Bitcoin Futures : What this Market Means

Bitcoin futures were launched on the Chicago Mercantile Exchange in follow on to last week’s introduction on the Cboe. The result of these formal introductions is liquidity in the market for Bitcoin may pick up quickly. Naturally that would compress the price between futures and the underlying Bitcoin which is called the “the basis.” Currently the Bitcoin basis is around $450 to $800 which suggests there remains a significant liquidity difference between Bitcoin and futures markets. But now that futures on Bitcoin are introduced, institutional investors can develop a better fundamental view on what the “price of digital money” means for the global economy.
In that regard, what’s important to watch is the “convenience yield.” This yield is the premium or benefit of holding the underlying commodity rather than the futures contract. In other words, it is a measure of implied return of holding physical inventory. Many commodity contracts offer the opportunity/’benefit’ to get a barrel of oil wheeled in the drive way or a bushel of wheat delivered in the mail. In case of a “shortage” of supply or excessive sudden demand, physical assets can trade at a significant premium to futures. In the case of Bitcoin, it is not a tangible asset and yet, Bitcoin futures do have a “convenience yield.” In summary the convenience yield formula is: Convenience Yield = interest on loan to settle futures + 1/# of days to futures settle * LN(Futures price/spot price). LN = log normal distribution. The chart below shows the convenience yield for CBOE Bitcoin. At first, the convenience yield was very large (150% to 200%) as Bitcoin futures traded with a larger premium over spot Bitcoin. As the CME now introduced its futures referenced against multiple Bitcoins, the convenience yield has collapsed but remains high (10% to 15%), see Figure 1. The economic meaning is that the “price of digital money”. i.e. Bitcoin, remains elevated. Not just because 21 million of Bitcoins have been mined in the hands of a few. On that basis, with $ 50 trillion of global money circulating, the value of Bitcoin could be as high as $2.5 million. But this value may not be achieved also because the digital price of money is determined by a different kind of interest rate; the convenience yield. Bitcoin is therefore more representative of a commodities based instrument rather than a currency. Its economic meaning may therefore be similar as what the price of wheat, silver or orange juice has to the average consumer. For financial markets, Bitcoin futures are new financial instrument that eventually may gain traction as a hedge against speculative money flows. Until then, like the other commodities, the value of Bitcoin and Bitcoin futures will be determined by the balance of supply and demand for digital money.

Source: Bloomberg, CME and Cboe

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