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Why it may not be long before Bitcoin is short

With stories of soaring stock markets becoming the new norm and analysts continuing to fall over themselves to predict the bursting of the debt market bubble, one could be forgiven for thinking that 2017 has merely been more of the same ol,' same ol' in the world of financial markets.

But that would be wrong.

Enter bitcoin, the biggest and most widely-known of an ever growing army of cryptocurrencies, and elephant in the room of investment houses the world over. Quietly appearing on the scene in 2009, bitcoin went from relative obscurity to today being easily one of the most talked about investment propositions. And this in the space of only eight years.

Taking a quick look at the numbers it is not difficult to see why. Bitcoin’s market capitalisation swelled from $9.7 billion on October 1, 2016, to 62.4 billion 12 months later; a staggering 541% increase. Etherium, the cryptocurrency with the second largest market capitalisation, increased a 2351% over the same period. Looking at the chart below for the Bitcoin Investment Trust (GBTC), an investment vehicle that acts like an ETF by allowing investors to gain bitcoin exposure by tracking its price, has surged 632% year to date. Interestingly, the fact that shares of GBTC have traded at a significant premium to the actual underlying price of a bitcoin seems not to have deterred the throngs of investors determined to cash in on bitcoin's new found stardom, and raises broader questions about the nature of bitcoin's price discovery mechanism.

Chart: GBTC Bitcoin Inv. Trust performance YTD

At this point it is worth noting that, while their benefits are manifold–low fees, decentralised transactions, enhanced anonymity–cryptocurrencies are essentially just that: alternative, or hidden, decentralised currencies that compete with traditional fiat currencies as a means of exchange and store of value.

But the questions remains, what are the reasons behind the cryptocurrency explosion witnessed in 2017?

For one thing, the rise of cryptocurrencies could well be an expression of the growing repudiation of fiat currencies in general, and the US dollar's global reserve status in particular. After decades of debasement, and a dubious move to phase out cash potentially signalling the end of purchaser's anonymity as we know it, there is a strong argument to be made that a viable alternative is long overdue. Furthermore, as the dollar historically performs very poorly in periods of heightened geopolitical risk compared to the Japanese Yen and the Swiss franc, North Korea's beating of the war drum, and the escalating tensions in the South China Sea in 2017, have made cryptocurrencies appear more favorable options for investors looking to lower their risk profiles.

Yet, there already exists an asset that has historically fulfilled the role of the go-to safe haven asset for those looking to safeguard their wealth in times of excessive debt, currency debasement and heightened geopolitical and economic uncertainty. That asset is gold, and although it’s ability as a hedge against inflation can be debated at length, there is near unanimity about it’s effectiveness as an immutable, long-term store of value and insurance policy against systemic risk; and it has a 5000 year track record to back it up.

Some astute observers may wonder why, then, during a period that has seen the price of the cryptocurrency explode exponentially higher, has gold, the ultimate and proven alternate currency been been trading in a relatively narrow bandwidth?

One compelling reason for this is that Bitcoin, at the time of writing, is not yet tethered to a futures market. Gold on the other hand, although also functioning as a currency, is traded as a commodity and firmly anchored to the Commodity Exchange (COMEX) derivatives complex.

To understand why this might be an important factor, one must first understand that the original purpose of commodity derivatives markets was to ensure stable prices and consistent availability for real-economy users of commodities, before large-scale inflation-hedge selling and retirement fund asset purchases pushed up prices and volatility. More importantly, futures markets enable large hedge-fund and institutional investors to take positions long or short a certain number of 'contracts,' which typically trade in multiples of the underlying physical commodity.

On the London Bullion Market Exchange (LBMA) website for example, it states that “In 2015, $20.7 billion (17.9 million ounces) of gold cleared daily through London.” This is the equivalent of just under 20% of the global annual mined supply of physical gold traded on a daily basis through these exchanges. Although not physically possible, this trading of gold on a quasi 'fractional reserve' basis, is fully legal, and provides a framework for large hedge-funds and other institutional actors to forecast and influence the spot commodity prices to ensure their stability and predictability.

The absence, hitherto, of such a mechanism in the crytocurrency market may go some way to explain bitcoin's extreme volatility to the upside as well as the downside, as witnessed in mid-September when it lost a third of its value in a single trading week. Gold, by contrast, has done little more than continue it's protracted bottoming process. Put another way, bitcoin, with its nascent price discovery mechanism, is a 'freer' market; gold is just the opposite.

In light of these facts and bitcoin's trading potential, it is no surprise that the Chicago Mercantile Exchange (CME) announced in October the launch of a "regulated trading venue" in the form of a bitcoin futures market in the fourth quarter of 2017. Terry Duffy, CME Group chairman and CEO stated:

"Given increasing client interest in the evolving cryptocurrency markets, we have decided to introduce a bitcoin futures contract. As the world's largest regulated FX marketplace, CME Group is the natural home for this new vehicle that will provide investors with transparency, price discovery and risk transfer capabilities."

Although it remains to be seen how exactly this will affect bitcoin valuations, if the charges made against Deutsche Bank and other large institutions of conspiring to manipulate the price of precious metals through the derivatives market carry any weight, it is hard to envisage how the advent of a bitcoin futures market will have anything but a substantial influence on bitcoin price behaviour. Seen within the context of what has already been a huge run-up in the bitcoin price, bitcoin traders must brace themselves for big moves, both to the upside and downside.


The information contained within is for educational and informational purposes only. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. McKay Research/James McKay is neither being compensated for this article, nor has any positions in the stocks/funds mentioned. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.


Featured Report:


Outside of Bitcoin’s promise to disrupt traditional financial intermediaries through trustless peer-to-peer transactions via a distributed network, its purportedly high environmental impact could well be its most controversial facet. This report presents a non-exhaustive, systematic overview of a cross-section of studies from the past three years that aim to contextualise and quantify the data pertaining to Bitcoin's energy consumption and environmental impact. 

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