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This is going to speak to my naivety around futures and how they work but if you're ending up with cash instead of bitcoin and there's no actual bitcoin wallets

by mdip 9y ago

This is going to speak to my naivety around futures and how they work but if you're ending up with cash instead of bitcoin and there's no actual bitcoin wallets/bitcoins involved, what on earth are you actually buying when you buy a Bitcoin future in this manner? It sounds like the one, sure, answer is "not Bitcoin". Can anyone explain this to a neophyte like me?

JoshTriplett 9y ago
There are two possibilities when buying a commodity-backed security like this. You could buy a representation of the actual commodity, such that every $X you own represents $X of Bitcoin. That's known as a "cash commodity", or an "actual", or various other terms. Or, you could buy what amounts to a bet on the future value of the commodity. Those don't need to correspond to any actual amount of the commodity. Those are called "futures", which are one type of "derivative" (because they're derived from the value of the commodity without directly representing an amount of the commodity).
- tedunangst 9y ago
  Even oil futures are still settled with actual oil though. The distinction here is they are cash settled, which is pretty weird for an asset that is easily delivered.
  - jnordwick 9y ago
    Depends on the contract. Whine CL on CME is physically settled, WTI on ICE is financially settled. Both are contracts for the same underlying crude (I've traded them one for one in various strategies).
- mdip 9y ago
  As one of the other commentators mentioned (and has been called out a few times), in the case of other futures, you are actually settling them with the commodity in question, but in the case of this product, you are settling with cash. I think I understand what you're saying, and I don't think I have any fundamental problem with it -- mainly because I don't invest in the futures market so it's simply "unimportant to me" how it works in this case -- but I'm curious: is this a normal practice? Is it more common for a futures-based product to be settled with the product it's based on or is it more normal for it to be settled in this manner? My curiosity, if the way they're executing on this is unusual, is "why"? I mean, take oil futures as a good example. It'd seem a whole lot easier to settle a BTC future with actual BTC than to settle an oil future with actual oil, so why isn't it the other way around? Heck, why wouldn't all of these futures-based financial products be handled in a cash-based manner -- what's the downside? (I'm not arguing for or against either method -- I really don't know). My apologies if these are truly stupid questions -- I imagine I sound to someone who works/studies this sector like people sound to me who think "Facebook" and "The Internet" are interchangeable terms, but if you're willing to play along, here, I certainly appreciate it. :)
  - kgwgk 9y ago
    Keep in mind that most commodities futures contracts are never settled. They are closed before expiration (rolling into a new contract if you want to keep the position open). Many brokers will close your position before expiration, because they are not prepared to handle delivery, even if younwant to. There are also some commodities futures that are cash-settled. Futures on financial indices, interest rates and such are usually cash-settled. But some futures based on financial instruments are “physically” settled, like US Treasury futures.
ncallaway 9y ago
There's a pretty decent explanation from the article > If you buy an oil futures contract on the CME, and you hold it when it expires, then someone hands you 1,000 barrels of oil, and you have to find a place to put them. If you buy a bitcoin futures contract, and you hold it when it expires, nobody hands you the 5 bitcoins underlying the contract. Instead, CME computes a daily "Bitcoin Reference Rate," "which aggregates the trade flow of major bitcoin spot exchanges during a calculation window into the U.S. Dollar price of one bitcoin as of 4:00 p.m. London time," and if the Bitcoin Reference Rate at the expiry of your futures contract is higher than the Bitcoin Reference Rate when you opened the contract, you get paid the difference ... and vice versa. In dollars. If you have any specific questions related to that paragraph, I'm happy to try and explain what I know.
- mdip 9y ago
  So you nailed down the specific part that I wasn't grasping in that paragraph: the "Bitcoin Reference Rate". Again, this is an area where I'm horribly naive and wouldn't imagine investing in (partly because I don't have enough knowledge around how futures markets, in general, work/behave and partly because I do understand Bitcoin). However, if what they're trading in is the "Bitcoin Reference Rate", isn't this really a future trading in this "Bitcoin Reference Rate" rather than Bitcoin? Does that even really matter, here, or is that an irrelevant detail? While Bitcoin isn't treated like an actual "currency" (outside of those of us who think of it as one, it appears the financial powers-that-be think of it like a traditional security/commodity-like instrument), are other currencies handled in this manner -- or any other futures product for that matter (i.e. is this common or is this something that is very unique)? Oh, and thanks for the offer to explain -- it's much appreciated. :o)
  - superbrama 9y ago
    The one takeaway from futures trading is that you probably don’t have enough risk capital to do it right. Professionals use large risk capital bases and have access to better information. Retail traders who don’t know better sign disclosure forms then overutilize the generous performance bond requirements, mathematically ensuring most will perish. This is probably the most practical takeaway that I can share with you, and it’s why they’re considered so risky. Leverage can kill.
superbrama 9y ago
Futures have something called open interest and an expiration. They come into existence because both a buyer and seller are willing to take opposing positions. When this happens, open interest increases correspondingly. Let’s say you believe btc will rise and you bid to buy one CME futures btc contract at 42000. I am willing to sell (short since, let’s say, I don’t have any contracts to sell) at 42000 and we have now created the future contract out of thin air. Upon expiry money has changed hands between us daily (mark to market pricing) between our futures trading accounts (customer segregated funds at our respective clearing firms to be exact), and price was tied to the underlying (spot — the real btc market) price at all times. All we did was bet against each other with the “score” being the actual btc price. The “cash settled” part means we don’t touch btc at all, we settle the bet between us in cash. If it sounds too obvious or if it seems like you’re missing something, you probably get it. It’s simple, and there are a lot of complexities underneath the surface (expiration months, cost of carry, contango and backwardation), but at the core it’s just a bet on the price with one party believing price will rise and other believing it will fall. Nothing less or more. In practice there is interplay between futures and spot markets’ prices, and this opens up a can of worms about liquidity and how futures could be used to “stabilize” a commodity (read up on hunt brothers cornering the silver market for an example of govt intervention into a futures market)
- mdip 9y ago
  On a very basic level, I get most of that. But in the cases you mention, you're actually buying a contract based in the actual asset/security you're targeting. In this case, it sounds like you're buying an asset that is priced based on the asset/security (BTC) but that outside of that price doesn't involve actually doing anything with BTC. Is my assessment here completely insane or am I somewhere near understanding what I've read in that article?
  - superbrama 9y ago
    No your assessment isn’t insane; instead you’re visualizing how they’re related and it’s important to understand it. CME does daily mark to market pricing so the futures price will always fall back in line with the “bitcoin index” which is based on the actual spot market. CME futures typically close once daily for a brief time (each market has its own schedule) and price settlement (the price adjustment) occurs around that downtime. This is distinct from most btc exchanges which as far as I know, operate round the clock (could be wrong on that point, I don’t actively use various btc exchanges). If someone were to sell a whole lot of futures and drive the futures market price way down relative to the spot market, another participant could then come in as a simultaneous buyer of the futures and seller of the spot market, pocketing the difference knowing the price will be marked to market daily. Such a natural force helps to keep the prices correlated in soft real time. Beyond that you’re correct it’s just a way to gamble on the side :) nothing to do directly with real bitcoin
tybit 9y ago
I'm going to try though I'm a neophyte myself. So if we take the example of oil, if you need to buy oil in 6 months time and don't want to be affected by market volatility you can pay a small premium on today's prices to guarantee the price in the future. People that don't actually need oil but think that it will go up in value can also use the futures instead to bet on oil being more expensive and cash out the difference between what they paid and what the future price ends up being. Speculating on Bitcoin vs oil isn't so different, the only difference I can see is that where as there is use cases for hedging and one for speculating traditional futures there only exists the speculating use case for Bitcoin futures.
- justincormack 9y ago
  It is not necessarily a premium.

