As Bitcoin continued to defy gravity this week, Albert “Pete” Kyle, professor of finance at the University of Maryland’s Robert H. Smith School of Business, says he believes the cryptocurrency’s plunge is inevitable. It may just be a bit delayed.
Kyle, is known for creating the “Kyle Model,” which provides a foundation for the modern theory of market microstructure.
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On Sunday, newly launched bitcoin futures began trading on the Chicago-based derivatives exchange Cboe Global Markets, offering market players something they’d long hungered for – a chance to easily short, or bet against, bitcoin. Many had presumed that the lack of a straightforward way to short the world’s largest cryptocurrency was part of what was propelling its valuation upward, to levels even beyond what many tagged to be bubble territory.
When those futures began trading on the Cboe, analysts had predicted, the bitcoin doubters would be lining up for short positions.
As trading got underway on the newly listed bitcoin futures, one thing was clear, it wasn’t just bitcoin’s bears that were lining up. Its bulls were out in number as well. Bitcoin’s futures rose at the open on its volatile first trading day, rising about 20 percent to touch fresh highs, before giving back some gains.
The one-month bitcoin contract was trading at $17,780 around midday Monday in New York, up from $15,460 at its Sunday open. That’s a modest premium for bitcoin, which has been on a tear all year – roughly 10 percent more than it was going for on a popular cryptocurrency exchange. But it’s a premium nonetheless, making for a decent market debut.
To be sure, it would be unusual for bearish investors to descend on any asset on its first day of trading, sending futures into a downward dive. But bitcoin is unusual.
Few assets have a price trajectory like bitcoin’s. And few futures debuts on the Chicago Board Options Exchange get as much attention as bitcoin’s. Next, the CME Group is expected to launch its bitcoin futures contract on Dec. 17.
Before bitcoin futures began trading on the Cboe, there were methods to short the cryptocurrency. They were just complicated.
For example, bitcoin itself sells on numerous online exchanges – Gemini, itBit and BitStamp are a few – and that creates an opportunity for arbitrageurs to do what they’re best known for: buying on an exchange where the prices are lower and sell on an exchange where they are higher. The arbitrage allows traders essentially to short Bitcoin on one exchange, but not short bitcoin on their whole portfolio, Kyle says, explaining that the trader would still have “an offsetting long bitcoin position somewhere else.”
The strategy carried some risk. “One way in which you could end up accidentally being short bitcoin is to sell them on one exchange and buy them on the other, and then have your bitcoin stolen from where you bought it,” Kyle says. “You’ve got to buy the bitcoin and trust the exchanges for a little while.”
Bitcoin futures contracts on the fully regulated Cboe are cash-settled, and that may appease some investors. But the risks remain, Kyle warns.
“Obviously, bitcoin is very risky because the volatility is very high,” Kyle says. “But it’s also very risky because the value of bitcoin is based purely on expectations of what other people are going to value it at.”
And no one quite knows what those expectations are.
“If you look at the stock market, it traditionally goes up or down about 1 percent a day. If bitcoin is going up about 10 percent a day, it’s not 10 times more volatile. It’s 10-squared times more volatile, or 100 times more volatile,” Kyle says.
By comparison, he adds, it would take the stock market about six months to go up or down as much as bitcoin goes up or down in a day.
“The volatility of bitcoin is extraordinary right now, and that really high volatility could indicate that nobody really knows what bitcoin is worth,” Kyle says. “But it also could indicate that there is a squeeze that’s going on, and somebody is somehow short bitcoin.”
After a pause, he adds, “An ordinary person has no business buying or selling bitcoin.”
The big-name cryptocurrency, he says, remains uncorrelated with all other risks in the markets.
“Bitcoin may well have an intrinsic value that is zero, and there could be a very large element of ‘greater fool’ theory going on,” he says. “Anybody who buys it now is likely to be the greater fool.”
To any ordinary investor who is saving money for retirement or to send kids to college, he says flatly, stay away from bitcoin.
Source: University of Maryland’s Smith Brain Trust