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Futures may legitimise Bitcoin, but let it infect other markets
December 17, 2017
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LONDON: Bitcoin is taking its first steps toward becoming a legitimate investment vehicle with the creation of futures contracts in the crypto-currency this month, moves which may also allow it to infect wider financial market stability for the first time.

Although the financial world simply does not have enough exposure to the sector to cause concern right now, growing participation of hedge funds and their banks via the new futures creates a link and risk that a bursting of what many see a gigantic bubble could leak into other markets.

In some ‘worst case’ scenarios, it could be the trigger for a correction across global equity markets that have seemed impervious to pretty much all other risks for the past two years. Let’s be clear — we’re not talking systemic risk here. We saw that with Lehman Brothers in 2008 when the financial and economic world as we know it came within hours of a wipe-out.

This is about the market-to-market contagion that could spread if large banks or leveraged speculators like hedge funds, having taken on big positions in bitcoin futures, find themselves on the wrong side of a sudden and dramatic price swing.

In this scenario, they would be forced to liquidate holdings of other assets like stocks or bonds to cover their position in Bitcoin, or meet the hefty margin requirements stipulated by the market-making exchanges and brokers.

Doug Kass, president of Seabreeze Partners Management, thinks one of next year’s big market surprises could be bitcoin soaring above $20,000 before plunging below $2,000, a crash that could take hedge funds down with it.

“Several large, well-known hedge funds desperate for alpha are caught with their pants and portfolios down and with a large weighting in bitcoins and other cryptocurrencies; they lose more than 30 per cent of their funds’ assets and value, and are forced to liquidate their cryptocurrency holdings and close their funds,” he ventures.

Clearing houses, the institutions charged with ensuring exchanges aren’t left exposed if a bank or fund is unable to meet a cash call, may also forced to sell assets to raise the required cash.

Selling begets further selling, especially in the opaque hedge fund world and market participants aren’t sure who’s bailing or why. If there’s the whiff of smoldering panic, a lack of visibility will fan the flames.

The collapse of a hedge fund, exchange or brokerage often has no impact on markets at all. But sometimes it does. The most famous was hedge fund LTCM in 1998, and in 2011 the demise of broker MF Global triggerd a 10 per cent correction on Wall Street over a 4-week period.

To say there’s been no shortage of volatility in bitcoin is an understatement. It has soared to over $17,000 from under $1,000 in January and intraday swings of $1,000 or more are now routine.

There are good reasons to believe bitcoin’s extreme volatility will hit only those exposed to the cryptocurrency, and that ripples across financial markets will barely be felt.

For all the hype, press coverage and wild price moves lately, bitcoin remains only a very small part of the financial universe.

Its entire market capitalization is around $280 billion, roughly the same as Walmart. If Walmart shares crash, say 50 per cent, will world markets crumble with it? Volatility would certainly spike higher, but it’s unclear how widespread or lasting the contagion would be. To put that market cap into context, Wall Street’s total equity market cap is over $20 trillion.

Reuters

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