The CME Group was one of the first large financial institutions to start experimenting with distributed ledger technologies. After the series of problems that caused bitcoin to crash in 2013, the sentiment from financial institutions looking into the space was that cryptocurrencies were never going to work given their decentralized nature. The innovation, they thought, was only ‘the blockchain,’ which could enable cost savings in settlement, reconciliation, compliance, etc.
Up until the massive expansion that cryptocurrency markets experienced earlier this year, the majority of the research these institutions performed in the space revolved around private blockchains. That paradigm has now changed, and perhaps one the biggest indicators of that change was the announcement of CME’s Bitcoin Futures. CBOE followed suit, and the first bitcoin futures contract is set to begin trading this Sunday.
But what does this mean for bitcoin?
Even though the launch of bitcoin futures contract is a step towards a more efficient and liquid market, the actual fundamental value that it brings to bitcoin is constrained by one factor: cash settlement. Futures, in simple terms, are agreements to buy or sell specific commodities some time in the future at a predetermined price. When the contract expires, both parties settle the contract based on the market rate of the underlying asset. Depending on terms of the contract, the buyer may choose to have the underlying asset physically delivered; be it gold bullion bars, barrels of wheat, or crude oil. A lot of foreign currency futures can also be physically settled through interbank transfers, but this will not be the case with bitcoin. Upon launch, both CME and CBOE will settle their Bitcoin futures contracts strictly with cash. What this means is that the clearing houses that support these exchanges will not be required to hold a balance of the bitcoin.
The reference rate that will be used to financially settle the CME bitcoin futures contract is calculated using pricing data from four constituent exchanges; Bitstamp, GDAX, itBit and Kraken. The methodology behind this index captures samples of each order book in equally-sized time intervals and weight prices based on volume. It will be interesting to see how the index will progress given the large spread in bitcoin prices across the exchanges, which can be up to $2000 in recent times:
Source: DigitalAssetResesrch, TradingView
The full implications of the securitization of crypto assets will be unveiled in the next months. Whether this contract will be used for hedging purposes or simply for speculation, it is clear that the interest from the institutional investor community has been on the rise. Even though the launch of these futures contracts do not generate demand for bitcoins, it introduces digital assets to institutional investors and prime brokers without the frictions of actually holding them. We will continue to monitor the ways in which these futures are used and measure its implications to the broader market. If you want to learn more about our research, please subscribe to our newsletter, where frequently share part of our research for free.