I am writing this article as a financial analyst for H.A.R Group, LLC. This article is strictly a hypothesis and any decision you make based on this information will be at your own risk. I do not give financial advice to outside clients and therefore this should be treated as purely hypothetical.
On December 18th, 2017 when it was announced that Bitcoin futures would be traded, the current price of Bitcoin was roughly $19,500. For those new to the financial markets a future is a contract written between two entities (or people) to transfer goods (or currency) at a specific time in the future (hence future contract). At this moment the price of the future settlement is based on the current price of the good at hand. For Bitcoin, the price when the first futures contract was announced was $19,500 and set to expire January 17th, 2018. Once that contract was produced, Person A (Whale) agreed to sell his or her Bitcoin to Person B (Unlucky Buyer) for $19,500 on January 17th, 2018 regardless of what the current market price will be.
Below here is a chart of the price of Bitcoin From December 1st to present.
The red circle roughly indicates December 18th, 2017 when it was announced that futures would begin being trading. This was considered an all time high for Bitcoin and naturally some people sold their positions to make a profit. Although for the whales or institutions holding Bitcoin they took advantage of the current situation as well, and besides selling Bitcoin at the price of $19,500 they also engaged in futures contracts to make even more money.
This is not hard to see on the graph above where as soon as the futures contracts began trading, the overall decline of Bitcoin began. Of course part of the reason this occurred is because average people like you and me sold, but a larger portion of this occurred because people holding large amounts of Bitcoin began to sell in sort of a stair-step fashion in order to not crash the market. Remember it was estimated that roughly 1,000 people (or entities) own roughly 40% of the total Bitcoin in circulation. “It’s not necessarily illegal for big holders of some cryptocurrencies to discuss trading with one another. That puts small buyers at a disadvantage.”
Now you ask well why is the market crashing right now in the cyrptocurrency world? Let me give you a basic example of how one whale could take advantage of this situation.
First pretend Person A is a whale. He has 10 Bitcoin in his possession that on December 18th, 2017 were worth $19,500 a piece. His total Bitcoin net worth is $195,000. He decides to take advantage of the current situation involving futures contracts and goes into a deal with Person B. With the futures contract, Person B agrees to buy Person A’s Bitcoin at the price of $19,500. Remember, with futures the good (or currency) in hand rarely if ever changes hands because the contract is settled in cash not Bitcoin. Anyway, as soon as Person A and Person B agree on this contract (agreeing to engage in 10 contracts with Person B at the settlement price of $19,500) Person A turns around and sells his entire position of Bitcoin priced at the current market rate at the time on December 18th, 2017 for $19,500. Naturally as a whale he has power to slightly manipulate the market so as he and other market movers are doing this the price of Bitcoin drops as indicated in the graph above. This along with novice crypto-investors helps drives the price even further. So the futures settlement price is $19,500 and the whale just sold his entire holdings for a gain of $195,000. Fast forward to January 17th, 2018, in the days leading up to this event other whales have slowly sold their positions and people are in panic mode which drives the price to $11,000 (current price as of January 16th, 2018 for sake of example). This is great news for the whales because the current settlement for Bitcoin as stated on the CME website is $11,160 (for the sake of ease pretend each contract is 1 Bitcoin instead of 5 as listed on the website). Now the math here is easy, but please try to understand the method. At a settlement price of $19,500 (agreed on December 18th, 2017) Person B agrees to buy from Person A (the whale) Bitcoin at the settlement price of $19,500. Although the current settlement price is now $11,160 that does not mean Person B can buy Bitcoin at $11,160. Instead he has to pay the price of the December contract settlement price which is $19,500 per Bitcoin contract.
EDIT: In an earlier version of this article I did the average of the spot price and settlement price of BTC. The number of $153,300 would have been the total price of the 10 BTC contracts adjusted for a 20% margin on the balance. When dealing with futures contracts you, in most cases, have to pay something similar to a down payment that depending on the price is due everyday on the difference of the daily spot and settlement price. I have since removed that equation to simplify the scenario and assume that the margin was included in the total cost of the contract pay out.
So once January 17th, 2018 rolls by, Person B has to pay a total of $19,500 x 10 = $195,000 to Person A (the whale) and no actual Bitcoins exchanges hands. This is perfectly legal and is allowed to happen on a daily basis. The whale in this simplified example made $195,000 from selling his Bitcoin at a peak PLUS made money from the natural effects of his power to manipulate the market with other whales and weak hands selling at the first sign of danger. In total this whale made $195,000 + $195,000 = $390,000 from 10 Bitcoin worth a total of $195,00 from the time he engaged in a futures contract. This is just one example, a simple example, of what many of the big players are doing and you can see how the market can fluctuate so much within a short period of time.
Why is this good and bad?
It is good because it gives us (the little guy) an opportunity to profit from wild price swings once the market realizes the massive discount presented to us by the way of the whale. Reason is first, the whale have even more buying power and can buy even more Bitcoin at the deeply discounted prices that he in the beginning caused. On top of cheap Bitcoin prices he essentially can buy back his 10 Bitcoins plus have a pile of cash sitting on the side from a mixture of him selling his coins at an all time high and getting paid from a contract that he won. We as little investors, we have the ability to go into the market of Bitcoin or Altcoins (Bitcoin and Altcoins are highly correlated in the overall market cap) and buy cheap coins and ride the price wave as everyone goes in and buys coins at a deep discount.
The bad part? Now that futures are trading for Bitcoin, what’s stopping from this happening all over again once the next futures contract expires in a couple weeks? Could this be the mirco-cycle of the cryptocurrency market that swings heavily from a month to month basis? There’s no telling what could happen because of all this and the only thing we can do is wait and see what tomorrow will bring us once these contracts expire and people have to pay up. The bottom of the market is hard to guess and no matter how good we think we are anything could happen in the market. People like to be optimistic and say that it will moon soon, that’s a nice thought, but we need to take out emotions and be realists here for a moment. Is it really decentralized when just 1,000 people have the power to fluctuate a market this much?
Not to deter the cryptocurrency world, the idea behind blockchain is revolutionary and I hope to see it prevail like never before. In my opinion, it’s best to watch closely today and tomorrow to see what these new markets have in store and be ready to buy coins you believe are at a deep discount while you can. Surely, in a couple days we’ll be sitting back wishing we didn’t stay out of the market during the market decline and instead jumped in at the right time and rode the price wave back up.
Speaking as a Financial Analyst looking into the cryptocurrency world, be careful, do your research, and never use emotion when investing in anything. Facts are facts and feelings are feelings. Your circle of competence is how you’ll make the most money in life. You wouldn’t let a truck driver teach you how to do open heart surgery, so why would you let an average Joe person (YouTuber, Reddit User, etc) tell you how to invest in cryptocurrency? Be smart and be aware, and always take what I or others say with a grain of salt.