by mdip 9y ago

JoshTriplett 9y ago

There are two possibilities when buying a commodity-backed security like this. You could buy a representation of the actual commodity, such that every $X you own represents $X of Bitcoin. That's known as a "cash commodity", or an "actual", or various other terms. Or, you could buy what amounts to a bet on the future value of the commodity. Those don't need to correspond to any actual amount of the commodity. Those are called "futures", which are one type of "derivative" (because they're derived from the value of the commodity without directly representing an amount of the commodity).

tedunangst 9y ago
Even oil futures are still settled with actual oil though. The distinction here is they are cash settled, which is pretty weird for an asset that is easily delivered.
- jnordwick 9y ago
  Depends on the contract. Whine CL on CME is physically settled, WTI on ICE is financially settled. Both are contracts for the same underlying crude (I've traded them one for one in various strategies).
mdip 9y ago
As one of the other commentators mentioned (and has been called out a few times), in the case of other futures, you are actually settling them with the commodity in question, but in the case of this product, you are settling with cash. I think I understand what you're saying, and I don't think I have any fundamental problem with it -- mainly because I don't invest in the futures market so it's simply "unimportant to me" how it works in this case -- but I'm curious: is this a normal practice? Is it more common for a futures-based product to be settled with the product it's based on or is it more normal for it to be settled in this manner? My curiosity, if the way they're executing on this is unusual, is "why"? I mean, take oil futures as a good example. It'd seem a whole lot easier to settle a BTC future with actual BTC than to settle an oil future with actual oil, so why isn't it the other way around? Heck, why wouldn't all of these futures-based financial products be handled in a cash-based manner -- what's the downside? (I'm not arguing for or against either method -- I really don't know). My apologies if these are truly stupid questions -- I imagine I sound to someone who works/studies this sector like people sound to me who think "Facebook" and "The Internet" are interchangeable terms, but if you're willing to play along, here, I certainly appreciate it. :)
- kgwgk 9y ago
  Keep in mind that most commodities futures contracts are never settled. They are closed before expiration (rolling into a new contract if you want to keep the position open). Many brokers will close your position before expiration, because they are not prepared to handle delivery, even if younwant to. There are also some commodities futures that are cash-settled. Futures on financial indices, interest rates and such are usually cash-settled. But some futures based on financial instruments are “physically” settled, like US Treasury futures.

