From Bitcoin’s inception in 2009 through mid-2017, its price remained under $4,000. In the second half of 2017, it climbed dramatically to nearly $20,000, but descended rapidly starting in mid-December. The peak price coincided with the introduction of bitcoin futures trading on the Chicago Mercantile Exchange. The rapid run-up and subsequent fall in the price after the introduction of futures does not appear to be a coincidence. Rather, it is consistent with trading behavior that typically accompanies the introduction of futures markets for an asset.
Bitcoin is a “cryptocurrency”—a digital currency that is not backed by any tangible or intangible assets of intrinsic value. After its launch in January 2009, the dollar price of a bitcoin remained under $1,150 until February 22, 2017, when it increased exponentially for about 10 months, as shown in Figure 1. This explosive growth ended on December 17, 2017, when bitcoin reached its peak price of $19,511. Notably these dynamics aren’t driven by overall market fluctuations, as shown by comparison with the Standard & Poor’s 500 stock index.
Figure 1
Bitcoin prices and S&P 500 stock index
Source: Bloomberg.
The peak bitcoin price coincided with the day bitcoin futures started trading on the Chicago Mercantile Exchange (CME). In this Economic Letter, we argue that these price dynamics are consistent with the rise and collapse of the home financing market in the 2000s, as explained in Fostel and Geanakoplos (2012). They suggested that the mortgage boom was driven by financial innovations in securitization and groupings of bonds that attracted optimistic investors; the subsequent bust was driven by the creation of instruments that allowed pessimistic investors to bet against the housing market. Similarly, the advent of blockchain introduced a new financial instrument, bitcoin, which optimistic investors bid up, until the launch of bitcoin futures allowed pessimists to enter the market, which contributed to the reversal of the bitcoin price dynamics....MUCH MORE
