Green light for physically-backed Bitcoin derivatives

VanEck and Bakkt have been leading the race to offer regulated physically-backed Bitcoin investment products. But they were pipped to the post by LedgerX and ErisX, with both exchanges gaining the designated contract market licenses from the Commodities Futures Trading Commission (CFTC). They now have the green light to offer physically-settled bitcoin futures contracts.

Unlike the cash-settled offerings of CME and BitMEX, these new futures contracts will allow customers to be paid out in actual bitcoin at the expiration date, putting them in the same category as traditional futures on products such as oil and corn that are settled with physical delivery.

Futures X-factor

US-regulated exchange and clearinghouse LedgerX, with former CFTC commissioner Mark Wetjen on its board of directors, was the first to gain approval and is expected to offer both physically-settled options and futures in bitcoin. Despite the exchange’s established presence serving institutional traders, these new products are to be aimed primarily at retail as part of a platform called Omni.

ErisX, headed by a group of Wall Street veterans and crypto pioneers with the backing of US broker TD Ameritrade, was given the go-ahead for its futures contract several days later. It is more focused on the institutional market.

On approval, the firm was issued a no-action relief letter that recognizes the product’s structure and sets out specific requirements that must be adhered to in exchange for exemption from certain federal regulations.

The structure of ErisX is “unique”, said CEO Thomas Chippas in a statement, because it “divides the trading and settlement functions using traditional DCM (exchange) and DCO (clearing) models.”

Typically associated with traditional markets, Chippas claims this infrastructure should help widen the customer base by making institutional investors more comfortable with the platform. “This reflects the structure that institutional investors expect from other asset classes and will help drive these markets toward greater relevance and accessibility," he said.

Though neither firm has yet issued dates for the release of the new products, traders living in the US and Singapore are expected to be able to use Ledger X’s service as early as July. This will be subject to an initial minimum deposit requirement of $10,000 paid in dollars or bitcoin.

This would make LedgerX’s product the first CFTC-approved physical bitcoin futures contract, and it will join several unregulated physically-backed futures offered by offshore exchanges like the Seychelles-based Coinflex.

At an undefined point later this year, ErisX’s futures contracts will also become available, a similarly short timeline which reflects the rush to capitalize on growing demand in the bitcoin futures market.

Crypto’s ‘new thing’

Institutional market-leader CME has recently claimed record trading volumes, reporting a fresh high of $1.7B in notional value traded on June 26, with average daily open interest (the number of open contracts) growing by 794 percent since December 2017.

This is confirmed by a recent Diar report, which notes that bitcoin derivatives have become crypto’s ‘new thing’. The report notes volume is particularly strong during the working week, suggesting their popularity with institutions.

Derivatives platform BitMEX boasts similarly impressive figures, claiming to have clocked more than $1 trillion in trading volume over the past year.

Both of these exchanges, along with other competitors like newcomers Deribit and Bybit, only offer cash-settled products. According to Richard Gorelick, the head of markets at trading firm DRW, these exchanges are prone to manipulation. "We continue to have concerns that the way that these futures contracts are pegged to these cash markets which are less transparent could result in dislocations in the future," Gorelick told the CFTC last year. "We’ve expressed our view that we would like to see physically settled crypto asset contracts to help deal with some of these concerns."

While these new physically-settled products might seem way ahead of Bakkt, which is currently waiting on a trust company license from the New York Department of Financial Services, ErisX and LedgerX are more focused on market infrastructure, rather than Bakkt’s broader approach which entails custodial solutions and partnerships designed to promote adoption.

As Bakkt COO Adam White pointed out a conference earlier this year, his thesis is that the "future of retail flow will not come from active daytraders", which the Coinbases of the world have already done a pretty good job of attracting, "but from the actual utility and application of crypto."