Crypto currencies: Bitcoin options come a step closer
Opportunity for banks same as in FX; Goldman investment ‘a positive signal’
An options market for crypto currencies is emerging that could escalate the growth of Bitcoin and Ripple. LedgerX an institutional trading and clearing platform is waiting for Commodity Futures Trading Commission approval to trade and clear options on Bitcoin for the institutional market.
The LedgerX application, filed in September 2014, is still under review. The CFTC has sometimes taken a year to review and approve clearing licences.
Paul Chou, chief executive and co-founder of LedgerX, and an alumnus of Goldman Sachs and the Massachusetts Institute of Technology, says that banks, while curious about Bitcoin trading, have been waiting for a regulatory framework to coalesce.
“Banks have set up working groups to look at the technology and some have made investments into Bitcoin companies,” he says. “But the banks are waiting for a federally regulated platform before they start to provide liquidity and to trade bitcoin.”
He adds: “A regulated infrastructure will provide the transparency and security needed to attract institutional investors and to grow the market.”
In April, Goldman Sachs led a $50 million funding round for Bitcoin financial services start-up, Circle Internet Financial. Circle offers mobile payments funded in US dollars or Bitcoins. It plans to add more currencies and expand in China.
“The investment is a great signal that Wall Street is interested in digital currencies,” says Chou.
Trading of Bitcoin derivatives currently happen over-the-counter, through bi-lateral trades or on unregulated international exchanges. “There are many institutional investors who need to stay within a US jurisdiction. They need to trade with a US-banked, US-domiciled and US-cleared exchange,” says Chou. “For investors to include this asset into their portfolios, a CFTC-regulated exchange and clearing house is an imperative.”
He says a federally regulated exchange would allow investors to meet compliance hurdles that have been holding them back. “In addition, bitcoin options give investors a method to trade and hedge volatility, making bitcoin a more attractive asset,” he says.
James Newsome, former chairman of the CFTC, former chief executive of NYMEX, and one of two independent directors on LedgerX’s board, says: “Digital currency derivatives present a huge opportunity, but to gain mainstream adoption, a regulated market will need to be developed. By providing liquidity and a secure venue for investors to manage short and long-term risk, LedgerX will facilitate the evolution and adoption of these products.”
Bitcoin volatility has been an issue for those who use the currency. At one point in 2013 its volatility was 20 times that of the average S&P500 stock.
“Bitcoin volatility has come down but having an options market can reduce that volatility further,” says Chou. It will also allow users the opportunity to hedge their exposure to fluctuations. Mining companies are among the largest users of Bitcoin, and enterprises like Dell, Microsoft, Expedia, United Way, Paypal and 1-800 FLOWERS accept Bitcoin.
A regulated infrastructure will provide the transparency and security needed to attract institutional investors
“Compared to three years ago, many more high calibre firms accept and use the currency,” says Chou. Indeed some 80,000 companies now accept it. Chou says the growth of digital currencies is hard to predict. “To date, the growth in Bitcoin has been entirely organic but already the market capitalisation is at several billion dollars.
Centralized clearing will allow the exchange, if it gets the go-ahead, to novate each trade. “This allows firms to treat Bitcoin options like they would any other option trade,” says Chou.
It will be a big step by the CFTC. There are only 14 active clearing-house licences in the US. The last one was issued in December 2013.
Other smaller firms are setting up, keen to ride on LedgerX’s tail. In Boston, Alt-Options has just launched its 1.5 version of an options trading platform for Bitcoin, which simulates block chains and the price of Bitcoin.
Its founders Joe Zhou and Marco Cuesta are planning a formal launch at the end of the summer following a simulated Bitcoin trading competition with Hong Kong based exchange BitMex.
“We are more focused on the retail side, unlike LedgerX and Tera Exchange, and in allowing individual traders and speculators to gain exposure to bitcoin through trading listed options,” says Cuesta. “In the future we see ourselves working more like a broker/dealer that could potentially trade the products that firms like Ledger provide and do the clearing with them. It’s a little too soon to say though until the regulatory environment is clearer.”
Cuesta says the future of Bitcoin is not certain and making the platform open to other currencies like Ripple or Litecoin is important for Alt-Options. Zhou adds that while Bitcoin is the most well-known, Ripple is an improved version.
Says Cuesta: “Who knows if Bitcoin will still be around in a few years, but crypto currencies certainly will. They are cheaper and more secure than cash. Once people understand the value and don’t just think of digital currencies as being used to buy illegal products or to make donations then crypto currencies will take off.”
He adds: “Where we are in the cycle of its popularity is reminiscent of the time when making payments by credit card over the internet emerged. Lots of people said they would never have their personal details online or that is was unsafe – but now everyone pays online. But which currency will prevail is still uncertain.”
Chou says Bitcoin will offer a lot of opportunities for banks. “Once the regulation is in place there will be the ability to make markets and provide liquidity much as they now do in FX.”