Bitcoin’s Decline Not a Fluke, Federal Reserve Says

Ever since bitcoin reached its high of $19,535.70 in December 2017, the digital currency has struggled to maintain that level of momentum. An Economic Letter released by the Federal Reserve on Monday (May 7) suggests, however, that there’s a good reason for its steady decline.

According to the institution, bitcoin lost momentum as a result of the launch of bitcoin futures trading on the Chicago Mercantile Exchange (CME), suggesting that the “rapid run-up” and price decline after the launch isn’t a coincidence.

CME launched the bitcoin futures on December 17 under ticker symbol BTC–the same day bitcoin reached its all-time high. The Chicago Board Options Exchange (CBOE) also launched bitcoin futures–a week before the CME on December 10–but the Federal Reserve said that trading was thin .

Before the launch of bitcoin futures, the Federal Reserve notes that the digital currency could only be bought and sold by investors and that there was “no market for bitcoin derivatives.” The letter said because of that, it was “extremely difficult, if not impossible, to bet on the decline in bitcoin price.”

“With the introduction of bitcoin futures, pessimists could bet on a bitcoin price decline, buying and selling contracts with a lower delivery price in the future than the spot price,” the Federal Reserve’s letter said. “The new investment opportunity led to a fall in demand in the spot bitcoin market and therefore a drop in price. With falling prices, pessimists started to make money on their bets, fueling further short selling and further downward pressure on prices.”

The Federal Reserve’s letter said it’s difficult to determine why bitcoin’s price dropped gradually rather than instantly. The firm said it could be because “pessimistic investors” lack attention, willingness or ability to flow into the market on the first day or week of trading.  Trading volumes on the CME futures market were initially low, the Reserve said, with an average trading roughly 12,000 bitcoins being delivered in the first week.

Looking ahead, the letter outlines a few reasons that may affect the fundamental price of bitcoin. For instance, the Federal Reserve notes that in terms of supply and demand, the supply growth of bitcoin will become limited as mining prices increase. If the transactional demand grows faster relative to supply, then the price will go up, although transactional demand depends on certain factors.

“If a different cryptocurrency becomes more widely used as a means of exchange in the markets currently dominated by bitcoin, demand for bitcoin may drop precipitously because these tend to be winner-takes-all markets,” the letter said.

However, if banking institutions begin adapting bitcoin as a method of payment, that could also push demand up. Regulatory acceptance of bitcoin as a method of payment would also increase circulation, the Reserve said, while on the other hand regulatory constraints or transaction fees may reduce it.

Since bitcoin’s high of nearly $20,000 in mid-December, it has dropped more than 52 percent to $9,184.16 as of 1:36 p.m. EST on Tuesday (May 8), according to data shown by Coinmarketcap. Bitcoin reached a low of $6,252.44 on February 5 and is down 32.5 percent since January 1.

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Securities Disclosure: I, Jocelyn Aspa, hold no direct investment interest in any company mentioned in this article.