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P&L Talk Series with Tim McCourt

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P&L Talk Series with Tim McCourt

Profit & Loss talks to Tim McCourt, managing director and global head of equity products at CME, about why the Chicago exchange is planning to launch bitcoin futures before the end of the year. 

Profit & Loss: So why has the CME decided to launch bitcoin futures?

Tim McCourt: We’re launching this futures contract off the back of customer demand. But a key thing for us is that this product isn’t necessarily something that’s new to the CME. We launched the Bitcoin Reference Rate a year ago, and so it makes very good sense – given the feedback and response that we’ve had from customers – that now is the right time to introduce a cash settled futures contract based on this index that tracks the bitcoin reference rate. 

P&L: But isn’t that customer demand linked to the price action of bitcoin? Will that demand still be there if there’s a massive price correction and the value of bitcoin drops dramatically? 

TM: When you look, for example, at other index products that CME offers, the risk management needs of customers are far more often a function of the need to hedge risk, to manage risk or gain access to the underlying asset.

In this case, the bitcoin future will be based on the bitcoin reference rate, but demand will not necessarily be driven by the discreet index level or the level of the underlying asset. As the index moves people have various needs to either change their position, risk manage, put more money to work, etc. 

I don’t think that the level of bitcoin is the motivating factor. When you actually look at the increase in usage of bitcoin over the past few months or the last year, it continues to be more widely used in commerce and is catching the attention of institutional players in the finance community. 

Our decision to list this product for our customers’ risk management needs has nothing to do with the actual value of bitcoin.  If the index goes up from here or down from here, we still expect people to have a need to trade it, which is why it makes sense to list a future at CME.

P&L: So the launch is obviously subject to regulatory approval. What are the steps that need to be taken on this front?

CME: We plan to submit for self-certification.But when you break it down, this futures contract is essentially a cash settled index contract. It will function in the same way that we list and settle futures against the S&P 500 or the Russell 2000 – there’s an underlying index and we settle US dollars against the underlying index observation price.

So although there are a lot of interesting conversations to be had about bitcoin as a unique underlying asset, the fact is that we’ve had the Bitcoin Reference Rate out there for a year now, we have a tried and tested historical data set for this index and so now we’re taking the next logical step of deploying a future on the index that is not functionally or materially different from other products. It’s just that the unique characteristics of bitcoin make this more interesting, but that’s really a statement on the underlying spot asset, not the financially settled futures contract on the index. 

P&L: So have you got market makers in place to support the contract already?

TM: We’re just finalising our CFTC filing and the contracts specifications is final, which is a precursor to filing a market making programme. But I can say that the customer response to our announcement has been overwhelming and we’re confident that we’ll have market makers there to support the product on day one when we launch in Q4. The demand for this product is palpable. 

P&L: Can you explain more about the Bitcoin Reference Rate?  

TM: Yes, I would say that the distinguishing feature of our contract is that it’s based on this established benchmark. The index itself is a statement on the aggregate underlying market, and what I mean by that is that the Bitcoin Reference Rate is established once per day and it is a statement on the relationship between the US dollar and bitcoin. It aggregates the trade data from four exchanges – Bitstamp, GDAX, itBit and Kraken – and then what it does is, in the hour leading up to the establishment of the reference rate for the day, it takes twelve five minute intervals and creates sample of them and then in each of the five minute segments it looks at the volume weighted average price of transactions. By establishing the reference rate over an hour, between three and four pm London time, and then taking the value weighted average of transactions that happen on these platforms, it really provides the aggregate function of the underlying spot market for bitcoin.

We think that this model provides and advantage over one platform controlling the fix or one spot fixing that is not the function of the average price over a period of time. One of the merits of using the Bitcoin Reference Rate is that it increases the comfort that it is a clear expression of the market and the value of bitcoin versus the US dollar, but it also gives a replicable market observation that people can hedge against, they can look to transact in a similar manner on all four platforms to re-create the reference rate with the ability to do so in a way that captures or gives them the ability to enter and exit at the same rate that our contract settles against. 

P&L: Does something like a hard fork potentially impact you as a provider of bitcoin futures? Clearly because it’s a derivative of the underlying asset there’s no direct impact, but are there any knock on implications? 

TM: We’ve spent a lot of time talking about hard forks, particularly with one looming on the horizon. While not directly germane to the futures, a hard fork could potentially impact the Bitcoin Reference Rate, so we’re developing a hard fork policy for this contract so that our customers understand what it will mean for them and to ensure that they can maintain their access and appropriately risk manage their portfolio to exposure if such an event occurs.

This is a very interesting topic in the bitcoin space and we think that, as an exchange operator, it is appropriate that we address the issue of hard forks in such a way that they don’t introduce any gaps in our customer’s ability to risk manage around these events, because that’s often when you need to manage your risk the most. 

P&L: What’s next for CME after launching bitcoin futures? Are you looking at launching options or futures in other cryptocurrencies?

TM: We’ve had a lot of customer questions about options. Our general philosophy is to develop products in response to customer demand, so we’ll look to our customers for more information about when the time is right to launch bitcoin options. We’ll be watching the bitcoin futures launch very carefully, because it really exemplifies our strategy of offering a product on the Bitcoin Reference Rate. So the telling signal for us will be whether or not there is a need for other robust reference rates in the other cryptocurrencies, Is this the preferred path for product introduction and will customers want us to deploy this in other cryptocurrencies? That’s the question we’ll be asking, but it’s too early to tell for sure.