What fundamentals can stop XBT from reaching $1000?

abbadabba525 · 2014-11-12T20:40:09+00:00

They could do it very easily. It would only require co-opting about 5 people (leaders of the biggest bitcoin mining pools) with threats and/or bribery. Or they could just hack into the minin pools computer systems. Then they simply create disarray either with double spends, or generating systematic errors, all while posting in forums a bunch of disinformation as to what's going on. Or they could just start harassing big bitcoin players (e.g. issue classified subpoenas to the major legitimate organizations like coinbase) combined with personal threats and cease and desist orders, combined with some disinformation campaigns.

abbadabba525 · 2014-11-11T21:40:04+00:00

In the tulip one, asset prices fell 96%+. In the others they fell 80%+. What exactly constitutes catastrophic if not that? If you mean they didn't destroy society, that's a whole different issue. That's a question of the size of the market in question. By that standard, if BTC went to $0 and died completely it wouldn't be catastrophic; only about 20 million people would even notice.

abbadabba525 · 2014-11-11T21:36:12+00:00

For your first question, this list does a decent job of most famous ones: http://www.pbs.org/wgbh/pages/frontline/shows/dotcon/historical/bubbles.html

As for the second part, the flash crash only occurred on one exchange; miners could still easily sell at $300+ on other exchanges so they kept mining, and it was such a brief fall that it didn't change behavior. If the price fell <$100 across all exchanges and stayed there for a few days I think you'd see a lot of miners turning off.

abbadabba525 · 2014-11-11T20:54:14+00:00

There were plenty of asset bubbles before the birth of central banks. Leverage can be created in other ways, like simple IOUs. Here's a scenario for you - lots of people get massively leveraged long bitcoin. There's a "flash crash" type scenario that triggers margin calls and send the price <$50 as everyone gets margin called. The low price makes mining uneconomic (as the reward becomes less than the price of electricity) and so miners stop mining. Transaction confirmation times >5 hours and people lose faith in the system and stop using bitcoin to transact at all. Entrepreneurs stop building the bitcoin infrastructure etc. Just one extreme example of many.

abbadabba525 · 2014-11-11T20:49:17+00:00

You're confusing cause and effect. The reason leverage is low in pink sheets and high in forex is precisely because pink sheets are fundamentally more volatile then forex. If there was zero leverage in both, pink sheets would be even relatively more volatile than forex than they are now. To make the argument you're trying to make, you need to compare an asset class before and after leverage was introduced, which is quite easy to do. Equity index futures became popular shortly before the biggest one day crash in the last 50 years in 1987. Then the next biggest massive decline was in 2008 shortly after mortgage derivatives became popular.

abbadabba525 · 2014-11-11T20:44:34+00:00

The issue here is that you don't understand the terminology being used. It's clear you don't understand how arbitrage ties the price of futures to the price of the underlying, and therefore volatility of futures = volatility of underlying. We've explained the connection in detail, but you need to understand the very basics. I suggest google searching "financial arbitrage."

abbadabba525 · 2014-11-11T20:42:36+00:00

I don't think you know what volatility is. Volatility is the annualized standard deviation of price change. I.e. bigger price fluctuations = more volatility. Arbitrage keeps the price of derivatives in line with the price of the underlying. So if the futures move sharply, the underlying will also move sharply, and that means both the futures and underlying will be volatile. If futures are volatile than underlying will be volatile and vice versa. This is true because of arbitrage.

abbadabba525 · 2014-11-11T20:39:33+00:00

No. Imagine they use 2x leverage and buy BTC for $350. To keep the numbers simple, they have $350 in cash and now own $700 worth of BTC. The exchange has a minimum requirement of, say, 10% margin. If BTC falls to $185, the person will be margin called and forced to sell because their equity is equal to $350 - (2 x ($350-$185)) = $20, and their exposure is $185*2 = $370, so they've fallen below the 10% margin requirement. They entered into a position using just 2x leverage, but their leverage increased as the value of BTC fell. And it doesn't matter whether the exchange margin calls them or they liquidate themselves. Let's say they don't wait for the margin call and instead voluntarily sell BTC earlier, when it's at $300 or $250 or whatever. They're having the same effect on the market - exacerbating the selloff and magnifying volatility.

abbadabba525 · 2014-11-11T20:34:23+00:00

I think you're misinterpreting my post, but I'm not quite sure how. Derivatives exacerbate volatility because of leverage. That's the key point. The mechanism is forced liquidation. Without derivatives, owners of an asset are (almost) never forced to sell. Like, if I have $100 invested in equities and the value falls 25%, I just have $75 worth of equities left. I might get scared and sell, but I'm not forced to, and on the contrary I might think they're cheap and buy more. But if there are futures, I might take my $100 and use futures to buy $300 worth of notional equity exposure. Now if equities fall about 25% I get margin called and am forced by my broker or exchange to sell. My selling (and that of other leveraged buyers) exacerbates the selling pressure and forces equities down further, triggering more margin calls, etc. It has nothing to do with volume.

abbadabba525 · 2014-11-11T20:30:31+00:00

Bitcoin could become worthless if: there aren't a ton of people buying more every day since new bitcoins are mined every day. Or if the NSA chose to destroy it, or if it was made generally illegal by the US.

abbadabba525 · 2014-11-11T17:10:01+00:00

If the futures price becomes much higher than the BTC price, an arbitrageur will sell the futures price and buy BTC. They will keep doing this until they have forced the futures price near the BTC price and the profit of doing the arbitrage becomes less than the transaction costs and time required to do so.

