The Chicago Board Options Exchange (CBOE) will unleash cash-settled bitcoin futures on Sunday, December 10, 2017, at 5 PM CT. I think the price of bitcoin will skyrocket in the exchanges and will become unhinged from the price of the futures because of the additional leverage and lack of effective arbitrage.

The CBOE recently raised the minimum initial margin requirement from 33% to 44%. On the other hand, an e-micro gold futures contract that represents ten ounces of gold has an initial margin requirement of only 5% and is settled in the underlying. For bitcoin futures, each contract represents one bitcoin and will be settled in cash. Bitcoin is definitely not “digital gold” in the eyes of the CBOE.

Futures are used for three reasons: hedging, speculation, and arbitrage. The hedgers will be miners; the arbitrageurs would be high-frequency trading firms; and the speculators will be a combination of retail investors and small, crypto-focused hedge funds.

The most important reason that the CBOE’s futures contracts will drive up the price of bitcoin is due to the fact that traditional, established arbitrageurs cannot operate effectively. They cannot trade the underlying because bitcoin exchanges are unregulated, and the CBOE’s futures contracts are cash-settled. Therefore, without the ability to trade actual bitcoin, there is no way for an arbitrageur to dampen volatility by taking “the other side” of the trade.

Miners will undoubtedly sell futures to hedge their production risk, which will exert downward pressure on the price of the futures. With higher margin requirements, it will be more difficult for speculators to enter the futures market, so only highly motivated bulls and bears will buy and sell futures. However, since there is an unlimited risk to a speculator who shorts futures, I would anticipate that the majority of the speculators in the futures market will be bulls.

This dynamic of bitcoin miners as sellers and speculators as buyers would mimic that of the current exchanges: the upward price movement will continue, except at a faster rate because of increased leverage. Furthermore, any speculative shorts will be squeezed, thus exacerbating the rise in the underlying bitcoin price.

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