Four lies about bitcoin futures that stock investors need to know

Dec 11, 2017
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Some investors are excited about bitcoin futures, and others think bitcoin itself is a fraud.

Most investors ought to focus on, for example, 11 bitcoin-related stocks due to much lower risk. Even if you are not a bitcoin BTCUSD, -3.28% enthusiast and are happy limiting yourself to stocks and ETFs, you still need to pay attention to the propaganda in the social media about bitcoin futures that may affect you as a stock (and bond) investor. Let us start with an analysis of a bitcoin futures XBTF8, -3.37%chart, and then we will get into the lies.

Chart

Please click here for an annotated chart of bitcoin futures’ January 2018 contract. The futures are now trading at Cboe CBOE, +0.86% Futures will also soon start trading at CME CME, -0.07% and later on the Nasdaq NDAQ, +0.56% Please note the following from the chart:

• Bitcoin futures’ trading range is very wide.

• There are no typical footprints of extensive short-selling as of this writing.


• Bitcoin futures are highly volatile.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

Manipulation

First, you need to know about “bitcoin whales.” Bitcoin whales refer to a small number of people who control a large amount of bitcoin. According to one report, less than 1,000 people may control 40% of all bitcoin. On the other side are relatively unsophisticated retail traders, some even putting their life savings into bitcoin. This is a perfect setup for manipulation.

Regulation

Bitcoin futures, however, are regulated. This is being promoted as a virtue of the bitcoin futures. However, the underlying bitcoin itself is not regulated. Can the regulation of a derivative be successful when the underlying main contract has no regulation especially at times of stress?

Contagion

If bitcoin goes to $1 million, as many bulls contend, then there is no problem. However, what happens if bitcoin goes much higher and then crashes? In plain English, contagion simply means a crash in bitcoin affecting other assets such as stocks, bonds and gold. In such an event, your beloved Nvidia NVDA, +1.66% and AMD AMD, +2.21% stocks may be cut in half; gold ETF GLD, -0.40% and silver ETFSLV, -0.74% along with gold miner ETFs GDX, -0.78% and GDXJ, +0.10% may fly. Investors who are engaged in the popular volatility trades of buying the ETFXIV, +3.52% and short-selling the ETF V, -0.20% may be crushed.

The propaganda is that bitcoin is simply too small to affect other assets. The following are the two problems with this:

• In my 30-plus years of investing, I have repeatedly observed investors’ behavior of selling an unrelated asset that can be easily sold when they suffer losses on a different asset that they cannot or do not want to sell at a loss. The anecdotal evidence is that many retail investors who are heavily invested in bitcoin also are aggressive investors in momentum stocks.

• Popular momentum stocks such as Netflix NFLX, -1.23% Micron TechnologyMU, -0.46% and Facebook FB, +0.02% have risen a lot. There is a lot of air between their present prices and major support levels. Sentiment can change very quickly if some investors start selling them because of their losses in bitcoin.

Volatility

The propaganda about bitcoin futures is that they are going to help volatility because short-selling is allowed. At the same time, bitcoin enthusiasts are promoting a $1 million target. If bitcoin enthusiasts are right, short-sellers will face almost infinite losses. On the flip side, short-sellers can gain only a limited amount. With such lopsided risk/reward, who in their right mind is going to put on long-term naked shorts on bitcoin? (Naked short-selling, or naked shorting, is short-selling an asset without first borrowing it.)