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BitCoin Futures: Boogeyman or Rational Evolution?

Traders Magazine Online News, November 8, 2017

David Weisberger

Headlines virtually ooze sensationalism as they inform investors that BitCoin a.k.a. “The boogeyman” is coming, in the form of futures contracts on the CME.   The news coverage ranges from the reasonable from Business Insider and the Wall Street Journal  to the ludicrous from CNBC, who stokes investor fears by comparing approval of BitCoin Futures to the cause of the Financial Crisis.

Such a comparison is simply idiotic, as the leveraged derivatives and rampant speculation on real estate was carried out in markets that are multiple orders of magnitude more systemically important than cryptocurrencies are today.  That crisis created almost complete paralysis in the debt markets, and threatened the solvency of the banking system.

That CNBC article quotes noted CryptoCurrency and Trading Technology expert, Joe Saluzzi, who also wrote his own blog on the topic yesterday.  As usual, the Themis blog starts from their typical “HFT firms are evil” meme, but they do make a valid point, which is that basing a futures contract on an INDEX of BitCoin prices would be subject to manipulation.  If the CME, however, created a futures contract that was “physically” settled, then such concerns would evaporate.  That does not mean that such a contract would have no volatility (It would likely have quite a bit), nor would it mean that investors wont lose money.  It would, however, mean that the contract itself would be much less susceptible to manipulation.

I realize that the notion of "physical" settlement is odd, since BitCoin is a digital asset, but the point is that sellers of BitCoin futures could be required to make delivery of the asset to the exchange on settlement, and the buyers could be required to take delivery.   IF that was the proposal, then manipulation of settlement prices becomes irrelevant, and BitCoin would be no different than any other commodity futures the CFTC regulates.  They could judge the proposal based on the CMEs capabilities of ensuring that the resulting blockchain transactions, which constitute the physical settlement, were able to be verified and secured.  This would, in actuality, be far easier to accomplish than with other commodities, since BitCoin delivery doesn’t require warehouses, grain elevators, or vaults to handle the transactions.  It has a well-established method for verifying “on chain” transactions and member firms trading the future would be capable of constructing or leveraging service providers to create the necessary secure systems to either deliver or accept delivery and maintain the resulting inventory.

If the CME proposes to settle this contract on the basis of an index, however, I would be forced to agree with Themis’s conclusion that the CFTC should reject the proposal.  This is not because of irrational “HFT-phobia” since it is unclear that speed would have anything to do with the capacity for manipulating the price and such firms have substantial franchises to protect.  Other firms, including clients of CME members who are not subject to regulation, however, would be in position to That said, I would characterize the idea of using a 5 minute VWAP of “some” Bitcoin exchanges to create an Index of the Bitcoin price, as extremely susceptible to manipulation.

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