was heading. Until I read this, that is, from Christopher Langner’s article on Bloomberg Gladfly, “Is Bitcoin Growing Up?”:
“The quarterly contract sold at Bitmex entered backwardation — the future price fell below the spot price — in January, shortly after the PBOC started cracking down on the exchanges. In a market with limited supply, the fact that most of the big traders are betting prices will go down must be bad news. So it proved, but this time hedging may have limited the downside.”
Let’s go beyond downside limitation. What if derivative positions were mainly used as a hedge, rather than as speculation in their own right? Backwardation could simply be an offsetting hedge on a large long position. The bearish signal would be false.
In other words, the derivatives traders are not necessarily betting that prices will go down – they could have a big long position (which means they think prices will go up), and the futures contract is a way to protect their downside if it turns out they’re wrong.
A smart trading strategy (assuming the premiums are not too steep – I need to look into that part some more). It does, however, make reading the tea leaves of futures contracts not much more than an entertaining pastime.