Can you drop Bitcoin price with futures contracts?
The real dynamics of futures & spot prices
TL;DR: Futures contracts increase sell pressure by allowing traders to sell synthetic contracts without borrowing the actual asset. However, that pressure may be absorbed by the market, as shown by the price action of Bitcoin.
Let’s take a look at the charts:
Who shorted the market?? Why did the government allow it to happen??
The traders love futures contracts. They can sell futures to build short positions without borrowing the asset & paying interest rate. That increases the pressure on buyers, who now have two choices: either buy the asset itself or the futures contracts. And with contracts, they don’t need to pay for storage of the underlying assets. Long-term, contracts are cheaper.
So traders switch to futures, hoping that somebody else will buy the asset. Which might happen… at a lower price.
Most of the time, the selling pressure is enough to trigger a baby bear market, especially if futures are introduced close to the end of bull cycle, as it happened with Bitcoin.
Arbitrage & muh profits
So why does the spot market follow futures market? After all, if the futures are cash-settled, there’s no need for traders to sell spot when the futures take a dive.
However, besides directional traders, we also have arbitrageurs, who are making money on the difference between spot & futures prices (so called “cash-and-carry arbitrage”). If futures price becomes substantially lower than spot (enough to cover the trading fees + make a profit), the arbitrageurs will buy futures and sell spot, temporarily restoring the equilibrium. However, that would decrease the spot price.
So, if nothing exceptional happens, spot will follow futures, in a peculiar “tail wags the dog” fashion.
Wind of change
However, the traders who sold the contracts may decide to buy them back to close the position. When they start closing, they produce a natural “automatic rally”. If the spot buyers join the futures traders to absorb the spot demand that is still coming to the market, the price action may develop into a full-blown uptrend, with liquidations of late shorts. The futures traders who notice the reversal may decide to buy contracts instead of selling them, further propelling the price upwards.
This way, selling pressure will turn into buying pressure, with futures leading the market.
Takeaways
- No, you can’t drop Bitcoin price by selling futures contracts (long-term).
- Yes, you can drop Bitcoin price by selling futures contracts (short-term).
- Arbitrageurs will equalize the futures & spot prices.
- The initial uptrend happens due to shorts closing.
- The continuation of uptrend is fueled by liquidations of short positions.
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