If you have spent any time with me you know that one of the things I tell all Business Owners is to prepare their Exit Strategy from day one. What most owners don’t understand is that an Exit Strategy is a financial plan. I believe in the power of using a diversified approach to building your Exit strategy and personal wealth. In this area, the question I get asked about more than any other is about the role Cryptocurrency plays in this. Now that said I am not a financial advisor and if you are planning or creating a portfolio of any kind you should always seek professional advice, I did want to share my take on this. To really make a judgement on how different Cryptocurrencies are we need to look at the Spot versus the Futures market.
In traditional assets, the spot market is 6-10 times smaller than the Futures market, but in Bitcoin’s case, the spot market is 3 times larger than the regulated Futures market. Where is
the institutional bottleneck?
WHAT IS THE SPOT MARKET?
The spot market is a financial market where financial instruments, such as commodities, currencies, and securities, are traded for immediate delivery, meaning the settlement occurs “on the spot.” In other words, it refers to the buying and selling of assets for immediate delivery, as opposed to the trading of contracts for future delivery, which takes place in the futures market.
In the spot market, the price of an asset is determined by supply and demand factors, including economic, political, and other relevant factors affecting the asset. The spot market is also known as the cash market or the physical market, as the transactions are settled in cash or with the delivery of the actual asset.
For example, in the case of commodities like gold or oil, the spot market is where buyers and sellers trade the physical commodity for immediate delivery. Similarly, in the forex market, the spot market refers to the exchange of one currency for another at the current market exchange rate, with settlement typically taking place within two business days.
WHAT IS THE FUTURE’S MARKET?
The Futures market is a financial market where standardized contracts are traded for the delivery of a specified underlying asset at a predetermined future date and price. In other words, futures contracts are agreements between buyers and sellers to buy or sell an asset at a specific time in the future at a price agreed upon today.
The Futures market allows traders to speculate on the future price of an asset, and it is used for risk management and hedging by market participants, such as farmers, miners, and manufacturers, who wish to protect themselves against price fluctuations.
Futures contracts are standardized in terms of contract size, quality of the underlying asset, and delivery date. For example, a crude oil futures contract may represent 1,000 barrels of oil to be delivered in three months. The price of the futures contract is determined by the market’s supply and demand factors, with buyers and sellers agreeing on a price at the time of the transaction.
Unlike the spot market, which involves the immediate exchange of an asset, the Futures market involves the exchange of contracts that represent the underlying asset to be delivered at a later date. Futures contracts can be traded on regulated exchanges, such as the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE), and they are subject to margin requirements and daily price limits.
WHERE IS THE INSTITUTIONAL BOTTLENECK?
The institutional bottleneck in Bitcoin’s case could be attributed to several factors. One possible explanation is the nascent stage of the cryptocurrency market compared to traditional financial markets. Bitcoin and other cryptocurrencies are relatively new assets that have gained widespread attention only in the last decade. Therefore, many institutional investors, such as pension funds, insurance companies, and hedge funds, may not have developed a clear strategy for investing in cryptocurrencies.
Another possible explanation could be the lack of regulatory clarity and infrastructure for cryptocurrencies. The regulatory landscape for cryptocurrencies is still evolving, with many jurisdictions adopting different approaches to regulating cryptocurrencies. This lack of regulatory clarity can create uncertainty for institutional investors, who may be hesitant to invest in an asset class that is not yet fully understood by regulators.
Furthermore, the infrastructure for trading cryptocurrencies is still developing, with fewer established exchanges and custodians compared to traditional financial markets. This can create challenges for institutional investors who may require more sophisticated trading and custody solutions.
Lastly, the volatility and perceived risk associated with cryptocurrencies may also be a factor in the lower institutional participation. While cryptocurrencies have shown significant growth and potential, they are also subject to large price swings and lack the backing of traditional financial institutions, which may make some institutional investors wary of investing in them.
OPPORTUNITIES AND THREATS
The opportunity and risks of Bitcoin trading in the spot and futures market are:
Opportunities:
- Speculation: Bitcoin’s high volatility makes it an attractive asset for traders looking to profit from short-term price movements.
- Hedging: Futures contracts allow investors to hedge against the risk of price fluctuations in Bitcoin.
- Liquidity: Bitcoin’s spot market is relatively liquid, which makes it easier to buy and sell Bitcoin quickly.
- Transparency: The blockchain technology used in Bitcoin ensures transparency in transactions and reduces the risk of fraud.
- Accessibility: Bitcoin can be traded 24/7, making it accessible to traders in different time zones.
Risks:
- Volatility: Bitcoin is highly volatile, and its price can fluctuate significantly in a short period, which can result in substantial losses for traders.
- Regulatory risks: The regulatory landscape for Bitcoin is uncertain and can change rapidly, which can create uncertainty for investors.
- Cybersecurity risks: Bitcoin transactions are irreversible, and the lack of regulation and central authority makes Bitcoin susceptible to cybersecurity risks, such as hacking and theft.
- Market risks: Bitcoin’s price is impacted by market factors, such as supply and demand, which can be influenced by a variety of factors, including media coverage, investor sentiment, and regulatory changes.
- Counterparty risks: Futures contracts involve counterparty risks, meaning there is a risk that the other party to the contract may not be able to fulfill its obligations, which can result in losses for traders.
While there are opportunities to profit from trading Bitcoin in the spot and futures market, there are also significant risks associated with the highly volatile and unregulated nature of the cryptocurrency market. Traders should carefully consider these risks before investing in Bitcoin or any other cryptocurrencies.
To doing the next thing and mastering it!
Mike Johnston
Co Founder & Architect of Evolve
