The markets are not as independent as they might seem. If the futures market gets ahead or behind of the other BTC markets, it creates opportunities for arbitragers to profit from the difference which has the effect of reducing the gap. It doesn't matter that they are cash-settled.

For example, if lots of money start pouring into Bitcoin futures, the futures price will rise above the price on BTC exchanges. It will then be profitable to sell the futures while buying Bitcoin on the exchanges, which drives the price of Bitcoin up on the exchanges. When the future matures, you just sell the Bitcoin on the exchange and pay your cash-settlement on the future for a guaranteed profit.

More precisely, it is possible to replicate the final value of a futures contract (on Bitcoin or any other asset) up front, by trading in the spot market, even though a futures contract’s payoff is uncertain until it expires. Whatever the future’s value ends up being at its expiry, you can put together in advance a portfolio of holdings that will have the same value simply by borrowing a certain amount of cash and using it to buy in the spot market a corresponding amount of the asset on which the futures contract is written; if you do this, the value of your holdings in cash (after paying interest on your borrowings) and in the asset are guaranteed exactly to equal the value of the futures contract at expiry, no matter what price the underlying asset ends up trading at then. So if there is any deviation in the value of the futures contract (at any point in its lifetime) from the aggregate value of the cash and assets in the portfolio that replicates its final value, then there is an opportunity for a pure arbitrage. Consequently trading by arbitrageurs bounds futures prices in a tight range determined by the variables that set the cost of putting together this replicating portfolio: the price of the underlying asset, the interest rate on cash and the yield on the asset (if any), the time until the maturity of the futures contract, and cost of transacting in these markets.

This arbitrage relationship is about as hard they get, so trading futures is tantamount to trading the underlying asset itself, since changes in price in the futures market will be translated directly via arbitrage into changes in price in the spot market for the underlying asset, and vice versa.

> by borrowing a certain amount of cash and using it to buy in the spot market a corresponding amount of the asset on which the futures contract is written;

So if 1 BTC@januar17 is priced 10 000 USD, you borrow 16 000 USD and buy 1 BTC. How does that help you?

> if you do this, the value of your holdings in cash (after paying interest on your borrowings) and in the asset are guaranteed exactly to equal the value of the futures contract at expiry,

Why? If the spot price at expiry is different from 10 000, let's say it sunk to 5 000, then you have to give back cash and you have 1 BTC that is now worth 5 000.

Could you illustrate how the equivalence comes out?

> So if 1 BTC@januar17 is priced 10 000 USD, you borrow 16 000 USD and buy 1 BTC. How does that help you?

You don't offer 1 BTC@january 17th for 10,000 USD if 1 BTC spot costs 16,000 USD.

> Why? If the spot price at expiry is different from 10 000, let's say it sunk to 5 000, then you have to give back cash and you have 1 BTC that is now worth 5 000.

You don't have to give back any cash. You sell the BTC, that gets you 5,000 USD, you give the 5,000 USD to the owner of the futures contract (cash settlement of the value of 1 BTC), they pay you the agreed-upon 10,000 USD (in reality, those two payments are netted, so they pay you 5,000 USD, that's it), and you pay back your 10,000 USD loan.

I do wonder how counterparty risk will be priced into the futures contracts. There've been a number of cases - Mt. Gox, Bitfinex, any Chinese/Korean/Zimbabwean exchange if you're not a resident of that country - where you can sell a Bitcoin for a nominal price on the exchange but not be able to withdraw that money into the fiat financial system. That's led to structural differences in prices between exchanges which don't get arbitraged away because potential arbitrageurs can't get their cash into or out of the exchange. What happens if that happens to institutional investors trying to settle futures contracts?

Right now 1 BTC on Gemini (the reference exchange for CBOE Bitcoin futures) is $16,600 and the futures price is $17,800 for a 1 or 2 month contract. Since the risk free rate is about 0.125% monthly and this spread is 7.2%, it looks like the market is pricing the counter-party risk at about 7% for one or two month durations.

That seems pretty high to me though, you can arbitrage on Coinbase and Gemini which are both US based regulated exchanges (they have licenses, insurance, and audits) with what I would expect to be less than 7%/month risk. Perhaps there just aren't many arbitragers with access to the futures market and knowledge of Gemini/Coinbase yet. I'd arbitrage it myself but I have no retail brokerage access to shorting the future contracts.

Further evidence the market just isn't acting efficiently yet: volume of 3.43k contracts today, which is only $61M. The 24 hour trade volume of the top 5 Bitcoin exchanges is $5 billion.

good points, the market is pricing the counter-party risk at about 7%

> Right now 1 BTC on Gemini (the reference exchange for CBOE Bitcoin futures) is $16,600 and the futures price is $17,800 for a 1 or 2 month contract.

> Since the risk free rate is about 0.125% monthly and this spread is 7.2%,

> it looks like the market is pricing the counter-party risk at about 7% for one or two month durations.

