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Do Futures Contracts Affect the Volatility and Prices of Bitcoin?

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    On December 18th, 2017 something remarkable happened in the cryptocurrency industry. It was a day when the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) group introduced Bitcoin futures contracts for the time. This groundbreaking move allowed investors to make speculations on Bitcoins price without owning any of it.

    These events marked a milestone in Bitcoin’s journey toward becoming widely accepted and adopted. However, they also gave rise to some questions; how would the introduction of Bitcoin futures impact the price and volatility of this asset?

    As the launch date approached, there was a surge in Bitcoin prices with some exchanges seeing it reach to $20,000 per coin. The entire cryptocurrency community was buzzing with excitement and speculation. Many experts believed that these futures contracts would further boost Bitcoin’s value by providing it with a sense of legitimacy, as an asset.

    In the end, Bitcoin prices steadily declined after peaking around the time the futures launched. They sank below $10,000 by February 2018 and continued sliding throughout the year. Volatility also spiked—Bitcoin's price fluctuations were 5 times greater after the futures debuted compared to before.

    Futures contracts allow two parties to lock in a price today for a transaction to take place at a future date. They are a common tool used in commodity markets to hedge against price volatility. For example, an airline might use oil futures to lock in fuel prices and prevent exposure to oil price swings.

    Several studies have since explored the futures market's impact on Bitcoin. Some found increased volatility; others reported a price decline after the futures' introduction. A few researchers even delved into hypotheticals: what would the Bitcoin market look like without the influence of futures? They attempted to predict the cryptocurrency's trajectory without future effects using structural time-series models. In conclusion, Bitcoin futures played a critical role in shaping the market.

    Satoshi Nakamoto's 2008 introduction of Bitcoin revolutionized financial markets. However, its massive popularity brought about extreme price fluctuations. The inclusion of Bitcoin futures aimed to address some of this unpredictability.

    Bitcoin futures provide traders with insights into future asset prices. They can gauge ongoing supply and demand, reflecting Bitcoin's underlying value. With futures' launch on regulated platforms, Bitcoin was thrust into a broader spotlight, enticing more investors and increasing overall market participation. 

    Bitcoin futures bring more to the table than mere speculation. They introduce hedging, a strategy traders employ to manage short-term market volatility. By offsetting their positions through futures, traders can minimize exposure to drastic price fluctuations in the spot market. This strategy can decrease volatility, as traders can manage risks more effectively and avoid impulsive decisions driven by panic. 

    However, the introduction of futures also has its challenges. Speculation can be a double-edged sword. If traders overwhelmingly believe that the Bitcoin price will rise, they might buy futures contracts in bulk, creating a demand surge that can inflate the spot price. Conversely, if the sentiment leans toward a price drop, traders might sell futures en masse, potentially driving down Bitcoin's spot price. 

    As futures contracts revolutionized commodities markets from wheat to oil over the past century, Bitcoin futures are integrating digital currencies into the mainstream economy. As cryptocurrency transitions from speculative mania to an established asset class, futures will enable the stability and confidence needed for major financial adoption. The evidence so far shows futures deliver on their promise to improve price discovery and mitigate volatility. However, despite the influence of futures, it's essential to remember that numerous other factors impact Bitcoin's price, including market conditions, global events, and media coverage.

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    This post was authored by an external contributor and does not represent Benzinga's opinions and has not been edited for content. The information contained above is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice. Benzinga does not make any recommendation to buy or sell any security or any representation about the financial condition of any company.

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