Always an innovative force in the financial services industry, CME Group recently announced it would launch a bitcoin futures contract in early December. As a single bitcoin approaches a valuation equivalent to $10,000, producing a stratospheric return (approximately +900% in 2017), the launch of a new yet widely understood and accepted product could lend legitimacy to the alternative asset and pave the way for user-base expansion.
Legitimacy often is in the eye of the beholder. Frequently, its presence impacts important decisions, especially when it comes to investing money.
Bitcoin, as well as other crypto-currencies, are rising as a new asset class in the financial world. Though a darling of the financial media and blogs, crypto-currencies are vague and ambiguous, largely misunderstood by an underinformed investment community. This is particularly true among institutional investors, whose very nature requires that they rely heavily on the legitimacy of the instruments, securities, and products they use to fulfill their investment needs. On the other hand, for retail investors – or, more aptly, individual investors – the absence of any fiduciary obligation, investment charter, or other binding point where a violation could be chalked up as “intellectual investment negligence” rarely factors into decisions to pursue speculative returns that new products often present. In other words, they are free to put their money where they see fit.
A recent decision by the CME Group (NASDAQ: CME) to launch a bitcoin futures contract may provide a bridge, bringing institutional and retail investors together to invest and speculate in this burgeoning asset class.
A few key facts about the newly announced and soon-to-be launched bitcoin futures contract: First, it’s a cash-settled contract. Second, it’s based on the CME CF Bitcoin Reference Rate (BRR), which is derived from prices aggregated from multiple bitcoin trading exchanges. Third, in terms of legitimacy, the contract will be listed and subject to the rules of the CME.
CME Group and Crypto Facilities Ltd. have been publishing the BRR since November 2016. The index is based on aggregated trade flow from major bitcoin exchanges – Bitstamp, GDAX, itBit, and Kraken – as of 4pm London time and follows the IOSCO Principles for Financial Benchmarks. Both the CME and Crypto Facilities believe the BRR has demonstrated proven reliability and transparency when it comes to articulating bitcoin-US dollar valuation based on global trading flows. Alongside the BRR, both firms also publish the CME CF Bitcoin Real Time Index (BTRI), which provides price transparency into the spot bitcoin market by aggregating indications of trading interest into a consolidated order book model.
While there are mixed reviews on the legitimacy of bitcoin’s current valuation, and of crypto-currencies in general, there can be no denying that as an emerging asset class, investors need to be educated and informed. The emergence of a futures contract that allows market participants to take a two-way risk position – and do it with the infrastructure and support of the world’s largest derivatives exchange – is adding to the legitimacy of the asset class.
To date, TABB Group research has determined that a large amount of the interest in crypto-currencies has emanated from individual investors. To be sure, individual trading accounts at some of the more prominent exchanges that trade bitcoin have been growing at double- and triple-digit rates for more than a year. One exchange reported having acquired more than 100,000 new accounts just in the past week. Millions of individual investors are trading an asset class now valued at approximately $300 billion. Our research also confirms that a fair amount of the interest in the new futures contract is being driven by non-traditional CME customers, potentially opening a new class of liquidity provider for the exchange. Liquidity begets liquidity, especially in the exchange, consolidated limit order book model. As the liquidity base grows, the organic growth may lure institutional investors to utilize the contract, given both its liquidity and legitimacy.
Skeptics abound. JP Morgan’s Jamie Dimon recently called bitcoin a “fraud”; but there is no doubt that his institution is heavily exploring and investing in the technological infrastructure that surrounds crypto-currencies. While large banks may question the speculative nature of the valuation bubble being created by this new, unregulated asset class, the legitimacy of the efficiencies brought about by the infrastructure that surround it is undeniable. The only question is:How much risk do universal currencies present to banks and the core businesses they run?That question is attracting a ton of research and development funding.
I won’t speculate on whether any investor, large or small, who jumps into the crypto-currency world now is making a wise decision. There are twenty-somethings cashing in on big paydays speculating on bitcoin’s continued rise. My BMW dealer recently showed me a picture of his colleague’s $288,000 Ferrari 488, purchased with bitcoin profits after taking some of his $110,000 salary and staking a claim. Then there are the multitudes who lost money in the downward volatility swings that also accompany the asset class. Significant risk/reward assets tend to have that effect. As I stated in aprevious editorial, the market needs to distinguish the valuation equation from the value proposition; the investment from the efficiencies potentially delivered by a universal currency. Only then can true legitimacy be defined and utilized properly.
For now, we await the first step in what is sure to be a drama that will play out over the course of the next several years. The CME launch of a futures contract based on bitcoin is an initial step in the legitimization of this burgeoning asset class. Initial adoption rates may signal the long-term viability of the asset. More important, if the development of a derivatives market begins to attract institutional investors, we may find an entirely new dynamic taking hold in the financial markets, where new product innovation and vision return to a financial ecosystem that is badly in need of something to spark the revival of investment returns.