But if a lot of traders think this way, they may have high execution cost when the contract expires and they try to sell the spot. Specifically, a lot of selling pressure by this kind of trade will push down the spot price and the traders may not be able to sell the spot at the price of the futures cash settlement. So, there is a connection but only up to a point.

Of course there a probably traders doing other kinds of trades that have a different effects on the prices, but it's quite tricky to analyze, compared to a physically-settled contract.

Because it is cash settled, if multiple traders are using BTC to hedge their futures and all sell their BTC at futures expiration they'll move the price introducing risk into the transaction.

Excellent explanation - thank you.

But doesn't this sort of bypass the true scarcity of the actual bitcoins?

No.

My read is that futures trading legitimizes Bitcoin, perceptually at least signaling mainstream financial adoption of Bitcoin.

I'm sure that read is only one of the myriad of subjective factors involved (let's all agree that Bitcoin rises and falls in clouds of collective subjective perception), but I think it may be the dominant one.

I'd say the dominant factor is "the sheer number of exchanges that have varying degrees of resistance, from mild to total, of converting BTC to USD" ...

Be they delays on withdrawal, explicit, or just ghosting.

Be they unrealistic minimums (Bitfinex will not process such a transaction for >250BTC, $4.5M or so at today's rates).

Be they whatever flavor excuse-of-the-day.

Some exchanges need to learn to walk before they run.

As far as I can tell it's just a way to outsource holding the BTC.

A BTC future can be perfectly hedged by taking a loan until the settlement date and using it to buy 1 BTC, holding it until settlement and then selling, so that's probably what the counterpart selling the future is doing.

As others have mentioned, contracts are marked-to-market on a daily basis, which impacts the margin needed to hold the contract. With wide price swings, this can force you to close your position before it settles in order to meet margin, especially if you're trading with leverage. CBOE also has a really high margin requirement (I think 40%+), so the capital costs to play are quite high here.

Not quite, since futures are marked to market every night, there is additinal cash flow relative to your scenario

Randy Mitterling, Nassim Taleb, Chris Cook appear to agree with you. [1]

So maybe that's the way it is - Bitcoin futures the biggest crypto ponzi scheme yet?

[1] https://twitter.com/nntaleb/status/939852491130396673

Just the next step from the Bitcoin economy, to the Bitcoin Standard economy, to the eventual Bitcoin Fiat economy.

Seriously, the Lightning network looks a lot like the old Gold Standard, and the arc of Bitcoin seems to be reinventing modern currency, so I'm trying to figure out what's next.

I agree, and I'm skeptical of Bitcoin on many levels. The vision it offers is very attractive, but each so-called feature comes with so many caveats that it's never clear there is a real advantage. Still, I think people hold onto the vision.

As digital cash, I can buy something online more or less anonymously, without a middle man. Well, except for the miners. And my anonymity is blown if the person from whom I purchase ever reveals my real-world identity. And the fact that the transaction may reveal my entire spending history. Other cryptos offer better privacy guarantees of course. Oh and the tax burden of buying a pair of socks with BTC makes it terribly unattractive for practical uses.

A nearly instant, low-fee settlement layer is great. Except the fee schedule is market driven which sucks for fee calculations, and the instant part is no longer true with full blocks, RBF, and other realities of a popular distributed ledger.

The deflationary model is interesting and is great for investment but not so great for money. And the volatility is too high to consider Bitcoin an investment.

The currency exists independent of national borders. But, rogue states can horde it and work around international sanctions, and it's quite popular for money laundering.

Be your own bank - with all the risks that may not be so obvious at first glance, and none of the benefits that real banks get.

The list goes on. These "features" will keep selling bitcoin, I don't know the dream will ever really die.

IF you want privacy, there are alternative coins that are fairly active with development: Monero, zcash, etc. I am not endorsing anything, but i believe the privacy & fungibility are important in a digital currency.

On the sad side, people who put money in bitcoin are thinking it's a great investment. This is not to devalue your comment, but for the past 10 years, almost every years, the low lows have been increasing.

Be your own bank is not a meaningful goal, though, at least with the way things are. Coinbase, for example, holds about 10% of circulating bitcoin is what i hear.

Maybe this isn't the right place to ask this question, but how is Monero any different than the Bitcoin example you respond to, when the vendor you sent your crypto currency to to exposes your identity?

Monero uses ring signatures to mix your transaction outputs with others', providing "plausible deniability" of the subsequent inputs. It furthermore uses stealth addresses to hide the transaction history to an individual address. This is not foolproof and has been shown to be traceable in a number of cases, but it's a heck of a lot better for anonymity than bitcoin.

There are new improvement - there was a article about monero being tracable > 50% of the time, but it was fixed right around when the article came out to be.

As for the original goals of bitcoin, maybe monero is closer to it. I don't know.

To me, the Lightning network looks like a terrible idea. It achieves nothing that an increased blocksize would not have done on-chain yet wraps a faster-layer around the slower, deliberately crippled (1MB) blockchain and does require multi-hop liquidity that must be provided by interested parties. My understanding would be that the slower layer (like TCP) would be stacked on the faster layer (like IP). The lightning network seems all wrong to me.

