Chances are you’ve recently come across a tweet or even a publication declaring the death of Bitcoin. But it’s good to be aware that in its short lifespan, Bitcoin has already been pronounced ‘dead’ over 377 times.
Once again, Bitcoin prices fell sharply just three weeks ago. It’s down 20% from last month. Some analysts have attributed this sudden drop to the somewhat tepid uptake of the much-hyped physically delivered Bitcoin futures contracts from Bakkt, a newly launched crypto exchange. Others cited macroeconomic instability.
But these dramatic price swings are nothing new. In fact, as reported in a recent paper by the International Monetary Fund (see page 6), the standard deviation of Bitcoin prices is approximately 10 times higher than in most G7 currency pairs. That’s hardly a surprise given the age of Bitcoin (a little over a decade old), relative to other currencies.
The reason for this comes down to multiple factors. And while such volatility may decrease over time – as the market continues to mature – Bitcoin’s persisting state of flux presents an opportunity, especially for investors who trade futures.
What is behind Bitcoin’s volatility?
This year, Bitcoin is reportedly more volatile than ever, but so far it’s also 2019’s best-performing asset – even after its recent downturn. We may be tempted to attribute certain movements in the price of Bitcoin to real-world events, such as Facebook’s proposal of Libra, a presidential tweet, or the launch of a new platform, but it’s good to bear in mind that there are various underlying and interrelated factors that make Bitcoin so susceptible to such influences in the first place.
Firstly, Bitcoin is still in its nascent stages. As it has not yet reached its full potential in terms of utility, either as a currency or a technology, price movements are still largely determined by sentiment. The terms FUD (Fear, Uncertainty, Doubt), and FOMO (Fear Of Missing Out) are sometimes used as common reasons for price movements.
Secondly, the market is still primarily populated by retail investors, with most of the institutional capital still on the sidelines. Apart from having implications in terms of liquidity and market size, this also means that the type of investors that engage Bitcoin, on the whole, may approach trading differently, or on the basis of a different time horizon, than for example pension or hedge funds would.
Thirdly, up until recently, there were virtually no regulatory and few security measures in place to protect the market against manipulation and theft. As a result, institutional investors have been somewhat reluctant to really engage this asset class, and those who do – unless they are active traders – are encouraged to take their funds out of the order book and into cold storage, which essentially leaves the market less liquid and thus more susceptible to slippage.
It’s reasonable to assume however that as technological improvements reduce security risks and drive adoption, and as regulatory measures are put in place to further instill investor confidence, we can expect more capital inflow, thicker order books, and consequently less volatility.
But Bitcoin’s volatility should not be seen as a problem. While we do anticipate price movements to stabilize over time, which is positive for Bitcoin’s utility as a store-of-value, it is good to recognize that assets present different investment opportunities across life cycles and at this stage in its development, Bitcoin’s volatility is particularly interesting for those who engage the futures markets.
Riding the waves with perpetual contracts
If 2019 has indeed seen Bitcoin at its most volatile, it’s also been about the rise of crypto derivatives. In addition to enabling investors to hedge their own position – instead of having to close it to limit their losses – what’s attractive about this type of financial product is that it enables investors to make a profit in different market conditions, depending on how you are positioned.
Perpetual futures contracts constitute an especially appealing class of derivatives as they grant investors maximum flexibility when it comes to entering and exiting their position. Furthermore, by trading with leverage profitability can be amplified considerably.
On the AAX platform, perpetual contracts for Bitcoin can be traded with up to 100x leverage, up to 50x for Ether, and 20x for Litecoin, EOS, and XRP.
To illustrate: If you short Bitcoin with 50x leverage and exit your position after a 2% drop in the price, you would have effectively doubled your investment.
With this in mind, it’s not surprising that the crypto derivatives market is heating up fast and at AAX we intend to drive innovation in this space further in ways that are both mindful of regulatory concerns as well as unique in terms of design.
Stay tuned for more updates as we continue to explore the opportunities at hand by signing up for our newsletter, or open an account with AAX to receive a bonus of 10 USD worth of Bitcoin to try futures trading today.
