The cryptocurrency industry is hailing the emergence of complex bitcoin investment products as a needed step to attract new investors while lending credibility to the digital asset and building a pathway to regulatory clarity.
The big development at the end of 2019 was the first trading of what’s known as physically settled bitcoin futures, following approval from state and federal regulators. And while the launch of these investment products hasn’t convinced everyone that they will lead to buy-in from a skeptical financial industry, those leading the charge say it’s a crucial step.
Futures represent an agreement to exchange a good for an agreed-upon payment at a later date. Futures have long been used by buyers and sellers to protect themselves from sudden swings in a market. The bitcoin futures that launched in 2019 trade through regulated exchanges and clearinghouses.
Clark Fonda, co-founder of Blockchain Advocacy Partners, said products with this level of regulatory oversight help his organization’s conversations with lawmakers. Fonda’s trade association represents the interests of the blockchain industry, the distributed ledger technology that makes cryptocurrencies possible.
“From a policymaker perspective, this lends a tremendous amount of industry credibility for tokens and cryptocurrencies in general,” Fonda told CQ Roll Call in an interview.
Fonda said there’s still a lot of skepticism on Capitol Hill, but regulatory clarity and investor acceptance of digital assets “help lawmakers feel at ease.” He previously worked as chief of staff to former Rep. Robert Pittenger, a Republican from North Carolina who was on the House Financial Services Committee.
Physically delivered futures differ from cash-settled ones, in which money, rather than cryptocurrency, changes hands. The worry over cash-settled contracts is their dependence on unregulated spot markets to determine bitcoin’s value when the contract ends. And there have been accusations that bitcoin markets are heavily manipulated by participants. Delivering the digital coins to an account, though, doesn’t require any determination of value.
Financial tech firm Bakkt LLC, a subsidiary of Intercontinental Exchange lnc., launched the first physically settled bitcoin futures in September. Bakkt President Adam White told CQ Roll Call in an interview that these contracts are less vulnerable to manipulation and an added layer of protection from using regulated exchanges to trade the contracts has opened the cryptocurrency to new investors.
Intercontinental Exchange says it wants to repeat for bitcoin what it did with energy trading in the early 2000s. Founded in 2000, the Intercontinental Exchange opened up the commodities market to more investors. Intercontinental also owns the New York Stock Exchange.
“Our real goal is to onboard new customers, new institutions that have never traded crypto before largely because they didn’t want to have a dependency on the unregulated spot markets,” White said.
Bakkt courts as clients institutional investors, a term that encompasses banks, pensions, mutual funds, endowments, investment advisers and other financial entities. The company relies on market technology and infrastructure regulated by the Commodity Futures Trading Commission and New York state to reassure investors.
Bakkt’s physically settled futures trade on a regulated futures exchange and are settled through a regulated clearinghouse owned by its parent company. Bakkt also provides custody of the bitcoins for the length of the futures contract through a New York trust license.
It took about two years to line up the regulatory approvals needed to launch the products, which has paved the way for others, White said. “We’re helping the whole market grow by spending time to work with regulators and help them understand what we’re doing and how it fits into frameworks that are already there.”
Physically settled futures could also help bitcoin grow beyond a tool for speculation, which is necessary for the digital asset to reach its full potential, White said.
The product “allows not just speculation but hedging and risk management,” he said. Those functions are necessary to lock in bitcoin value if you’re a miner producing the currency or a merchant accepting bitcoin as payment.
Steven Adamske, head of communications for the Futures Industry Association, said futures contracts have long served that purpose in other commodities markets, including corn, wheat and soybeans. He said he expects that they could provide similar benefits for producers and users of bitcoin.
“Futures have proven to be extremely useful tools for managing the volatility of commodity prices,” he said in an email.
The other company offering physically settled bitcoin futures is ErisX, which caters to institutional and retail investors trading digital assets. Its futures launched in December.
CEO Thomas Chippas said he expects to see a “healthy mix” of producers, speculators, hedgers and market makers as customers, including bitcoin miners that need to move inventory and investors or consumers who want the underlying commodity. The company is backed by U.S. online brokerage TD Ameritrade. Chippas likened the function to gold futures, which a buyer may use to gain ownership of gold to hold as a long-term investment or to use as a raw material in manufacturing a product, such as jewelry.
Not everyone agrees that the new products will erase doubts about bitcoin’s volatility.
Nafis Alam, a finance professor at Asia Pacific University of Technology and Innovation, said he’s skeptical that the futures will mature bitcoin markets beyond speculation. Alam’s work focuses on financial technology.
“With a physical settlement, we can get rid of speculative trading, but the underlying asset needs to be a stable, popular and valuable asset like gold rather than a speculative one like bitcoin,” he said in an email.
Bitcoin’s price is driven by speculation, rather than actual popularity, he said. Moreover, regulated futures didn’t solve the greater legal and regulatory uncertainty surrounding bitcoin or digital assets, Alam added. Declining prices, for example, are proof that new investment products have done little to solve bitcoin’s underlying problems, he said.
From the September launch of Bakkt’s futures to Jan. 1, bitcoin’s price dropped by about 26 percent. In the first three days after the launch, the price dropped by more than $1,600, according to the cryptocurrency news outlet CoinDesk.
“With a physically settled bitcoin future, the price should have gone up but unfortunately, it has not happened which shows a lack of trust in Bitcoin as an asset,” Alam said.
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