How to Invest in Bitcoin Futures

Here’s What’s Going On with Bitcoin this Week

It’s about to get a lot easier to invest in bitcoin, thanks to two new financial products that came to the marker in December.

These two products (known as bitcoin futures, which I’ll discuss more below) are a big deal because until now, bitcoin’s growth has been driven by individuals, without any participation from Wall Street.

Most early bitcoin investors were techies attracted by the technological potential of the blockchain, bitcoin’s independence from any government, or a combination of both. Even bitcoin’s more recent surge—it has climbed over 1,500% so far this year—has been mostly driven by individuals, not large institutions.

But even though financial institutions were late to the party, now that bitcoin is too big to ignore, you can be sure they’re going to be a major part of bitcoin’s future.

The big banks haven’t made any commitments yet, but it’s likely only a matter of time. Instead, the first major financial institutions to embrace bitcoin are the financial exchanges.

Those are the companies that own the markets where people trade, like the NYSE and Nasdaq (for stocks), the Chicago Board Options Exchange (for options) and the Chicago Mercantile Exchange (for commodities).

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And two major financial exchanges are introducing bitcoin futures this week. CBOE Global Markets, which owns the Chicago Board Options Exchange, started trading in bitcoin futures Sunday, and CME Group, which owns the Mercantile Exchange, will launch their own contract on Monday, December 18.

Like any futures contract, the bitcoin futures allow traders to bet on the price of bitcoin without buying the underlying asset (in this case, bitcoin).

Why Are Bitcoin Futures a Big Deal?

The introduction of bitcoin futures is a big deal for two reasons.

First, to date, most bitcoin trading has happened on unregulated exchanges. Started by enterprising cryptocurrency enthusiasts, most of these exchanges are legitimate (though a few have been outright scams). But they’re also relatively new—usually run by small teams with little experience operating a global-scale financial exchange.

The largest U.S. exchange, Coinbase, only has 180 customer service employees (up from 24 at the start of the year) but was getting about 100,000 new customers a day in late November.

That’s contributed to problems large and small, including frequent website crashes—most of the major bitcoin exchanges were offline for at least some of the weekend after Thanksgiving, for example.

The exchanges are trying to scale up quickly—Coinbase recently hired the COO of TD Ameritrade—but growing pains remain. Investing in bitcoin today can feel like buying stocks online in the 1990s, when online brokerages frequently went offline and were targets of criticism from traditional brokers and regulators.

More importantly, these exchanges aren’t regulated.

The Federal government isn’t known for its speed in adapting to technological progress, and has been slow to roll out regulations to govern this new industry.

By comparison, every aspect of trading in stocks is heavily regulated by the SEC—so when you buy shares in an NYSE-listed company through E*Trade, you have confidence that E*Trade will complete the trade as requested, that the price provided by the NYSE is accurate, and that the company that issued the shares has been more less truthful about their finances and other public information.

In the bitcoin world, the blockchain removes the need for some of that trust, but introducing third parties like Coinbase reintroduces the trust factor into the equation.

In 2014, the world’s largest bitcoin exchange (at the time) suddenly closed up shop and filed for bankruptcy after losing $450 million in customers’ bitcoins. The case shook the cryptocurrency world, although it seems to have recovered.

Being able to trade bitcoin futures on a regulated exchange will make it possible, for the first time, for investors to bet on the price of bitcoin with all the financial safeguards they’re already accustomed to in place.

The other reason bitcoin futures are a big deal is that they’ll make it possible to short bitcoin. Up until Sunday, investors could only bet on bitcoin—not against it. That probably contributed to cryptocurrency’s meteoric rise, although how much it matters depends on who you ask. What’s certain is that the ability to short other assets—like equities and commodities—affects asset prices in those markets on a daily basis.

One thing the introduction of futures probably won’t affect is bitcoin’s volatility—which has recently gone off the charts. In fact, circuit breakers halted trading in CBOE’s bitcoin futures twice in their first few hours on Sunday. Bloomberg quoted one market participant as saying, “It is rare that you see something more volatile than bitcoin, but we found it: bitcoin futures.”

Many large financial firms, including Goldman Sachs (GS) and JP Morgan (JPM), argue that bitcoin futures will be vulnerable to market manipulation and other problems because of the lack of an official, regulated source of bitcoin pricing.

When you buy futures in Facebook stock, the futures exchange gets pricing information for the underlying stock from Nasdaq, the official (and highly regulated) source. But there’s still no such authoritative, regulated source of the bitcoin price.

Pricing issues are exacerbated by stress on the bitcoin network, which can be very slow to process transactions when traffic is high. On their first day of trading, CBOE’s futures quickly rose well above the cash price of a bitcoin, which would normally be prevented by arbitrage. But because of issues executing trades in the cash bitcoin market, the large spread persisted.

So while futures bring some structure and safeguards to the bitcoin market, even futures investors will face an unusual amount of risk because of the nature of the underlying asset.

However, there are ways to invest in bitcoin without consigning yourself to the possibility of losing your shirt.

How to Invest in Bitcoin Futures (without Investing in Bitcoin Futures)

As bitcoin mania has spiked, shares of anything even tangentially related to bitcoin have soared in recent months.

Overstock.com (OSTK), which was one of the first major online retailers to accept payment in bitcoin, saw its shares soar 123% over the past three months (along with a huge increase in both volume and volatility). An Israeli mining company (the old-fashioned kind), Natural Resources Holdings (NRH:IT), saw its stock spike 159% in one day last week after they said they were buying a stake in a Canadian bitcoin miner. And one British company simply added the word “blockchain” to its name and saw their shares immediately spike 394%.

I don’t recommend buying any of those companies. They’re not much less speculative than bitcoin, for one thing.

But there is a publicly-listed company that’s benefiting from bitcoin mania that I do recommend. I added the stock to my Cabot Dividend Investor portfolio on October 2, and we’re already up 13%. The company isn’t a pure play on bitcoin—that would be way too risky—but they’re participating in the drive to bring bitcoin into mainstream financial markets.

Not only that, the company has paid dividends for 14 years, and pays special dividends that can more than double its yield at the end of every year. If you’ve been thinking about investing in bitcoin, or bitcoin futures, but thought they were too risky, this dividend-paying stock is a great alternative. Just click here to learn the company’s name.

Timothy Lutts

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