Bitcoin futures arrived this week, with the CBOE Global Markets Inc (Nasdaq: CBOE) contract, which trades under the ticker XBT, debuting Sunday night to much fanfare. Not to be outdone, the CME Group is set to launch its contract on Dec. 18, and in the first quarter of 2018, Nasdaq plans to introduce a bitcoin contract.
The new futures contracts come as bitcoin prices have grabbed headlines, with values up about 1,600 percent this year. The sharp rise in prices and their volatility have more than a few market watchers calling it a dangerous bubble.
CBOE and CME received regulatory approval from the Commodity Futures Trading Commission (CFTC), which oversees commodities markets. Both contracts will be cash-settled, with the CBOE’s contract based on bitcoin prices set by digital asset exchange Gemini and the CME’s contract based on the CME CF Bitcoin Reference Rate, an index calculated by CME Group and Crypto Facilities Ltd.
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Until the futures contract launch, it’s been relatively difficult for people to access bitcoin. Investment options are limited to buying the digital currency on exchanges like Coinbase, or trying to buy it via esoteric swaps and options or through Bitcoin Investment Trust, an over-the-counter market security that trades 13 percent above net asset value.
Eric Ervin, chief executive officer of San Diego-based exchange-traded fund provider Reality Shares, can attest to the difficulties ordinary bitcoin investors face. He’s purchased bitcoin in the past and says “it’s incredibly complicated from an individual person’s perspective.” Among the big risks are losing the data and theft from hacking, he says.
But with bitcoin now trading on the futures market, experts say it’s one step closer to legitimizing cryptocurrencies. That doesn’t mean these early days will be smooth — it’s likely bitcoin will face plenty of bumps before it’s fully accepted and used as an alternative currency.
The evolution of a new asset class. Brett Manning, senior market analyst at Chicago-based Briefing.com, says having a bitcoin futures market is an important step in the evolution of digital currencies as an asset class. “The futures market does something very, very specific and very, very important,” he says. “It allows the bigger institutional capital to get involved in this rally for the first time because you can hedge.” Hedging means people who already own bitcoin in some other capacity can offset that position by selling futures and lock in a price.
The Securities and Exchange Commission has yet to approve any bitcoin securities, such as exchange-traded funds. That might occur now that the CFTC approved bitcoin futures, Ervin and Manning say. On Monday, two fund providers, Rex Shares and VanEck Associates, filed proposals with the SEC for their new bitcoin ETFs, which will be based on the trade in futures contracts.
The fact that no one “owns” the cryptocurrency and the lack of regulation for bitcoin may be why the SEC hasn’t approved any securities, Ervin says. What makes the futures contracts different is counterparty clearing, Manning says, which means the futures exchange clearinghouse is the backstop to all the trades.
Trade at your own risk. The CFTC admits bitcoin “is a commodity unlike any the commission has dealt with in the past,” J. Christopher Giancarlo, CFTC chairman, says in a statement. In its regulatory filing, the CFTC says the exchanges are “self-certifying,” meaning exchanges may certify a product for trading by the close of business one day and then list the product for trading the next day.
The CFTC said regulators and the exchanges have agreed the exchanges are in charge of oversight given that the CFTC can’t completely oversee the bitcoin cash market. But some industry members think the exchanges and the CFTC rushed to get these contracts up and trading and are taking on unnecessary risk. The Futures Industry Association, a trade organization, issued a statement last week saying the self-certification process for digital currencies “does not align with the potential risks that underlie their trading and should be reviewed.”
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Richard Levin, chair of the fintech and regulation practice at law firm Polsinelli in Denver, says futures exchanges are the right organizations to handle this risk. “The exchanges are all highly sophisticated organizations that have sophisticated mechanisms in place to manage risk,” Levin says. “Even in the depths of the last financial crisis, the clearinghouses and the exchanges functioned in a highly efficient manner. I think the fact that we are creating a digital asset product that is connected to an exchange and an exchange-sponsored clearinghouse is actually a good thing.”
The regulators issued a warning to participants who want to wade into cyber currencies. “Market participants should take note that the relatively nascent underlying cash markets and exchanges for bitcoin remain largely unregulated markets over which the CFTC has limited statutory authority,” Giancarlo says.
For now, it’s unlikely the average person will be able to afford bitcoin futures given that one CBOE bitcoin contract is one bitcoin and for the CME the contract is five bitcoin. On Wednesday CBOE bitcoin futures were trading around $17,000.
Rick Lane, chief executive officer of Chicago-based trading firm Trading Technologies, which trades cryptocurrencies in the cash and futures market, says having futures exchanges involved in cryptocurrencies may improve the cash exchanges’ operations, as many have rudimentary infrastructures. Stories of digital currencies that were hacked and stolen are common, and that’s made many people wary. “If nothing else, it will help this asset class in terms of risk mitigation and volatility,” Lane says. “It’s a signal to them [that] you need to up your game; this is what the professional trading community is going to expect.”
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Levin says it’s important that regulators start to get involved in cryptocurrencies because so many people are enticed by them and could suffer harm. “Regulators believe that if there is a bubble and if it pops, these people [who bought bitcoin] could be adversely affected,” Levin says. Anything that can be done to help manage the risk is a good thing in the minds of regulators, he says.
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