Bitcoin Futures and the Road Ahead

Topic: Business Commentary

Watching the price activity of Bitcoin, generates a tremendous amount of excitement and discussion. I have no view on the current value/price level, but do find the volatility of the instrument be worth keeping an eye on. The Cboe is aggressively marketing the launch of Bitcoin Futures as they patiently wait for final CFTC approval for this new futures instrument.

Cboe's push makes sense, given the fact that cost in trading cryptos on existing exchanges/platforms, is very expensive. Round-trip trades can cost 30-40 bps! This is getting cheaper, but will still be a lucrative revenue stream for Cboe, with comfort in its centrally cleared platform for settlement purposes. Comfort with counterparty risk, and the confidence that you will get your margin/investment back. The current state of platforms where cryptos trade have some uncertainty on moving money out.

The excitement and positive story coming out of the market is driven by statements like "volatility creates opportunities for investors to wager on or hedge price moves, and it drives trading volumes that fuel exchange profits". This is where I want to temper the enthusiasm for the Cboe to be the place for massive trading volumes to take advantage of this "volatility". Having grown up in the interbank currency trading business in the 80's, I saw first hand the advantages of profits off the back of volatile trading. But, the critical market player for making large money was the "Hedger" on the other side of the trade. Investors are well aware of the split between speculators (traders) and commercials (hedgers) in the Futures Marketplace, as they are required to publish the findings. I am not a proponent of this data for making buy/sell decisions, but only to remind investors that these players exist in the market. Traders trading with each other will provide profits to the smarter or faster group, but it's a zero sum game. Losers leave, and winners need new players to participate. Money is made, but transaction costs add up for both sides. Back in the 80's the IMM (old name for currency futures house - International Money Markets) would trade decent amount of volumes, but nowhere near the volume in OTC FX market. They were separated because futures were an instrument that settled in US Dollars, for the difference in the buy price and sell price. That was fine for speculators, but hedgers rarely took delivery of the underlying currency because the movement of cash was very expensive and operationally risky, along with adding banks with foreign accounts to get involved. Large corporates with international exposures would use their banking relationships to execute the FX in the OTC markets. There was a group on Funds that needed a benchmark to mark their books and the futures market provided an exchange print for them. In the mid 80's, these growing Funds pushed the futures exchange to create a mechanism to merge the FX Instruments in the OTC and Futures contracts. This was the birth of EFPs, Exchange for Physical transaction that brought the brokers on the IMM to Banks PB network for credit and clearing functions. Now Funds could use the OTC market for liquidity (and 24 hour availability), and maintain their margins with the exchange and their underlying brokers, as well as having access to the underlying currency. This was the real growth in FX, because the market understood the value in speculators getting to face off against corporate flows. These players had two different timeframes and needs. Now volatile markets actually provided opportunities for most traders to make money off the hedger/commercial flows. You're dreaming if you think traders just make money in volatile markets.

In summary, I think the actual lift in Bitcoin from the Futures market will come when the future can convert to the underlying. The core flow initially will need to come from accounts that are acting as Investors in Bitcoin, who want a safer place to hold the underlying exposure. Traders that are watching the OTC platforms, and want to arb back to the futures will have accounting issues that will not be easily settled, and will cost more than the opportunity. Cboe will need to focus on creating the complete package that includes credit, counterparty risk and delivery of the underlying asset before benefiting in a meaningful way.  

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