After months of discussions, US regulators have greenlighted two of the biggest exchange operators to create derivatives tied to bitcoin, a digital asset that officials acknowledge is unlike any they have dealt with before. Though many financial heavyweights are skeptical of cryptoassets, the decision may help tame the unruly market.
Institutional high rollers will soon have much greater access to bitcoin, despite its potential to facilitate money laundering as well as worries about whether the market infrastructure can withstand its volatility. The Commodity Futures Trading Commission cleared the way for three firms to launch bitcoin derivatives. Exchange operator Cboe Holdings said it will announce a start date for its bitcoin futures soon, while CME Group says its futures will launch on Dec. 18. Cantor Fitzgerald, a brokerage and investment banking firm, is also creating binary options for bitcoin.
Big investors generally haven’t been able to bet on (or against) bitcoin because they could run afoul of regulations. Futures—which allow traders to speculate on the price of an asset at a later date—are another matter. It will be easier for major institutions to buy and sell the Chicago exchanges’ derivatives because they already trade assets on those regulated markets.
The CFTC says it isn’t endorsing bitcoin or any other cryptocurrency, but nonetheless gave its go-ahead. The major platform for actual bitcoin in the early days, Mt. Gox, was a repurposed exchange for trading “Magic: The Gathering” cards. Its successors have suffered outages, hacks, and been the subject of scores of complaints to the Consumer Financial Protection Bureau.
Creating a robust futures market may increase oversight for exchanges that provide trading for actual bitcoin—such as Coinbase and Gemini—because the futures contracts rely on those exchanges for prices. The CFTC says it expects Cboe and CME to monitor trading on those platforms for market manipulation, crashes, as well as trading outages. The watchdog anticipates more information sharing from cash bitcoin exchanges to help provide surveillance and says it will also monitor the market and traders.
A big worry is bitcoin’s sheer volatility—this year it has risen from $900 to more than $10,000. Edward Tilly, CEO of Cboe, argues that futures could help dampen price swings by bringing in more buying and selling (liquidity), transparency, and by giving investors a way to bet against the digital asset.
Thomas Peterffy, the founder and chairman of brokerage firm Interactive Brokers, isn’t convinced. Traders who are short bitcoin, betting on it to decline, could be crushed, as there’s theoretically no limit to the cryptoasset’s price increases. The futures expert worries price swings could cause a major default.
To stop a default from spinning out of control, futures exchanges rely on clearinghouses to collect collateral and offset the risks. Peterffy told Quartz that he doesn’t have a problem with bitcoin—he thinks it could compete with the dollar as a reserve asset one day—but he thinks the cryptoasset is far too wild for CME’s clearinghouse. He said allowing futures to be cleared there is “suicidal,” is a rushed decision, and that Cboe shouldn’t do it, either.
“Anytime Thomas speaks, I listen,” said Tilly at Cboe. His company has taken note of Peterffy’s concerns, he said, and the clearinghouse Cboe uses provided things like backtesting and position limits to increase safety.
CME says it has experience handling big price swings in other commodities and financial products. Based on an index, CME said that bitcoin’s average daily price move has been about 3%, which isn’t out of line with some commodities. (Bitcoin jumped 25% in one day in July, according to Coindesk.) Crude oil volatility hovered around 125% in 2008 to 2009, according to the Chicago exchange.
Bitcoin volatility versus other assets. (CME Group)
Tilly says some of the early users of bitcoin futures are likely to be sophisticated individual traders and cryptocurrency dealers who until now couldn’t effectively hedge their positions. Others have suggested that bitcoin miners who incur massive electricity bills could use futures to hedge their costs.
Bitcoin has captivated public attention, but there’s no guarantee futures contracts will catch on. Tilly said he expects uptake to be faster than usual at the beginning but will still take time. For bitcoin enthusiasts, the future always seems to be all of nothing: If it works, it ushers in a new era for finance. If not, maybe it just goes to zero.