“I think before this year, people either didn’t talk about bitcoin or talked about it in a dismissive way,” said Joshua Klayman, of counsel at law firm Morrison & Foerster in New York. “One of the things that is potentially so attractive for those not already involved with cryptocurrencies is that with these futures you will never actually have to hold bitcoin to get exposure.”
Cryptocurrencies have romped into conventional financial markets this year.
In July, LedgerX won approval from the Commodity Futures Trading Commission to trade and clear cryptocurrency derivatives. Then in August, the Chicago Board Options Exchange announced that it too would be offering bitcoin futures in the fourth quarter of 2017.
“It seems that CME does not want to be left off the bandwagon,” said Matthew Kluchenek, the global head of derivatives at law firm Baker & McKenzie. “Traders want cryptocurrency trading solutions, and soon they may have them.”
A spokesperson for CME told GlobalCapital that the audience for the futures was “broad”.
“We are a regulated exchange and we can offer all of the benefits that a listed derivative brings with it,” she said. “So introducing greater transparency and price discovery to enable bitcoin traders, institutions and people who want to manage risk in this market to do just that.”
The futures will be based on the CME CF Bitcoin Reference Rate, which takes pricing data from bitcoin exchanges such as Bitstamp and GDAX once a day, providing a standardised reference rate in US dollars for one bitcoin.
The last reported price for the index on Thursday was $7,068.43.
“The demand in the market at this point is so great, they didn’t really have much of a choice,” said Mati Greenspan, a market analyst at brokerage eToro. “It’s either move in the new direction or lose customers.”
On Monday, bitcoin’s value hovered around $6,150 per bitcoin. On Thursday, in the wake of CME’s announcement, the virtual currency reached $7,100, but had retreated as GlobalCapital went to press, resting at just above $7,000.
Intercontinental Exchange, a CME competitor, launched the NYXBT Index representing the US dollar value of bitcoin in May 2015. GlobalCapital asked an ICE spokesperson on Wednesday if the exchange operator planned to launch any derivatives products based on the index, but they declined to comment.
Institutional interest
The advent of listed futures and derivatives based on bitcoin could mean that institutional investors and other market participants will try to get exposure to bitcoin.
Carol Van Cleef, partner at BakerHostetler in Washington D.C, said that at cryptocurrency conferences she had noticed the "audience evolving, much like the issues".
"We are seeing more hedge funds, more institutional investors and family offices coming to the table," she said.
Martin Garcia, VP sales and trading at Genesis, a digital currency brokerage firm, has noticed a similar trend. He said that institutions were “circling the space” and interested to learn more.
“A lot of their interest has been exploratory in nature given that there are not great ways to custody digital currency as a qualified custodian,” he said. “As more institutions come into the space, they will start to demand the same products and services that they enjoy in other asset classes. That’s why you will see options and futures get more liquidity over time.”
LedgerX, which markets its exchange and clearing house services to institutional investors, has enjoyed some success in the past weeks, after beginning trading on October 16. In the second week of operations, the exchange fulfilled $2m worth of notional value, with the most popular contract being day ahead swaps.
Peter Green, partner at Morrison & Foerster in London, said that as a wider futures and derivatives market develops, it will become easier for institutional investors to hedge and “get the benefits of any upside”.
Regulatory focus
The news comes as the regulatory policy of US authorities towards cryptocurrencies becomes increasingly clear.
The CFTC in 2015 showed the world that it meant business on regulating cryptocurrencies. In an order against Coinflip, a bitcoin options and futures platform, the CFTC determined that “bitcoin is a virtual currency” but “does not have legal tender status in any jurisdiction".
The CFTC itself acknowledged in the order that the definition of a commodity was “broad” but that “services, rights and interests in which contracts for future delivery are presently or in the future dealt with” are commodities, bringing bitcoin and other cryptocurrencies into its scope.
The Securities and Exchange Commission also entered the fray in July, determining that certain tokens issued in an initial coin offering (ICO) could classify as securities, thus falling under their purview.
Many tokens issued in ICOs entitle their holders to a share of profits of a particular project, while others allow holders to use a particular platform for a variety of services.
But Baker & McKenzie's Kluchenek told GlobalCapital that he wasn’t sure the SEC and CFTC were co-ordinating sufficiently in their efforts to regulate cryptocurrencies.
“It seems that the CFTC and SEC are on parallel paths with respect to bitcoin investment opportunities, but it’s not clear that there is any meaningful co-ordination between the agencies,” he said. “If anything, co-ordination seems not to be the case. The race for the first mover advantage is on.”
Establishing consensus
Across the pond in Europe, financial regulation of cryptocurrencies has been slower, with a coherent response among European member states forthcoming.
“That’s partly down to the fact that it is a more complex landscape than the US, in terms of financial regulation, with many member states that need to agree on new legislation,” said Green. “So things take more time than in the US.”
He added that it would be interesting to see where bitcoin and bitcoin futures would fall under existing and upcoming financial regulation.
“There are some interesting questions as to the extent those will be covered by EMIR and treated as financial instruments under MiFID II,” he said.
The European Markets Infrastructure Regulation was introduced to better police derivatives in Europe, encouraging more clearing of derivatives products and transaction reporting. The Markets in Financial Instruments Directive will bring a broader overhaul of European financial markets, aiming to improve transparency and price discovery.
In October, GlobalCapital reported that ESMA was looking into token offerings and could issue a “warning” on the practice to spur European member states to action. However, it remains unclear if the agency will ban the practice as has happened in China and South Korea, or come out in favour of bringing ICOs into the scope of existing securities regulation, like in Switzerland.
The introduction of an exchange traded fund for bitcoin has widely been tipped by GlobalCapital sources as the next big step in digital currencies' drive into capital markets.
