MARKET MAKER

Bitcoin is too big to ignore, so exchanges are coming up with new ways to trade it

Obsession
Future of Finance
Obsession
Future of Finance

Bitcoin is growing up. CME Group, the world’s largest derivatives exchange, said yesterday that it will create a futures contract for trading the cryptocurrency, another sign it is becoming a mainstream financial asset like gold or oil. The news sent the bitcoin price soaring to yet another new record, surpassing $6,500 for the first time.

For crypto-enthusiasts, the CME’s announcement signals that it thinks bitcoin has real-world applications beyond pure speculation. Derivatives exchanges like CME and CBOE Holdings, which also has plans to launch bitcoin futures, can theoretically create options, futures, and other derivatives linked to just about anything, but they usually only do so when there’s a commercial reason for it. Oil futures, which traders use to bet on crude’s price, allow companies to hedge the risk of oil prices rising or falling. Futures tied to a football team winning or losing, on the other hand, probably wouldn’t have a meaningful commercial application.

As for bitcoin futures, they could make the digital asset more useful by allowing users and intermediaries to hedge their foreign-exchange risks. That could increase the cryptocurrency’s adoption by merchants who want to accept bitcoin payments but are wary of its volatile value. Institutional investors are also used to trading regulated futures, which aren’t plagued by money-laundering worries.

CME’s move also suggests that bitcoin has become too big to ignore, since the exchange seemed to rule out crypto futures in the recent past. Bitcoin is just about all anyone is talking about at brokerages and trading firms, which have suffered amid rising but unusually placid markets. If futures at an exchange took off, it would be nearly impossible for any other exchange, like CME, to catch up, since scale and liquidity is important in derivatives markets.

“You can’t ignore the fact that this is becoming more and more of a story that won’t go away,” said CME CEO Terry Duffy in an interview with CNBC. There are “mainstream companies” that want access to bitcoin and there’s “huge pent-up demand” from clients, he said. Duffy also thinks bringing institutional traders into the market could make bitcoin less volatile.

That said, bitcoin still has a long way to go before it becomes a feature of global financial markets.

Lots of futures contracts never gain wide adoption, no matter how promising they seem at first. And neither the CME futures contact nor the CBOE one has been approved by regulators yet, although their announcements suggest they’re confident they can pull it off.

For big institutions, there are other hurdles. CME’s bitcoin futures are “cash settled,” meaning investors are delivered dollars instead of bitcoin at the end of the contact. That seems like an easy solution for companies that worry bitcoin could be “dirty,” but their limited ability to buy and sell actual bitcoin (for arbitrage or hedging) could reduce how much trading is possible.

And then there’s the issue of volatility. Exchanges like CME might require brokers to post extra collateral to trade bitcoin futures, which could further restrain buying and selling.

The CME news is one more sign that exchange executives think bitcoin is “here to stay.” Even so, some of its biggest believers, like Fortress Investment’s Mike Novogratz, believe prices are probably in a bubble. As usual with something so new and exciting as cryptocurrencies, there’s a risk that the hype runs ahead of the reality.

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