- Published: Friday, 14 March 2014 08:58
- Written by Editor
Derivatives in the form of futures, options and other financial instruments have been around for hundreds of years, traded at exchanges around the world as well as over the counter. Historically futures have been traded in just about every commodity from precious metals to wheat and corn, cotton, oil, gas and more.
Futures and options originated from the need to lock in a future price for a particular commodity for future delivery to account for uncertainties such as weather conditions.
Derivatives are also traded by banks and speculators in the hope of making a profit from the highly leveraged commodity on margin, offering the potential to make or lose much more money than buying or selling the physical commodity itself. For example, a contract of Gold is buying the right to control 100 ounces of Gold bullion for a fraction of the cost of owning the physical metal. To purchase 100 ounces of physical Gold would cost $137,000 at today's price, but a Gold futures contract to control 100 ounces of Gold costs around $8000.
Wikipedia defines a futures contract thus:
In finance, a futures contract (more colloquially, futures) is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the futures price) with delivery and payment occurring at a specified future date, the delivery date. The contracts are negotiated at a futures exchange, which acts as an intermediary between the two parties. The party agreeing to buy the underlying asset in the future, the "buyer" of the contract, is said to be "long", and the party agreeing to sell the asset in the future, the "seller" of the contract, is said to be "short".
However, in recent years and decades derivatives have been extremely abused by banks by creating highly leveraged "over the counter" derivatives purely in the hope of making massive profits for the banks and massive "bonuses" for the bankers trading them. This all went horribly wrong in 2008 when classes of derivatives known as "mortgage backed securities" and "collateralised debt obligations" lost value dramatically as house prices crashed and consumers defaulted on the easy credit they had been deliberately tempted with over the preceding years. The result was the banking crisis of 2008 when the entire global banking system nearly collapsed and would have collapsed if it had not been injected with trillions of Dollars of printed money from the Federal Reserve, debasing the currency and causing inflation.
This situation is still playing out and will no doubt eventually result in an implosion of the global financial system as not only banks but whole countries cave in under the weight of debt.
Another area where futures have been grossly abused is the Gold market. Based on supply and demand for the real physical metal, the price of Gold should be considerably higher than it is today, at least $5000 per ounce. Gold bullion now is in seriously short supply as China, Russia and many other countries buy as much Gold as they can get their hands on in readiness for the coming destruction of fiat currencies. Gold and Silver have been the only true forms of money for at least 5000 years.
However, as the Gold price rises the Dollar weakens because going long on Gold is the same as selling, going short on the Dollar. So just as the stock market has been manipulated to absurdly high levels to give the impression of a strong economy - the truth is the opposite - the price of Gold has been suppressed to make the US Dollar look strong when in fact it is virtually worthless. The US government achieves this by selling an unlimited amount of Gold futures on the commodity exchanges, mostly the Comex, to drive down the price of Gold which is quoted based on the futures price. Whenever the price of Gold begins to rise based on normal market conditions, the US Government, through a bank, will sell literally billions of Dollars of Gold paper, futures contracts, over a very short time, to drive the price back down again. This happens several times every month. Consequently, every available ounce of physical Gold has been sold around 120 times and Comex is nearly out of deliverable physical Gold. When they do run out and Gold contracts cannot be delivered upon the whole scam will be exposed, there will be a huge scandal and the price of Gold will rocket to true value.
Is There A Case For Bitcoin Derivatives?
In view of the way that derivatives are so highly abused, is there a case for Bitcoin derivatives?
Well that is like asking because fiat currencies are highly abused, is there a case for Bitcoin?
Bitcoin is revolutionary because it takes the power away from governments and banks to abuse money, and places it in the hands of the people. The same would apply to Bitcoin derivatives. In fact Bitcoin derivatives could well be crucial to the future of Bitcoin.
One of the biggest barriers to more general acceptance of Bitcoin, particularly by merchants is volatility. Volatility arises due to a lot of demand for the relatively few Bitcoin in circulation, a situation that is likely to get worse as Bitcoin is stored and saved at a much faster rate than it is mined. Without some sort of secondary mechanism to fix Bitcoin price, this will be a major issue and barrier to Bitcoin in the mainstream. Also Bitcoin derivatives are required for the same reason as conventional derivatives, to hedge and manage risk and for large scale speculation in a fair market of buyers and sellers.
So how would Bitcoin derivatives work in practice?
Well clearly a Bitcoin derivative market or markets needs to be as open, transparent and peer to peer as Bitcoin itself to avoid the possibility of manipulation by governments and banks. Limits on the number of contracts that can be held need to be in place for the same reason. It only became possible for the US government to manipulate Gold for example when contract limits where removed - indeed this is likely why they were removed.
The best way to operate Bitcoin derivatives markets would be on a blockchain the same as for Bitcoin itself, in other words completely separate blockchains for futures, options etc. Ultimately, like Bitcoin, this will be purely peer to peer and decentralised, but in the interim there would need to be Bitcoin derivatives exchanges which operate with complete transparency and to a strict set of rules to prevent abuse by governments and banks.
Such markets would be highly liquid and, like conventional futures markets, be the basis for a stable underlying Bitcoin price.
Not only then is there a case for Bitcoin derivatives, it is probably crucial to the future of Bitcoin and most certainly doable using blockchain technology.
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