U.S. futures and options trading venues will “self-certify” new contracts for the crypto currency’s futures products as the CFTC is watching from the wings.
Bitcoins, the digital “crypto” currency that in 2017 became one of the world’s fastest growing assets, reaching a high of more than $11,000, an increase of more than 900 percent for the calendar year, may still have its detractors, who compare its sudden popularity to Dutch Tulip Mania in the 17th century, or to the Dotcom Bust at the turn of the millennium.
But those recent stratospheric valuations have caught the attention — and the backing — of important players in the financial services world, who have pledged to “self-certify” new contracts for the crypto currency’s futures products.
Specifically, the Chicago Mercantile Exchange Inc. (CME) and the Chicago Board Options Exchange’s (CBOE’s) Futures Exchange (CFE) say they will self-certify new contracts for bitcoin futures products, and the New York-based Cantor Exchange, a binary-options specialist, also will self-certify a new contract for bitcoin binary options, according to a statement from the CFTC.
Bitcoin “emerged after the financial crisis and is not underpinned by a central bank,” The Guardian, a British newspaper, notes in its summary of the crypto currency’s rapid rise. “It allows people to bypass banks and traditional payment methods for goods and services – an idea that has evidently caught the imagination of some investors, because its price has surged by more than 900% in 2017.”
The fact that Bitcoin is “not underpinned by a central bank” might give would-be investors pause, and any would-be bitcoin investor would do well to keep Mount Gox or Bitfinex in mind.
Mount Gox was an early bitcoin exchange that collapsed in 2014, “after hackers pillaged nearly $500 million,” in bitcoin. And just this year, “thieves grabbed $72 million from Hong Kong cryptoexchange Bitfinex in one fell swoop,” according to a review of crypto-currency developments by Fortune magazine.
Brazen bitcoin robberies like that have caused investors and regulators to rethink security measures for the blockchain-based currency.
Nonetheless, the exchanges are “racing to embrace bitcoin, dragging federal regulators into a realm skeptics call a fad and fraud,” Bloomberg News observes.
Once the self-certified crypto-currency contracts are launched by the Chicago-based exchanges, the CFTC says, its staff will “engage in a variety of risk-monitoring activities. These activities include monitoring and analyzing the size and development of the market, positions and changes in positions over time, open interest, initial margin requirements, and variation margin payments, as well as stress testing positions. Commission staff will additionally conduct reviews of designated contract markets, derivatives clearing organizations (DCOs), clearing firms and individual traders involved in trading and clearing bitcoin futures.”
In addition, the CFTC says it will also “work closely” with the National Futures Association, which has “issued an investor advisory on this topic to its members, including futures commission merchants and introducing brokers that are involved in the trading of any virtual currency futures product, and will closely monitor its member firms trading this product. If the Commission determines that the margin the DCOs hold against bitcoin futures positions is inadequate, it can take measures to require that the margin held at the DCOs be increased, including requiring that they use a longer margin period of risk to generate margin requirements.”
“Bitcoin, a virtual currency, is a commodity unlike any the Commission has dealt with in the past,” CFTC Chairman J. Christopher Giancarlo says in a statement. “As a result, we have had extensive discussions with the exchanges regarding the proposed contracts, and CME, CFE and Cantor have agreed to significant enhancements to protect customers and maintain orderly markets. In working with the Commission, CME, CFE and Cantor have set an appropriate standard for oversight over these bitcoin contracts given the CFTC’s limited statutory ability to oversee the cash market for bitcoin.”
“Market participants should take note that the relatively nascent underlying cash markets and exchanges for bitcoin remain largely unregulated markets over which the CFTC has limited statutory authority,” the commission warns. “There are concerns about the price volatility and trading practices of participants in these markets. We expect that the futures exchanges, through information sharing agreements, will be monitoring the trading activity on the relevant cash platforms for potential impacts on the futures contracts’ price discovery process, including potential market manipulation and market dislocations due to flash rallies and crashes and trading outages. Nevertheless, investors should be aware of the potentially high level of volatility and risk in trading these contracts.”
According to research from digital forensics firm Chainalysis, reported by Fortune, “3.79 million bitcoins are already gone for good based on a high estimate — and 2.78 million based on a low one.”
Those “gone” bitcoins “imply [that] 17% to 23% of existing bitcoins, which are today worth around $8,500 each, are lost,” says Chainalysis, which was founded in 2014 to provide anti-money laundering software for the digital currency.
The CFTC says that its staff “held rigorous discussions with CME over the course of six weeks, CFE over the course of four months, and had numerous calls with Cantor. CME, CFE and Cantor agreed to significant enhancements to contract design and settlement, and CME to margining, at the request of Commission staff, as well as more information sharing with the underlying cash bitcoin exchanges to assist CME, CFE, Cantor and the CFTC in surveillance. The Commission, CME, CFE and Cantor will also coordinate to the extent possible in any surveillance activities, including providing the CFTC with additional surveillance information.”
The self-certification process requires the designated contract markets (DCMs) either to submit a written self-certification or to “voluntarily submit the contract” for CFTC approval.
“When a DCM self-certifies a new contract it must determine that the offering complies with the CEA [Commodity Exchange Act] and Commission regulations, including that the new contract is not readily susceptible to manipulation,” the CFTC says. “This is the same standard the Commission uses when reviewing products for approval.”
“CME, in its capacity as a DCO, plans to clear its own contracts,” the commission notes, “while CFE plans to clear its contracts at another DCO, the Options Clearing Corporation.”
“As trading on these DCMs evolves,” says the CFTC, it will “continue to assess whether further changes are required to the contract design and settlement processes and work with the DCMs to effect any changes.”
Importantly, the CFTC declares that its staff has “assessed potential risk of defaults in these futures contracts on the DCOs. Based on analysis of different stress scenarios, staff estimates that any potential impact will not be significant to a DCO. “
The commission cautions that its latest crypto-currency pronouncements do not constitute “approval. It does not constitute a Commission endorsement of the use or value of virtual currency products or derivatives. It is incumbent on market participants to conduct appropriate due diligence to determine the particular appropriateness of these products, which at times have exhibited extreme volatility and unique risks.”
Furthermore, the commission notes that — under the current statutory and regulatory framework — it has “limited ability to require the DCMs to make changes to their contracts or to require the DCOs to change their approaches to clearing the contracts.”
In fact, the CFTC “does not have the authority to require the DCOs to establish separate clearing systems or guaranty funds to clear these contracts. Those decisions are left to individual DCOs acting through established risk governance mechanisms and in compliance with the CEA and Commission regulations. But based on feedback received from a number of market participants, Commission staff did not find widespread support for these contracts to be cleared in a separate guaranty fund,” according to the CFTC.