The introduction of bitcoin futures was expected to boost bitcoin’s prices. But that hasn’t happened. The cryptocurrency has been in a free fall since the middle of December last year, roughly around the same time that futures were introduced. Now a new economic letter by the San Francisco Fed posits that futures are responsible for the slide in bitcoin’s price. According to them, futures contracts allowed traders to short the cryptocurrency, thereby leading to a slide in its price.

“Before December 2017, there was no market for bitcoin derivatives. This meant that it was extremely difficult, if not impossible, to bet on a decline in bitcoin’s price,” the letter’s authors write. As a result, speculators had a field day betting on an increase in bitcoin’s prices with few to zero countervailing bets against them. But the introduction of bitcoin futures contracts at Cboe and CME in rapid succession changed the playing field, enabling short sellers to get in on bitcoin action. “With offers of future bitcoin deliveries at a lower price coming through, the order flow necessarily put downward pressure on the spot price as well,” the letter states.

To illustrate their point, the letter’s authors have charted a graph that compares prices for bitcoin before and after the introduction of bitcoin futures using a benchmark peak price that the asset reached in the middle of December. The authors also point to the historical precedent of the mortgage-backed securities market, which witnessed a similar decline in prices after the introduction of Collateralized Debt Securities (CDS) when it was widely expected that CDS would boost prices because it provided traders to bet on a future increase in prices.   

Why The San Francisco Fed’s Argument Does Not Make Sense

While it makes economic and rational sense, the argument made by the San Francisco Fed fails to argue on three key points.

First, it makes no mention of the disparity in trading volumes for bitcoin futures and spot markets. Trading in futures contracts has been relatively thin as compared to influx of individual investors and traders in spot markets. Trading volumes for futures contracts, which has mostly stayed in the low billions, lags those in the spot markets, whose market capitalization topped $700 billion in December last year. It is difficult to imagine a situation in which a market with low trading volume activity has a significant influence on spot markets.

Second, it does not account for the decline in bitcoin’s price prior to the introduction of futures. The authors state that there was no way previously to bet on a fall in the cryptocurrency’s price. That may be true to a certain extent but it does not explain the swoon in crypto prices resulting from adverse news coverage and hacks. For example, news of the Mt. Gox hack led the cryptocurrency into a downward spiral that lasted more than a year.

One could argue that the coverage spooked investors and traders into making a sale. But a similar reaction was noticeably absent last year. As bitcoin gained currency amongst mainstream media, a growing chorus of commentators (which included prominent economists and bankers) criticized the cryptocurrency and its utility. Added to this was the Chinese government’s decision to ban ICOs, a popular form of fundraising for crypto projects. But bitcoin’s price charged forward despite the criticism. While futures contracts have injected liquidity into the system, their contribution pales in comparison to that of spot markets. As such, it is difficult to believe investor views on bitcoin have not evolved.