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P&L Talk Series with John Deters

P&L Talk Series with John Deters

Profit & Loss talks to John Deters, chief strategy officer and head of multi-asset solutions at CBOE, about the potential for cryptocurrencies such as bitcoin to trade on regulated exchange platforms.

Profit & Loss: You recently announced a deal with Gemini to use its bitcoin market data to develop your own bitcoin derivatives and indices. What was the thinking behind this deal?

John Deters: We’ve been observing the evolution of the cryptocurrency space, and of bitcoin specifically, for some time. In parallel with that, we’ve been thinking about what sort of structures might work well for these products.

While the focus of others on bitcoin has been a pendulum swing, with interest moving from the asset itself to blockchain technology and then back again, we’ve always had a fairly consistent view that these are different topics and different things. Given our business is providing things to trade and giving people ways to play with those exposures, bitcoin remained a vitally interesting element for us.

It’s only been recently – in the last year or year-and-a-half – that we’ve seen the bitcoin market evolve to a size in terms of its market capitalisation, in terms of turnover and volumes, and in terms of how trading of it reacts to other asset classes and to economic news cycles, and this has helped to form a more compelling business case for us. Our thesis is that ultimately, cryptocurrencies will be viewed as an asset class in and of itself, and it will be a widely accessible asset class with characteristics that reflect a hybrid between commodities, and act as a store of wealth and currencies. There’s evidence of that occurring already, and that has helped accelerate our plans.

That was the deliberate part of the equation behind the announcement. The more serendipitous part of the equation was that our combination with Bats led to us getting to know the Gemini group and the Winklevoss brothers because of the relationship that already existed there as we helped them build COIN (their bitcoin ETF). As we learned more about the ETF effort and all the infrastructure that Gemini had put in place to support it, we realised the potential for derivatives products, especially because it has a tradeable settlement process.

That’s when we started to seriously explore putting the pieces together and striking up a partnership like this.

P&L: But does a cryptocurrency like bitcoin really have a future in mainstream financial markets? For example, some firms are hesitant about using bitcoin because it uses a permission-less blockchain ledger that they worry could potentially leave them exposed to anti-money laundering (AML) and know your customer (KYC) regulations.

JD: That can be a problem if the trading environment is not set up properly. But one of the things that made us so excited about partnering with Gemini, beyond the actual construct of the bitcoin option that our contracts will settle to, is their whole philosophy and approach towards establishing their exchange.

They have embraced transparency and regulatory oversight. So they are the only cryptocurrency exchange that is fully licensed as a New York State Trust company, and all of the participants on their exchange go through a full AML and KYC process. 

I think that there is some caution from interested market participants because they’re otherwise uncertain about regulatory oversight. This is why we believe that having derivatives for bitcoin available on a well-regulated, onshore, exchange listed and cleared type market place like the CBOE Futures Exchange makes so much sense. It will enable people to trade with confidence – they know the exchange and the regulatory environment that exists here.

With their reservations in mind, we’re proposing cash-settled futures products, so firms will be able to trade it without engaging with the bitcoin blockchain. But at the same time, because of this direct link to the Gemini bitcoin auction – the settlement value corresponds precisely to the decimal point to a specific transaction in cryptocurrency – if a market participant does want to hold the physical product, they can become a member of Gemini and participate in that auction. What we’re doing is providing a jumping off point into this fascinating marketplace, and we think that’s really going to resonate with customers. 

P&L: So who do you envisage being the initial users of the futures you’re planning to launch?

JD: The structure of the product that we’re contemplating speaks to different segments of the market. We see a variety of institutions being interested, from asset managers who want to start experimenting with cryptocurrencies in their portfolios because they’re largely uncorrelated to other asset classes, to sell side and more classic buy side firms, such as hedge funds. 

In addition, we see the potential for high net-worth individuals, or other individuals, taking directional views and positions on bitcoin, to trade the futures. Then you have the natural derivatives user base, which will be firms or people that are already trading the underlying cryptocurrency asset class and want to hedge their exposures.

Once you put all those pieces together, I think that you have the makings for a very healthy, diverse market place, with natural buyers and sellers.

P&L: Do you have plans to list derivatives of other cryptocurrencies than bitcoin?

JD: Our partnership with Gemini covers all cryptocurrencies that they may list. Today they list bitcoin and ethereum, which is an interesting one, and certainly we have our eye on it. Ethereum has grown very rapidly and not only in terms of capitalisation: it has a very robust turnover, it trades very rapidly, and so it could serve as an interesting future product for us.

P&L: Is bitcoin trading centrally on a regulated exchange not somewhat the antithetical to the concept of bitcoin? Wasn’t the whole point that it’s a decentralised currency where the trading rules are determined by the underlying bitcoin protocol? 

JD: I would argue that it isn’t. If you think that the idea of a cryptocurrency is to avoid transparency, then maybe you could make that argument, but we don’t believe that is the main thrust of cryptocurrencies. What’s more compelling to us, when thinking about cryptocurrencies, is that it is an asset the value of which is not determined by state actors.

Nothing about our proposal changes that: we just make sure that market participants behave according to well-established rules that are fair and then we let people make their pricing determinations in a completely independent manner.

P&L: Bitcoin has had its fair share of negative headlines, with the Silk Road scandal, Mt. Gox collapsing and the Bitfinex hack. Due you think this is likely to scare market participants away or is it a sign of bitcoin’s robustness that it is trading higher than ever this year despite these incidents?

JD: I think it’s the latter. One of the really interesting things that we’ve been observing as this cryptocurrency develops over time is how the market responds to these events, that are really just growing pains for this asset. What we’ve seen is that there’s still engagement from market participants, bitcoin comes back even stronger, fixes are put in place and people learn to operate their systems in better ways.

I’d say the same thing for the recent fork event. We’ve actually been looking for a meaningful fork type event to occur, because we wanted to see the distributed decision making community come to a rational conclusion and then move on. While maybe not everyone in the community had the same viewpoint, it isn’t necessary that they do. The market got past it, some enhancements were made and this shows the true process of maturity and evolution that has taken place.