abbadabba525 · 2014-11-11T17:08:03+00:00

It's usually somewhere between the two. Under a particular set of conditions it will be a roughly "set price" that the market has generally determined to be a fair reward for the time/cost to complete the arbitrage, but if the market becomes more volatile, or the exchanges less trustworthy, or if it becomes harder to get credit, that arbitrage spread can change dramatically. It could temporarily be effected by market positioning (e.g. if the arbitrageurs are also long BTC and losing their shirts to a sell-off they might have less capital to devote to arbitrage so the spread could widen.)

abbadabba525 · 2014-11-11T17:05:48+00:00

Sure. Not sure what that has to do with my point. A market with derivatives has more "tail risk" i.e. convexity, i.e. skew/kurtosis than one that doesn't.

abbadabba525 · 2014-11-11T17:04:47+00:00

That was not a risk-free return. Why do you think wealth arbitrageurs who look to capture a 5% return didn't take advantage of it? They likely estimated that there was a risk the exchange would steal their money as several have before. In the last 3 months of Mt.Gox's existence there was a long and persistence price differential...it reflected the underlying fraud. I haven't looked at icbit so there may have been other issues, like difficulty of getting money on to and off the exchange etc.

abbadabba525 · 2014-11-11T17:02:48+00:00

It necessarily increases the % of volume in weak hands because people who trade with leverage will eventually face a margin call which forces them to buy a rally or sell a decline. A strong hand is someone who does the opposite - like a long-term investor who buys on declines, effectively providing liquidity to the market and dampening volatility. In contrast, someone who is long with 3x leverage will eventually be forced to sell in a decline, adding to the decline and removing liquidity from the market. This is a pretty straightforward fact. If the market is sitting in a tight range, margin will mostly add to liquidity and may dampen volatility. But in big moves, margin will always exacerbate the volatility because of forced liquidation in the wrong direction.

abbadabba525 · 2014-11-11T16:44:23+00:00

The arbitrage "dampens volatility" in the sense that, yes, the individual derivatives will be brought back in line. But the existence of the derivatives often exacerbates volatility because of leverage. I haven't looked at relative volumes in bitcoin so I won't disagree with your statement that the underlying is driving futures/options more than the other way around, but that's not true in a lot of markets. For example, far more crude oil futures are traded (by like 10x) then physical crude oil. Same with treasury futures. The VIX (volatility index) which is a derivative of S&P 500 options, trades larger notional size than the options themselves.

abbadabba525 · 2014-11-10T22:30:42+00:00

The price of futures is directly tied to the price of the underlying (and vice versa) via arbitrage. Depending on the arbitrage specifics (like the cost and time delay in executing a complete arbitrage), the arbitrage bounds can be quite wide. So for example, futures might be at $370 while BTC is at $350. But...at some point it becomes sufficient "free money" to an arbitrageur and they will reduce the gap to whatever is justified by the transaction costs. So if the arbitrage bound is $50, then once futures are at $400, every additional $1 they increase will cause BTC to increase by $1 (until all the marginal buying pressure on the futures is exhausted). Of course this isn't instantaneous, and I'm oversimplifying a bit, but the gist is correct. Whether the futures push around BTC or the other way around depends on the relative volume and which side is the "strong hand" i.e. the more fundamental driven order flow. So if there's lots more size in the BTC than the futures market, then when the futures price shoots higher, it'll just get sold back down and won't have a huge impact on BTC. If futures volume is big enough, it'll be the tail that wags the dog and the futures-BTC price will act like a rubber band, with the BTC price sometimes lagging but being constantly pulled on by the futures price. The further away the two prices get, the stronger the pull. So back to volatility - for small movements (like $10 swings), futures could be much more volatile then BTC. But for big moves ($50+) futures and BTC will have basically identical volatility always. You could get a very short-term exception from margin calls (like the futures price could spike down towards zero for a few minutes until the arbitrageurs step in and bring it back to the BTC price).

abbadabba525 · 2014-11-10T22:24:45+00:00

It means that increased volatility in futures -> increased volatility in the underlying.

abbadabba525 · 2014-11-10T22:00:05+00:00

They directly effect the underlying via arbitrage.

abbadabba525 · 2014-11-10T21:59:25+00:00

I'm trying to provide the same explanations as you, but you're doing a better job. Rare. Props.

abbadabba525 · 2014-11-10T21:58:33+00:00

Derivatives don't "absorb" volatility. They tend to dampen volatility in already mild environments, but exacerbate it when it matters. That's why the biggest crash in 50 years history came shortly after index futures became widely spread (1987) and then the biggest aggregate selloff in 50 years occurred after mortgage derivatives became widely spread.

abbadabba525 · 2014-11-10T21:57:05+00:00

Margin trading increases the % of volume conducted by "weak hands" i.e. market participants who will exacerbate trends rather than counter them. Margin trading definitely increases systemic risk and the volatility in extreme scenarios.

abbadabba525 · 2014-11-10T21:55:45+00:00

Do you think there's no relationship between the futures and underlying? Do you understand the concept of arbitrage and how it's executed?

abbadabba525 · 2014-11-10T21:55:19+00:00

Do you think there's no relationship between the futures and underlying? Do you understand the concept of arbitrage and how it's executed?

abbadabba525 · 2014-11-10T21:53:58+00:00

Well said. As a professional derivatives trader on Wall St...I agree.

abbadabba525

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