Bitcoin futures trading began on the Chicago Board of Options Exchange (CBOE) in mid-December of 2017, about a week after the cryptocurrency posted an all-time high above $19,000. By mid-January of 2018, bitcoin’s price has dropped by nearly half. Just a coincidence? Not according to the Federal Reserve Bank of San Francisco or Japanese economist Yukio Noguchi.

In early May, four researchers at the San Francisco Fed published an Economic Letter attributing the end of bitcoin’s bull run to the appearance of a CME futures contract on bitcoin. Japan’s Noguchi, writing for Japanese-language website Diamond Online, agrees.

Before the CBOE futures contract (and the Chicago Mercantile Exchange contract about a week later), there was no way to bet against the rise of bitcoin except by not buying it. That had no effect on the skyrocketing price. Introducing a futures contract that gives traders a way to short an asset typically slows down or stops altogether a rapid price rise like the one bitcoin experienced in the second half of 2017.

The San Francisco Fed researchers compare the introduction of a futures contract for bitcoin with the rapid run-up in mortgage-backed securities ahead of the financial crisis of 2008. The financial innovations that fueled the run-up hit a wall when futures contracts gave short sellers an opportunity to bet against an ever-rising housing market. (See “The Big Short” for details.)

Following the introduction of bitcoin futures contracts, things changed. The Fed researchers write:

[O]ne-sided speculative demand came to an end when the futures for bitcoin started trading on the CME on December 17. … With the introduction of bitcoin futures, pessimists could bet on a bitcoin price decline, buying and selling contracts with a lower delivery price in the future than the spot price. … 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. For all investors who were in the market to buy bitcoins for either transactional or speculative reasons and were willing to wait a month, this was a good deal. The new investment opportunity led to a fall in demand in the spot bitcoin market and therefore a drop in price. With falling prices, pessimists started to make money on their bets, fueling further short selling and further downward pressure on prices.

Where will the bleeding stop? After dipping below $6,000 late last week, the price has come back to around $6,600. Contract volume averages around 270 trades a day on the CME, but that’s apparently enough to keep a bull run like we saw last year at bay.

Even the margin requirement of around 40% to make a short bet is about half what it was when the futures contracts were introduced. That’s still significant cash: a contract comprises five bitcoin, so that’s around $30,000 and 40% of that is $12,000, about twice the cash needed to buy a crude oil futures contract on 1,000 barrels at $75 a barrel. And the oil market is far more liquid, trading an average of 215,200 contracts a day.

What is so striking to us is the relatively small number of contract trades that were needed to stop the bitcoin bull run and how few it takes to keep the bulls from running wild again. Do the economists in San Francisco or Japan have any ideas about that?

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