The Existence of Bitcoin Futures Has Perhaps Led to a New Market Regime Where Bubbles Are Suppressed, Leading to a Healthier Ecosystem and Shorter Bear Markets

November 1, 2019 / by Zachary Mashiach

The rally in the first half of 2019, when Bitcoin (BTC) lifted off from its bear market lows of $3,200 to as high as $13,800, may have been just as significant as any of the major Bitcoin (BTC) rallies in the past even though a new record high was not achieved. Here, we’ll discuss how the existence of Bitcoin Futures likely explains why the rally in the first half of 2019 stopped short of an all-time high, and how this actually leads to a healthier crypto ecosystem due to market bubbles popping before they hyper-inflate.

First off, it is important to review the major Bitcoin (BTC) rallies in the era before Bitcoin Futures. In late 2013, Bitcoin (BTC) rallied to over $1,000 for the first time, rising from less than $100 to almost $1,200. Some speculate that Mt. Gox induced this bubble via buying Bitcoin (BTC) with money that did not exist

Regardless of what exactly sparked the rally, a speculative buying feedback loop was one of the reasons that Bitcoin (BTC) rallied an order of magnitude, rising from $120 to $1,200, in only 2 months. Essentially, people start buying Bitcoin (BTC) for some fundamental reason, causing the price of Bitcoin (BTC) to go up, and other people start to buy Bitcoin (BTC)  so they do not miss out on the rally, aka fear of missing out (FOMO). A positive feedback loop is soon established where the price rising causes more people to buy, and then price rises even more, and more people buy. The result is an accelerating price increase. 

Then, some whale traders/investors may take profits or some bad news may happen, causing Bitcoin’s (BTC) price to tick downward, which may cause more people to sell. Basically this results in another feedback loop in the opposite direction, one where price drops, causing more people to sell, and then price drops even faster causing even more people to sell, resulting in an accelerating price decline.

Since there were no Bitcoin futures markets when the late 2013 rally happened, the positive speculative buying feedback loop caused the market bubble to inflate as much as possible before it popped. Within a month of the $1,200 peak Bitcoin (BTC) dropped to less than $400, precipitating a bear marker that lasted approximately from December 2013 to May 2016 — 2.5 years. 

The reason the bear market lasted for years is likely due to the damage caused when the market bubble popped. A lot of people around the world bought into the hype as Bitcoin (BTC) rapidly rose, only to get burned when it crashed. A large number of traders, investors, and businesses ended up leaving the crypto space, and many more people decided to never participate in the crypto market after hearing about how risky the market is. 

Eventually, the market recovered, and the number of businesses, traders, and investors reached record numbers. In particular, there was an initial coin offering (ICO) frenzy, when thousands of different blockchain-based projects were being created and funded by investors. 

The price of Bitcoin (BTC) and all these ICO cryptocurrencies began to climb in the latter half of 2017, and this price rise accelerated due to the speculative feedback buying loop mentioned earlier. Most of the price rise happened within the two months before the $20,000 all-time high, just like during the late 2013 rally. 

As described in-depth in a previous Crypto.IQ article, Chicago Mercantile Exchange (CME) Bitcoin Futures launched on Dec. 17, 2017. Significant short-selling pressure was introduced into the Bitcoin (BTC) market due to this, immediately causing the bubble to pop with a decline from $20,000 to $11,000 in less than a week, precipitating the 2018 bear market. During the 2018 bear market numerous businesses in the crypto space closed, and many traders, investors, and users were scared away, just like the bear market following the late 2013 rally. Additionally, the previously flourishing ICO industry ended up being outlawed in the United States due to all the losses, bankruptcy, and fraud following the ICO bubble collapse, and aside from that, numerous investors who were burned would never to choose to invest in an ICO again. 

The Crypto.IQ article about this event claimed that CME Bitcoin Futures were essentially poison for the crypto space, arguing that short-selling pressure from CME Bitcoin Futures was pushing the market far lower than it should be, which damages the crypto industry. 

However, it seems that ultimately CME Bitcoin Futures may be more medicine than poison for the crypto market. This is because in the absence of Bitcoin Futures, speculative buying feedback loops grow unopposed, since people can only buy or sell Bitcoin (BTC), and there is no way to bet on Bitcoin (BTC) going down instead of up. Bitcoin (BTC) may end up rallying way more in the absence of Bitcoin Futures, but ultimately this results in an even harder crash and a more destructive bear market. 

Now that Bitcoin Futures exist, traders can bet that Bitcoin’s (BTC) price will go down, which acts as an opposing force to speculative buying feedback loops. Instead of the market bubble hyper-inflating to the maximum possible size, the presence of short selling via Bitcoin Futures causes the bubble to stop inflating before it gets completely out of control. A crash still results, but the crash is far less severe and most businesses, traders, and investors stay in the market. 

Therefore, although the crash and bear market following the late 2017 rally was severe, it could have been even more severe if CME Bitcoin Futures never launched. Bitcoin (BTC) may have rallied to $50,000 or $100,000, only to come crashing down just as fast as it rose, which could have led to possibly an order of magnitude more damage during the subsequent bear market. 

From February through June 2019 the first major Bitcoin (BTC) rally of the Bitcoin Futures era occurred, and unlike the previous major rallies, Bitcoin (BTC) did not set a new all-time high. The lack of a new all-time high may cause people to think that this was not a major rally, and perhaps a mini-rally. However, the rally in the first half of 2019 may have been on the same scale as the late 2017 rally, only the short-selling pressure from Bitcoin Futures halted the market bubble before it got completely out of control. 

When the market bubble popped the price of Bitcoin (BTC) still crashed from $13,800 to $9,000. After a recovery rally to over $12,000 Bitcoin (BTC) eventually went on to drop as low as $7,500 four months after the peak price of $13,800. However, this is only a 46% drop in price from peak to low, versus the 2018 bear market which saw an 84% decline and the bear market after the late 2013 rally which saw an 87% decline. 

Further, the Bitcoin (BTC) market is already showing signs of recovery and rallied near the end of October to as high as $10,000. This can hardly be called a bear market, with the price of Bitcoin (BTC) already rising significantly only four months after the market bubble popped. Indeed, for the most part, the ramp-up in Bitcoin’s (BTC) price during the first half of 2019 was mostly positive for the crypto space, and the subsequent price decline does not seem to have caused investors, traders, and users to exit the crypto space on a mass scale.

Zooming out and looking at the big picture, essentially CME Bitcoin Futures may have precipitated the 2018 bear market via introducing short-selling pressure, but this likely caused less damage than if the CME Bitcoin Futures never launched and the late 2017 bubble continued to grow unchecked. Likewise, the first market bubble experienced since the launch of the CME Bitcoin Futures, during the first half of 2019, did not rise as drastically or crash as severely as previous market bubbles of a similar scale. 

In summary, it can be theorized that CME Bitcoin Futures are actually a medicine for the crypto space since they prevent extreme market bubbles and subsequent bear markets. The market may now be in a regime where severe and long-lasting bear markets do not happen anymore. This is far more conducive for the growth of the crypto space, since the number of users, traders, investors, and businesses will steadily rise, rather than being scared away en-masse due to a market bubble collapsing. Likewise, this should lead to a steady long term rise in the price of Bitcoin (BTC), rather than the market being defined by bubble cycles.