Cryptocurrencies and Derivatives: The Battle for Dominance

From Left to Right — Colleen Sullivan from CMT Digital, Ron Bernstein from Coinbase, Thomas Chippas from ErisX, John Deters from Cboe Global Markets, Tim McCourt from CME Group and Adam White from Bakkt.

The Futures Industry Association (FIA) held their 44th Annual Boca conference last week in Boca Raton, Florida. The gathering attracted over 1100 attendees consisting of regulators, market makers, technology providers and exchange leaders. ErisX attended the conference and chief executive officer Thomas Chippas shared his expertise on a panel exploring how cryptocurrencies are impacting the derivatives industry. He was joined on stage by moderator Colleen Sullivan from CMT Digital, Ron Bernstein from Coinbase, Tim McCourt from CME Group, John Deters from Cboe Global Markets and Adam White from Bakkt.

The Lay of the Land

The panel kicked off with quick introductions starting with Bernstein who admitted the San-Francisco based spot Exchange is still exploring derivatives trading. Bernstein came to Coinbase through their acquisition of his decentralized trading platform in 2018, Paradex.

“Crypto does not require trust because it will go on the public blockchain,” said Bernstein who was the only representative on the panel from a decentralized exchange.

A decentralized exchange is a marketplace that does not leverage third-party services. It is purely a peer-to-peer transaction. The rest of the exchanges rely on regulatory guidance from the Commodity Futures Trading Commission (CFTC), but their offerings vary. Bakkt will offer a physically delivered futures contract, and CME has a cash-settled Bitcoin product as well as a suite of pricing products. Cboe has a cash-settled contract but after the panel announced they would be pausing their crypto offering.

ErisX will launch a unified physically delivered spot and regulated futures marketplace on digital assets this year. On the panel, Chippas explained the reasoning behind ErisX’s intermediary-friendly model.

“People want familiarity. They do not want to set up a new account to trade cryptocurrencies,” he said. “It’s easier to go through a broker such as TD Ameritrade, Fidelity or Tradestation where a customer already has an account and where they can diversify their already-existing portfolio.”

Market Participants and Price Discovery

After introductions Sullivan asked Cboe and CME about the type of participants trading their bitcoin futures contract.

“There is a balance of liquidity providers, prop trading firms, hedge funds and retail customers,” said CME’s McCourt. “We have also seen an advent of crypto-only funds applying what they know from traditional capital markets.”

Cboe’s Deters agreed with McCourt.

“When we launched our contract there were a lot of unknowns. Who would participate? Where in the world would they be located? Who would be first? There is a diverse group of market participants and the price discovery and term structure is very different than other asset classes.”

Price discovery was another topic throughout the discussion and how the cash markets were playing an important role.

“Look at what firms like Genesis and Cumberland are doing in this space,” said White. “While it’s the spot markets that are helping customers with price discovery right now, this should switch when the futures markets are more developed.”

Spot markets are not regulated but ErisX will administer the same CFTC rulebook that applies to futures markets. On the panel, Chippas talked about how this would help legitimize the digital asset markets.

“We can’t look at volume and think it’s real or relevant and there are a lot of moving parts with OTC markets and offshore trading,” said Chippas. “As we develop [our spot markets on the same platform as our regulated futures offering], we will produce more trustworthy data. Spot and futures contracts with collateral in a clearinghouse will clean up some of this noise.”

In addition to operating a CFTC-regulated designated contract market (DCM), ErisX has a derivatives clearing organization (DCO) application pending with the CFTC to operate a clearinghouse, which would guarantee all futures trades.

“Centralized clearing provides certainty, which is important in financial transactions,” said McCourt.

Regulation

Centralized clearing and regulated markets is also something institutional investors have come to expect. However, many of the large institutions are looking for more regulatory clarity and the panelists believe this might take some time.

“There is still a lot of confusion in this space with the CFTC calling some cryptos commodities, the SEC says some are not securities, the Treasury Department refers to them as assets and the IRS calls them currencies,” said White. “The winners and losers will not be determined overnight.”

Chippas agreed and spoke about his experience working with global regulators.

“The regulators will take their time to gain extensive knowledge. This is not about how fast one can ship code,” he said. “But in my experience, regulators have never wanted to stop someone from doing something innovative.”

Regulators are focused on investor protection and preventing market manipulation, and Deters pointed out that what regulators do now carries a lot of weight.

“If a line gets drawn in the sand, it’s hard to go back,” he said.

Before the conversation concluded, Sullivan asked the panelists what was most exciting to them about this new asset class.

“To be a part of something like this, a new and emerging risk management tool as it relates to crypto is very cool,” said McCourt. “These opportunities, or fundamental changes in the market, do not come around often.”

The FIA Boca conference brought together some of the most influential leaders in the crypto derivatives space last week to discuss the debate between decentralized versus centralized exchanges, price discovery and regulation as it all applies to the crypto markets. With regulated exchanges, brokers, market makers and intermediaries getting involved; it was a good time to take a step back and view the digital asset landscape to see where we have been and where we will go.

“Let’s not forget that this market would not exist without the retail traders,” said Deters. “But we talk about institutional activity because that is the next frontier.”