CFTC proposal would create path to investment for funds
Proposed bitcoin futures contracts could give pension funds and other asset owners a way to get a piece of the booming action in cryptocurrencies.
CME Group Inc. on Oct. 31 announced it would launch a bitcoin futures contract in the fourth quarter, following an Aug. 2 announcement by Cboe Exchange Inc. that it planned to create a similar contract. Both proposals require approval of the Commodity Futures Trading Commission.
Bitcoin futures, sources said, could become the underlying element of exchange-traded products, which would give institutional investors a way to tap into the enormous growth in the largest cryptocurrency in terms of market capitalization without having to acquire or trade it directly. It also mitigates concern among investors as to how regulators view bitcoin and cryptocurrency — as a commodity, in the case of a futures contract; a security, in the case of a bitcoin ETP; or a currency, a form of cash used for payment.
The bitcoin market is undeniably booming. According to CoinMarketCap.com, a cryptocurrency measurement website, bitcoin market capitalization was $119 billion as of Nov. 7, up from $15.6 billion on Jan. 1. There are more than 1,200 cryptocurrencies, according to CoinMarketCap data, but according to a CME statement on its bitcoin futures contract plan, bitcoin has 54% of the total cryptocurrency market cap. Also, bitcoin value has grown a whopping 667% year-to-date through Nov. 6, according to the New York Stock Exchange bitcoin index.
Those numbers are piquing institutional investor interest — but cautiously, said Bobby Cho, head of over-the-counter trading at Cumberland Mining and Materials LLC, the cryptocurrency unit of trading firm DRW Holdings LLC, Chicago.
"Some of the long-term managers are being very cautious about bitcoin because, one, it's gone up (more than) 500% in less than a year; and two, from the regulatory side, bitcoin may be a concern until you know what regulators are going to do," Mr. Cho said. "There are people waiting for bitcoin (exchange-traded funds) because they'll be more comfortable using that as an investment over direct holdings."
Added John Deters, chief strategy officer and head of corporate initiatives, Cboe Exchange, Chicago: "We see a similar landscape to what a lot of institutions have seen. For spot trading of bitcoin, most venues are startups with a wide spectrum of oversight, but mostly on the non-regulated side. Our view is that cryptocurrency is here to stay, and we want to add to what's out there. ... Bitcoin futures trade and sell in ways institutional investors are familiar with. We believe that fundamentally, an element that's tradeable is better from a market point of view."
CME, in a statement supplied by a company spokeswoman, said: "A futures contract on a regulated exchange is attractive to digital asset traders and hedgers because it offers the ability to hedge and/or short their spot bitcoin positions. Central clearing also addresses much of the counterparty risk issues that exist today in the spot marketplace."
CME would not comment on regulatory issues related to bitcoin.
Interest among assets owners in bitcoin isn't new, Mr. Cho said, but determining how to invest in it has only recently become clearer with the Cboe and CME announcements. He said Cumberland has had talks with institutional investors "on a daily basis, from the time we started in bitcoin in 2014 to today. Back then, pension funds didn't know what bitcoin was. But the conversation has changed. Today, they're trying to figure out how to put capital into the space. There's been a lot of excitement" about the potential for bitcoin futures contracts.
While the contract proposals require CFTC approval as derivatives products, they also check the box of a Securities and Exchange Commission requirement that a liquid derivatives market be created for the agency ultimately to approve a bitcoin ETF. "Many view a potential approval by the CFTC on a bitcoin derivatives market as a first step toward an approval of a bitcoin ETF by the SEC," Mr. Cho said.
Still, said Norm Champ, New York-based partner at the law firm of Kirkland & Ellis LLP and former director of the SEC's division of investment management, the different ways bitcoin is treated by the CFTC and SEC make the regulatory uncertainty a concern for potential institutional investors. "The biggest reason is, which regulator's rules apply to each product," Mr. Champ said. "If you've got the SEC saying that they're securities, there are certain rules the issuer has to comply with. If they're not securities, they don't have to. Now the CME comes along with the bitcoin futures contract, and now it's in the CFTC's jurisdiction. This would be in line with making it a commodity. But it's far from settled. Each regulator has different regimes. If it's a currency, certain licenses are required to do money transfers and money-laundering regulations apply. Now it's a heck of a conundrum. Who do I register with?"
But despite that uncertainty, Mr. Champ said, the attraction of investing in bitcoin is hard for potential investors and issuers to ignore. "Regulators are lagging behind some on bitcoin," Mr. Champ said. "I know that's not the first time that's happened, but everyone is interested — issuers and investors."
Mr. Champ said the debate highlights the ongoing competition between the financial regulatory agencies.
"If you think about it, in a different world, if something like this would come up, we'd get on a phone and compare what we should do. But with two different commissions, this bitcoin issue does reflect the division between the two. (In Mr. Champ's book, "Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis," he supports a merger of the two agencies.) If there were just one regulator, this wouldn't be an issue. They'd come up with a consistent solution. But I don't think either of them is trying to steal jurisdiction from the other."
Cumberland's Mr. Cho said the issue of what bitcoin is also affects custodians, because what they do for investor clients is affected by the fact that, with bitcoin, traders don't know the actors involved in the trade.
"Bitcoin's characteristics touch every three- or four-letter (regulatory) agency," Mr. Cho said. "It has elements of everything, but ultimately, it's code. There are no qualified custodians in bitcoin, either. I think (custodians) are looking at this space, but how do you insure something that, if you send it off, you can't get it back? The monetary system is based on trust and agreement. Bitcoin is a trustless system that is insured by cryptography. The code can't be altered. It's verified by miners and nodes on the network. You don't need to know the actors. As a custodian, you have to know the actors."
One pension fund, the C$85.2 billion ($66.5 billion) Ontario Municipal Employees' Retirement System, Toronto, invests in bitcoin indirectly through its C$800 million in-house venture capital investment unit, OMERS Ventures. Jim Orlando, OMERS Ventures managing director, said exchange-traded products also could be an attractive way for other pension funds to get exposure to bitcoin. "How else could pension funds go into cryptocurrencies?" Mr. Orlando said. "First and foremost, (bitcoin is) very volatile. I don't see pension funds going directly into bitcoin. But my guess is that every pension fund is investigating how to invest in bitcoin."
OMERS Ventures in the past two years has invested in two bitcoin-related companies: Digital Currency Group, a venture capital group that invests in bitcoin-related industries; and Citizen Hex, a hedge fund that directly trades in bitcoin. Mr. Orlando wouldn't say how much OMERS Ventures has invested in the firms, but "we've been very pleased with their performance and continue to look at bitcoin investments."
"We at OMERS are unique in that we are a direct-investing venture firm, which allows us to invest in higher-risk items like bitcoin," Mr. Orlando said.
Cboe's Mr. Deters said institutional investors should "get smart on where bitcoin fits in their financial infrastructure. Once they form that view, it's just a matter of time before bitcoin investment takes off. It's understandable that there's a novelty to it, which underlines the need to understand and get comfortable with it. We have some familiarity with intangible items; bitcoin is an example of that. While you can't touch a bitcoin, I think the world will ultimately develop a comfort level with it."