With virtual currency markets booming and bitcoin prices at record highs, U.S. financial regulators have been—each in its own manner—considering whether and how to regulate virtual currencies and related products. Last week, the U.S. Commodity Futures Trading Commission (CFTC) announced that three futures exchanges—CME, Cboe Futures Exchange, and Cantor Exchange—self-certified listings of exchange-traded bitcoin derivatives, with trading in these products set to begin as soon as December 10. These products could significantly shape the development of virtual currency markets, and the CFTC’s approach in permitting self-certification reflects a recent emphasis by the agency on being forward thinking about the regulation of virtual currencies.
The self-certifications, and the imminent trading of these products, are interesting in several respects:
- Not readily susceptible to manipulation. A key regulatory requirement underlying the self-certification process is that each listing exchange must determine that the contract to be listed is not readily susceptible to manipulation. Meeting this requirement was of particular importance, in light of CFTC Chairman Giancarlo’s characterization of bitcoin as “a commodity unlike any the Commission has dealt with in the past” and the underlying cash market for bitcoin as “relatively nascent” and “largely unregulated.” Each exchange approached this requirement differently: CME argues, among other things, that cash market bitcoin prices have historically been no more volatile than those for other commodities underlying futures contracts; Cboe describes the robustness and transparency of its reference price source and risk management procedures; and Cantor focuses on “bitcoin’s Internet roots mak[ing] its real-time pricing one of the most transparent market prices of any asset.”
- Effects on bitcoin cash markets. Trading of listed bitcoin derivatives will inevitably affect pricing, volatility, and liquidity of bitcoin cash markets. Each of the CME, Cboe, and Cantor contracts uses different sources for its reference asset price. The CME contract references a proprietary index, the CME CF Bitcoin Reference Rate, which aggregates prices from several selected bitcoin exchanges. The Cboe contract references bitcoin prices from the Gemini Exchange. Cantor does not publicly disclose the sources of bitcoin pricing data underlying its contact, but it will look to cash exchange and index prices that are “widely followed and publicly available.” Given the wide dispersion of cash market bitcoin trading and the newness of the market, we expect that the introduction of these three listed bitcoin derivatives will be a boon for policy makers, researchers, and market participants seeking to better understand pricing, liquidity, and other aspects of this market.
- A door opens for investors and traders. Investors that may have been hesitant about entering bitcoin markets, including for regulatory or operational risk reasons, may find some additional comfort in accessing this market through listed derivatives. These contracts can be traded through regulated brokers, are cleared through regulated FCMs and clearinghouses, are available to retail customers, and do not require holding actual bitcoin. Because the regulatory treatment of, and trading in, listed futures and options are well understood, these contracts may be a more attractive entry point into the bitcoin market, including for some institutional investors.
- And perhaps also for bitcoin ETPs? In March of this year, the SEC denied an application by Bats BZX Exchange (now Cboe BZX Exchange) to list shares of the Winklevoss Bitcoin Trust as an exchange-traded investment vehicle that holds only bitcoin. The SEC based its determination on bitcoin trading only on unregulated markets and, thus, Bats BZX Exchange being unable to engage in the surveillance over those markets necessary to “prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.” The availability of futures products has, in the past, been a basis for SEC approval of exchange-traded securities and, given time, listed bitcoin futures and options products could serve a similar function.
- More evidence that the CFTC does not view bitcoin as a security. The CFTC has consistently taken the position that bitcoin is a commodity and also, implicitly, that it is not a security. The bitcoin product self-certifications are further evidence of this view: the self-certifications were done under Part 38 of the CFTC’s regulations rather than those in its Part 41 regulations, which govern the listing of single stock futures. If the CFTC were treating bitcoin as a security, the bitcoin derivatives products likely would have been viewed as single stock futures and the exchanges would have followed the Part 41 regulations to list these products. The SEC has neither stated that bitcoin is a security or taken actions that would indicate that it believes bitcoin is a security.
In describing its discussions w4ith the exchanges leading to the self-certification of these products, the CFTC emphasized its role in continuing oversight, risk monitoring, and surveillance of the markets. We believe that the approach taken here by the CFTC—that is, to permit trading of these product despite the new and novel asset class and focusing on ongoing surveillance and risk monitoring—is encouraging for the development of virtual currency markets more generally.