december 10, 2017

Bitcoins gone wild!

You would need more than 20000 of the recently minted Swedish copper-alloy-coin in the picture to buy one bitcoin today! As for the old French gold-coin from 1874 you would need some 50 of them! In other words, a bitcoin is a very expensive bit of computer code right now! I think you all know that. The price has gone from $700 to $14000 in 12 months. That is, it has gone up 20 times! 2000% in one year. Meanwhile the stock market has gone up som 10%..... and the inflation and the interest rate is around 1% or 2%.

Bitcoin prices are also very volatile! An interesting development related to that is the introduction of bitcoin futures on two futures exchanges now in December 2017. Any day this or next week CME and CBOE will launch their products. I am looking forward to this for several reasons:

- First, of course, as an investor, is the possibility the launch will give anyone to bet on a falling bitcoin price, not only on a rising one. Also, for someone who likes the idea of the bitcoin but sees the danger from an ever rising price, the introduction of futures is likely to bring the benefit of putting some downward pressure on the bitcoin price. Maybe a lot of downward pressure!! There will be some interesting coming weeks in the bitcoin market.

- Second, as a researcher, the launch will be a nice example of how to choose (or not to choose...) margins in futures exchanges. That is, the collateral that the bourse demands from participants. Considering the extreme volatility of the bitcoin price I expect extreme margins as well. The initial margin required from investors at CME will be 35%. On CBOE the margin will be 33%. In other words, the allowed leverage will be a puny factor 3! For the Investor, it means, nonetheless, that a fall in the bitcoin price with one third will wipe out their entire position. Now, is that a likely scenario? Or put differently, what is the risk that CME or CBOE will suffer losses due to unexpected large price movements?

To answer these questions, let’s look at the price history of bitcoin. Over the last 12 months there are 17 daily price movements that are larger than +/-10%. The largest is 25%. Over the same periods there are 10 weekly price movements that are larger than +/-30%. The largest is 70%! This means that the margins would have been exceeded 10 times within a week over the last year. Luckily, though, the margin would never have been exceeded between two closing dates. Based on this I nonetheless think margins as high as 33% make sense. In fact, I would probably have demanded slightly higher ones if I were in charge. But, of course, for an exchange it is not only a matter of being safe, you also need customers. And I would guess that customers in this particular market like to fire up their stakes with as much leverage as possible! But do they, and their brokers, know that they are playing with fire when doing so...?

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PS. As of lately, journalists, friends and colleagues have all asked me whether the bitcoin market is in a bubble. My answer has been the same every time: Yes, I think so, but I would not bet my house on it! As I see it, either there is a bubble or the bitcoin market knows something we don’t! Perhaps they have some insider information about an impending collapse of every currency in the world (one dollar buys 0.00007 bitcoins) plus Elon Musk already successfully mining huge amounts of gold on asteroids (one oz of gold buys 0.09 bitcoins).... It can happen :)