Congress

Futures product to test Wall Street taste for cryptocurrencies

Startup company plans to start trading futures contracts in bitcoin

Senate Agriculture Chairman Pat Roberts, R-Kan., and ranking member Debbie Stabenow, D-Mich., have sought clarity from the Commodity Future Trading Commission on guidelines for cryptocurrencies on the futures market. (Tom Williams/CQ Roll Call file photo)

Cryptocurrencies have been viewed skeptically by some old-guard financial institutions — the head of one bank famously called bitcoin a fraud a few years back — but there’s a new plan to offer derivatives based on bitcoin that may show how deeply Wall Street is adopting new financial technology.

A startup company plans in July to start testing futures contracts in bitcoin, and begin trading them shortly after. The products, unlike cryptocurrencies themselves, aren’t designed for the masses. Bitcoin futures are meant for financial firms that want to find new ways to profit from fintech, and launching the futures contracts is essentially a bet that there’s enough demand from the big players.

A surge in cryptocurrency prices this year may make the prospect more enticing.

The company launching the derivatives is Bakkt Trust Co. LLC., founded last year by Intercontinental Exchange Inc., the owner of the New York Stock Exchange, and other financial companies. Bakkt’s backers also include Microsoft Corp. and Starbucks Corp.

Bakkt CEO Kelly Loeffler said the company has worked closely with regulators in crafting the derivatives to comply with federal regulations.

A futures contract is an agreement to buy or sell an asset — often it’s a commodity like wheat or corn — at a date in the future, as opposed to immediately trading at the current price. Futures contracts are traded on an exchange.

Bitcoin futures launched once before — in late 2017 when cryptocurrency prices were at an all-time high — with seemingly mixed results.

Cboe Futures Exchange LLC, one of the exchanges trading bitcoin futures, has since pulled back from its aspirations, saying in March that it would not offer new bitcoin futures contracts, and that it is reassessing the approach on digital asset derivatives. CME Group Inc., meanwhile, a derivatives trading group, said it traded a record number of contracts on May 13, almost 50 percent more than in the previous record.

Cryptocurrency prices are also rising again, a development that, if it continues, could affect the new contracts. The price as of May 19 was about $7,700 per bitcoin, depending on the market, more than double what it had been just a few months ago. But it’s still well short of the high of more than $19,000 in December 2017.

The recent price increase may bode well for Bakkt, but cryptocurrency prices are more volatile than many other assets traded in the futures market.

Physical settlement

Bakkt’s futures contracts will differ from earlier versions by requiring physical settlement, or payment, in bitcoin. The Cboe and CME products are settled in cash, with payment in dollars. Bakkt is testing whether traders will prefer the physical settlement.

Loeffler said the group has worked closely with the Commodity Futures Trading Commission to develop contracts that are legally compliant, transparent, and provide customers certainty that the market will work as advertised.

“The landscape won’t change overnight,” Loeffler said in the announcement of the expected launch. “But the intersection of technology and finance requires cooperation between business and policy makers to ensure the U.S. maintains a critical voice in how this space evolves.”

It’s unclear whether the launch will generate as much controversy as the first go-round.

The CFTC received substantial criticism then, chiefly by the Futures Industry Association, the main organization representing the derivatives trading industry. The association railed against the agency’s stance that allowed the exchanges to self-certify bitcoin futures for trading, saying it posed major risks.

“We believe that this expedited self-certification process for these novel products does not align with the potential risks that underlie their trading and should be reviewed,” the organization’s CEO, Walt Lukken, said at the time.

CFTC Chairman J. Christopher Giancarlo also acknowledged that “clearing members” of the exchanges on which the futures are traded aired concerns about the lack of consultation before being forced to accept new risks associated with them.

Clearing members ensure that trades will be satisfied in the event of default by one party. The volatility of bitcoin prices can saddle the clearing members with risk.

The concerns prompted lawmakers last year to seek answers as well.

Senate Agriculture Chairman Pat Roberts and ranking member Debbie Stabenow asked for clarity last year on how the agency was managing the risks and whether the CFTC has enough resources to govern cryptocurrency markets.

Laws governing commodities trading are fairly clear, Giancarlo said in a speech in March. Exchanges can self-certify that their products meet proper standards, he said, and exchange representatives had substantial discussions with CFTC staff before launching the products.

The CFTC declined to comment for this story. The agency ruled previously that it has jurisdiction over virtual currencies, such as bitcoin, when the asset is used in a derivatives contract or in cases of fraud or manipulation.

Some advocates are praising Bakkt’s move.

“These derivatives have a beneficial impact on the stability of the underlying digital token market,” Kristin Smith, director of external affairs at the Blockchain Association, said in an emailed statement to CQ Roll Call. “Like earlier projects with the CBOE and others, this is a positive step forward.” The Blockchain Association is a cryptocurrency lobbying group.

Bakkt filed documents with the CFTC on May 13, saying it has applied to be licensed as a limited-purpose trust company by the New York State Department of Financial Services.

Adam White, Bakkt’s chief operating officer, wrote in a post in April that the bitcoins underlying the futures contracts will be stored at a regulated custodian.

“This means investors will have access to the same high performance, low latency exchange and clearing infrastructure that powers many of the world’s most liquid futures markets,” White wrote.

The company says it will contribute $35 million for mitigating risk, a move Loeffler calls “skin in the game.” She said in a post this month that the company plans systems to detect abusive trading practices, and the operation is supported by insurance, cybersecurity, and comprehensive compliance.

Bakkt’s successful launch of the futures contract would then test Wall Street’s interest.

That might mean convincing the likes of Jamie Dimon, head of JP Morgan Chase & Co., the banking CEO who criticized bitcoin as a fraud back in 2017. Since then, the megabank has formed its own cryptocurrency.

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