ncallaway 9y ago

There's a pretty decent explanation from the article > If you buy an oil futures contract on the CME, and you hold it when it expires, then someone hands you 1,000 barrels of oil, and you have to find a place to put them. If you buy a bitcoin futures contract, and you hold it when it expires, nobody hands you the 5 bitcoins underlying the contract. Instead, CME computes a daily "Bitcoin Reference Rate," "which aggregates the trade flow of major bitcoin spot exchanges during a calculation window into the U.S. Dollar price of one bitcoin as of 4:00 p.m. London time," and if the Bitcoin Reference Rate at the expiry of your futures contract is higher than the Bitcoin Reference Rate when you opened the contract, you get paid the difference ... and vice versa. In dollars. If you have any specific questions related to that paragraph, I'm happy to try and explain what I know.

mdip 9y ago
So you nailed down the specific part that I wasn't grasping in that paragraph: the "Bitcoin Reference Rate". Again, this is an area where I'm horribly naive and wouldn't imagine investing in (partly because I don't have enough knowledge around how futures markets, in general, work/behave and partly because I do understand Bitcoin). However, if what they're trading in is the "Bitcoin Reference Rate", isn't this really a future trading in this "Bitcoin Reference Rate" rather than Bitcoin? Does that even really matter, here, or is that an irrelevant detail? While Bitcoin isn't treated like an actual "currency" (outside of those of us who think of it as one, it appears the financial powers-that-be think of it like a traditional security/commodity-like instrument), are other currencies handled in this manner -- or any other futures product for that matter (i.e. is this common or is this something that is very unique)? Oh, and thanks for the offer to explain -- it's much appreciated. :o)
- superbrama 9y ago
  The one takeaway from futures trading is that you probably don’t have enough risk capital to do it right. Professionals use large risk capital bases and have access to better information. Retail traders who don’t know better sign disclosure forms then overutilize the generous performance bond requirements, mathematically ensuring most will perish. This is probably the most practical takeaway that I can share with you, and it’s why they’re considered so risky. Leverage can kill.

superbrama 9y ago

Futures have something called open interest and an expiration. They come into existence because both a buyer and seller are willing to take opposing positions. When this happens, open interest increases correspondingly. Let’s say you believe btc will rise and you bid to buy one CME futures btc contract at 42000. I am willing to sell (short since, let’s say, I don’t have any contracts to sell) at 42000 and we have now created the future contract out of thin air. Upon expiry money has changed hands between us daily (mark to market pricing) between our futures trading accounts (customer segregated funds at our respective clearing firms to be exact), and price was tied to the underlying (spot — the real btc market) price at all times. All we did was bet against each other with the “score” being the actual btc price. The “cash settled” part means we don’t touch btc at all, we settle the bet between us in cash. If it sounds too obvious or if it seems like you’re missing something, you probably get it. It’s simple, and there are a lot of complexities underneath the surface (expiration months, cost of carry, contango and backwardation), but at the core it’s just a bet on the price with one party believing price will rise and other believing it will fall. Nothing less or more. In practice there is interplay between futures and spot markets’ prices, and this opens up a can of worms about liquidity and how futures could be used to “stabilize” a commodity (read up on hunt brothers cornering the silver market for an example of govt intervention into a futures market)

mdip 9y ago
On a very basic level, I get most of that. But in the cases you mention, you're actually buying a contract based in the actual asset/security you're targeting. In this case, it sounds like you're buying an asset that is priced based on the asset/security (BTC) but that outside of that price doesn't involve actually doing anything with BTC. Is my assessment here completely insane or am I somewhere near understanding what I've read in that article?
- superbrama 9y ago
  No your assessment isn’t insane; instead you’re visualizing how they’re related and it’s important to understand it. CME does daily mark to market pricing so the futures price will always fall back in line with the “bitcoin index” which is based on the actual spot market. CME futures typically close once daily for a brief time (each market has its own schedule) and price settlement (the price adjustment) occurs around that downtime. This is distinct from most btc exchanges which as far as I know, operate round the clock (could be wrong on that point, I don’t actively use various btc exchanges). If someone were to sell a whole lot of futures and drive the futures market price way down relative to the spot market, another participant could then come in as a simultaneous buyer of the futures and seller of the spot market, pocketing the difference knowing the price will be marked to market daily. Such a natural force helps to keep the prices correlated in soft real time. Beyond that you’re correct it’s just a way to gamble on the side :) nothing to do directly with real bitcoin

tybit 9y ago

I'm going to try though I'm a neophyte myself. So if we take the example of oil, if you need to buy oil in 6 months time and don't want to be affected by market volatility you can pay a small premium on today's prices to guarantee the price in the future. People that don't actually need oil but think that it will go up in value can also use the futures instead to bet on oil being more expensive and cash out the difference between what they paid and what the future price ends up being. Speculating on Bitcoin vs oil isn't so different, the only difference I can see is that where as there is use cases for hedging and one for speculating traditional futures there only exists the speculating use case for Bitcoin futures.

justincormack 9y ago
It is not necessarily a premium.