If the Lightning network is so great, why do we need a blockchain at all? If not, why not just increase the blocksize? It achieves nothing that couldn't be done on-chain. There have been successful tests of blocksizes of up to 1 GB or 1000x the current size. Even getting it up to a small multiple of the current size would dramatically cut transaction costs and waiting times.

> It achieves nothing that an increased blocksize would not have done on-chain

Regardless of blocksize the block times are still 10 minutes which means you need one hour for the transaction to settle, per the 6 block standard. You can't compare that with LN.

Also good point - no matter how much you scale "onchain" you still end up with settlement periods, a few min at least. Impractical for offline payments.

With the current difficulty level isn't the '6 block standard' a bit dated unless we're talking about a transaction that is extremely valuable.

Could you elaborate on that? I recall doing transactions that had 6+ confirmations in far less than 1 hour. Do I recall incorrectly?

That's just luck. The 10 minute is an average. There are times where you need three hours for 6 confirmations.

> It achieves nothing that an increased blocksize would not have done on-chain

It lets one party in a channel send arbitrarily large numbers of payments ("arbitrary" subject to the total payment value being capped to the channel capacity, as well as to the Bitcoin divisibility) to another without increasing the UTXO set as you would on-chain.

> It lets one party in a channel send arbitrarily large numbers of payments ("arbitrary" subject to the total payment value being capped to the channel capacity, as well as to the Bitcoin divisibility) to another without increasing the UTXO set as you would on-chain.

No that is not true. Each Lightning Channel needs UTXOs to be created before it can be used at all.

Its goal is rather to do trustless multi-hop off-chain payments on pre-opened channels.

Notice that Satoshi himself implemented simple payment channels in Bitcoin. (Without the multi-hop part)

It is all but clear that the much more complex LN contraption will help in the real world.

Furthermore, a case can be made that this going closer to decoupling Bitcoin from the economy on top. The "gold standard" argument hinted at above might be a too close historical parallel, really.

Because, eventually, the gold standard got abolished.

I mean without creating a new UTXO for each micropayment. Of course you need new UTXOs to open the channel

My opinion exactly

It's not a "terrible idea" it is what should have existed in the first place in the oficial blockchain

They're just adding a 2nd layer on top, calling it official and then saying "bitcoin is working"

It should _have_ existed, but the idea came around only about 2015? It's evolving slowly. But if it were "built-in" would be a lot better of course.

The lightning network allows the payer and the payee to be anonymous from each other, which could be useful for some things, like for example anonymous charity donations.

If you do that, in a year a new full node will take a year to fully sync. That means no new nodes. That means that over time bitcoin is dead.

These successful tests are research-level developments, just like lightning network.

Bitcoin is extremely early stage technology. It'll take years for a bunch of scaling developments and blocksize is just a temporary measure.

> There have been successful tests of blocksizes of up to 1 GB or 1000x the current size

no need to be genius to just increase blocksize 1000x and "assume" gigabit connection which no one has.

Lightning network is a great idea, in theory, in practice however it will just not work for the problem you mentioned - no one is interested in providing this kind of liquidity.

As of why need blockchain at all - is because 1st layer is the court and guarantees you to own money from the channel. You just don't have to ask court for every coffee payment (i.e. broadcast to every single laptop in the world).

Fort Knox storing paper BTC wallets instead of gold?

>the Lightning network looks a lot like the old Gold Standard

There's no fractional reserve with LN.

Not yet, but Bitcoin is fixed in supply & deflationary, just like gold was, and there have been non-fractional reserve gold standards.

Crypto might even be manipulated, but in this case what’s the issue? I don’t get your logic. Some independent financial entity decides to start trading futures on horse manure. That makes horse manure a heavily manipulated underlying financial product?

Well. You will see what manipulation means when the first contracts are about the expire!

Mid-january then?

yes

> That makes horse manure a heavily manipulated underlying financial product?

Yes. You will find people who use their fields of cows to pass off excrement as horse manure, injecting various gasses into the manure to pass excrement-inspections. You will also find actual owners of horses who discard half their horse manure.

It’s about risk management. The highest volume futures contracts are cash settled as well(ES, NQ, ZB, 6E’s).

Example usage 1: you may want to own BTC and de-risk before economic events by hedging <x>% short BTC contracts.

As if there was any link between BTC and economic events...

was this a /s? IF it's not: With the current HODL mentality, you can imagine the bitcoin price go even higher. I wish the same HODL'ers were around in 2008, things would have been much different. "Buy the dips" is the best investment strategy that became mainstream thanks to bitcoin.

Wait, I’m sorry, are you claiming that Bitcoin HODL’ers gave us the ‘buy the dips’ strategy? :)

No, i said they made it mainstream, to the guy who had 500$ as investment.

There is a link between all currencies with value and major economic events. FOMC minutes, FOMC rate decisions, GDP, NFP... just to name a few. Look at your BTC quotes at the timeframes those events are released to see for yourself.

Or, just a regular day in the massively manipulated futures trading market...

It’s so weird, people are treating it like a share instead of a currency