As the Bitcoin reward halving event closes in in just under 6 months, market participants are speculating whether the reduction in emission and thus inflation has already been priced into the market. Those who study fractals and historic price action of Bitcoin relative to the halvening event will be keen to point out that in each of these fundamental changes to the network, the price of Bitcoin has rallied into a bull market, with new all time highs set soon after.
It is evident that this time round the climate is different and this has led to key opinion leaders postulating that the reward halving may already be price in and we will not have the expected bull run soon after. It is important to note that though the sentiment may be bearish in the short to medium term, the majority of these short term bears remain bullish in the longer macro term. They express the opinion that the halving itself will not yield the same kind of price action as previous cycles but some unknown catalyst in the future will inevitably reinvigorate the crypto markets back into a bullish trend. They are likely right.
In 2017, the CME Chairman Leo Malemed said that the derivatives markets "Will regulate, make bitcoin not wild, nor wilder. We'll tame it into a regular type of instrument of trade with rules." Upon the opening of the CME futures markets, Bitcoin proceeded to decline from near 20,000 dollars to just over 3000 dollars.
Cash Settled vs Physically delivered?
Derivatives markets have long played a key role in other assets and commodities and pundits have commented that what we saw with Bitcoin was not the first time a bubbling market was "tamed" by the introduction of derivatives markets.
Bakkt was launched with the intention of delivering physically settled futures contracts which would effectively nullify the naked short selling on platforms such as CME. It was touted as the opportunity for institutional investors to trade Bitcoin as well as have spot exposure to the asset. Physically settled futures contracts would mean that real Bitcoin need to be held by the Bakkt warehouse and delivered to it's traders at settlement. A mechanic which introduces real exposure to the participants. It was later revealed that Bakkt did not fully implement the physically delivered Bitcoin and that by in large, it was operating much like the cash settled markets at CME.
This is obviously not a positive development and it remains a thorn for real institutions who would like to get regulated exposure as well as ownership of physical Bitcoin.
What is really taming the Bitcoin markets?
Is the effect of more and more derivatives exchanges popping up having an effect on actual Bitcoin prices? I would argue yes. For a lot of the participants currently in the market, they are more interested in trading and making a profit, either increasing their USD or "stacking sats" through leveraged derivative trades. The market interest went from speculating on "the next Bitcoin" to trading Bitcoin Futures itself. There is a significant decline in volume on the spot markets whilst open interest on futures exchanges continue to grow.
As long as people think that they can just make more bitcoin by trading it on futures exchanges, the short run volatility of Bitcoin will continue to be high and price will have "random" walks to capture liquidity from traders who are over leveraged. We've seen a lot more of this aggressive hostile price action in recent times where price is frequently "manipulated" to squeeze unsuspecting traders.
Will the fundamentals eventually drive price to new highs?
With all of the speculative trading and incentives for large interests to wipe out an ever growing demographic of amateur retail traders, there is less need for the large interests to play the spot markets. Just take a look at the Bitmex Insurance fund blow up over the last few years. As long as there are speculators willing to trade futures, the exchanges don't care whether the Bitcoin price goes up or down. They make a killing both ways.
That being said, we have seen the effects of futures in earlier market cycles, particularly in the days of Okcoin, and other Chinese exchanges in 2014-2015. There will come a point where retail interest in futures will decline as most traders are wiped out and leave the game and it is at this point, that the transfer of wealth is complete.
Large interests sit on an ever bigger pile of Bitcoin and the path of least resistance to realising more gains is to push the markets back up. Forcing all of the people who sold out and gave up to rush back in in a euphoric frenzy.
The modus operandi never really changed. In order for a new bull cycle to emerge, the large interests need to have sufficient control of the market such that driving the price up becomes profitable again. And that cannot happen when more and more people are sitting strong, holding, and trading Bitcoin in the hopes of making more as the price goes up. Markets reveal a lot about the human psychology but they also reveal a lot about the state of the market as a whole. Even though the trend coming into the new year as well as the halving event is clearly bearish, there remains too much hopeful hodlers who need to capitulate before a true bull market can resume.
Derivatives are simply a tool for transferring wealth and should the fundamentals of Bitcoin continue to improve (on chain transactions, mining hash rate etc.) as well as some catalyst (perhaps ETF, Libra or other) to drive mass participation, a bull market will eventually emerge - just not as soon as people hope (this time round anyway).