Key Takeaways
- • Federal Reserve Bank of San Francisco economists attribute bitcoin's late-2017 price collapse to the introduction of bitcoin futures, which gave pessimists a way to bet against the asset for the first time.
- • Bitcoin rose from under $1,150 in February 2017 to a peak of $19,511 on December 17, 2017, the day CME bitcoin futures began trading, per Bloomberg data cited in the paper.
- • Before December 2017 there was no bitcoin derivatives market, so speculative demand came only from optimists, which the authors describe as a self-fulfilling price spiral.
- • The average daily trading volume in the month after CME's launch was roughly six times larger than when only the CBOE offered bitcoin futures, which started trading December 10, 2017.
- • The authors explicitly decline to forecast bitcoin prices, arguing the long-run fundamental value depends on transactional demand relative to supply.
Summary
A research Economic Letter from the Federal Reserve Bank of San Francisco, authored by Galina B. Hale, Arvind Krishnamurthy, Marianna Kudlyak and Patrick Shultz, examines why bitcoin's price rose and then fell so sharply in 2017. According to the paper, bitcoin remained under $4,000 from its 2009 launch through mid-2017, then climbed to nearly $20,000 in the second half of the year before reversing. The authors argue that the peak, recorded at $19,511 on December 17, 2017, coincided with the start of bitcoin futures trading on the Chicago Mercantile Exchange (CME), and that the timing is consistent with trading behavior typically seen when futures are introduced for an asset.
The authors frame the dynamic using a model of optimistic and pessimistic investors, drawing on Fostel and Geanakoplos (2012), who described how financial innovation in mortgage-backed securities drove the housing boom and bust in the 2000s. In bitcoin's case, before December 2017 no derivatives market existed, so betting on a price decline was extremely difficult, if not impossible. Speculative demand came only from optimists, whose buying pushed prices higher in a self-reinforcing cycle. Pessimists had no mechanism to act on their views.
The Chicago Board Options Exchange (CBOE) opened a bitcoin futures market on December 10, 2017, but trading was thin until the CME entered on December 17. The paper reports that average daily volume in the month after CME's launch was approximately six times larger than during the period when only CBOE offered the contracts. With futures available, pessimists could sell forward contracts at prices below spot and pressure the spot market, and falling prices then rewarded further short selling. The authors compare the three largest bitcoin price declines of 2017 and find the CME-linked decline was clearly larger; the two earlier reversals had recovered to pre-crash levels within about a month, whereas as of late April 2018 bitcoin had not returned to its pre-futures peak. The gradual nature of the decline is attributed to slow entry by pessimists, with early CME futures volume averaging contracts for roughly 12,000 bitcoins in the first week, against estimated spot turnover of about 200,000 bitcoins.
On fundamental value, the authors state they do not forecast prices. They note that mining costs, estimated at around $250 per bitcoin in 2015 by Hayes (2015), should have little bearing on value, and that long-run price depends on transactional demand relative to a supply that is becoming more constrained. Factors cited include competition from other cryptocurrencies, acceptance by traditional financial institutions as collateral or payment, and regulatory recognition or constraints. The authors conclude that once speculative dynamics fade, transactional benefits are likely to drive valuation, though they consider those benefits too imprecise to quantify today.
The authors frame the dynamic using a model of optimistic and pessimistic investors, drawing on Fostel and Geanakoplos (2012), who described how financial innovation in mortgage-backed securities drove the housing boom and bust in the 2000s. In bitcoin's case, before December 2017 no derivatives market existed, so betting on a price decline was extremely difficult, if not impossible. Speculative demand came only from optimists, whose buying pushed prices higher in a self-reinforcing cycle. Pessimists had no mechanism to act on their views.
The Chicago Board Options Exchange (CBOE) opened a bitcoin futures market on December 10, 2017, but trading was thin until the CME entered on December 17. The paper reports that average daily volume in the month after CME's launch was approximately six times larger than during the period when only CBOE offered the contracts. With futures available, pessimists could sell forward contracts at prices below spot and pressure the spot market, and falling prices then rewarded further short selling. The authors compare the three largest bitcoin price declines of 2017 and find the CME-linked decline was clearly larger; the two earlier reversals had recovered to pre-crash levels within about a month, whereas as of late April 2018 bitcoin had not returned to its pre-futures peak. The gradual nature of the decline is attributed to slow entry by pessimists, with early CME futures volume averaging contracts for roughly 12,000 bitcoins in the first week, against estimated spot turnover of about 200,000 bitcoins.
On fundamental value, the authors state they do not forecast prices. They note that mining costs, estimated at around $250 per bitcoin in 2015 by Hayes (2015), should have little bearing on value, and that long-run price depends on transactional demand relative to a supply that is becoming more constrained. Factors cited include competition from other cryptocurrencies, acceptance by traditional financial institutions as collateral or payment, and regulatory recognition or constraints. The authors conclude that once speculative dynamics fade, transactional benefits are likely to drive valuation, though they consider those benefits too imprecise to quantify today.
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