By John Palmer
As Cboe Digital prepares to launch our U.S. regulated, margined futures contracts on Bitcoin and Ether, I’d like to take a few minutes to reflect on the impact it will have on crypto markets. U.S. regulated crypto derivatives have a number of important structural impacts, ranging from offering many U.S. investors an acceptable market to participate in, and improving price transparency to simply provide new trading opportunities in the form of competition and expanded liquidity that is not currently available.
Trading Mandates
Many asset and fund managers may be prohibited from investing in physical commodities per their fund mandate, or under the Investment Company Act of 1940 (The 40 Act). Some mandates may further limit trading only to liquid products listed and cleared by regulated exchanges and clearinghouses. Such mandate-constrained funds are unable to participate in the crypto spot markets today. However, access to Exchange-Traded Funds (ETFs) and futures products create onramps to the crypto markets for some of these funds. Whether these managers access crypto futures markets directly or gain exposure via a fund that in turn holds future contracts on spot crypto assets; the availability of derivatives opens access to many institutions and investors alike, looking for a regulated structure for exposure to crypto assets that are familiar with.
Futures also offer an effective hedging tool to the spot market as margin and settlement guarantees enable a more symmetrical and capital efficient offset to the ETFs for Authorized Participants (APs), and market makers, as well as trading firms generally. If a physical settlement becomes necessary, market participants can leverage physically-settled futures, request an exchange for physical (EFP) with a specialized dealing desk to convert their futures to physical commodities, or trade directly on a spot market. In the case where both spot and futures trade on a single market, the investor may gain additional cost and operational efficiencies. Cboe Digital’s recent approval to clear digital asset futures via margin unlocks these efficiencies, offering U.S. investors a single well-regulated solution to trade and clear spot and futures contracts on digital assets. No longer would you need to connect to a spot exchange, and futures exchange, and a separate clearinghouse – all operated by different entities with different strategic visions. Instead, Cboe Digital brings all 3 of these aspects to our customers via a unified technology solution and strategy.
Capital Efficiencies
Market makers and trading firms benefit from all of the associated capital efficiencies of trading futures, due to their margin-eligible, cleared nature. These efficiencies include leverage, prime brokerage (credit), netting, and settlement guarantee. In other words, they will not incur the same costs and burdens that exist in the spot market where margin is prohibited, trades are generally required to be fully pre-funded and counterparties face settlement risk.
U.S. regulated crypto futures also benefit from the transparency and oversight of regulated exchanges, including fair access, standard published fees and market surveillance to prevent fraud and manipulation. Quote competition on a price/time priority high-performance matching engine drives tighter spreads and all-to-all trading allows market depth to accumulate in fewer aggregation points.
Additionally, market participants can access liquidity and transparent prices with less effort and cost. This access drives efficiency compared with spot over the counter (OTC) bespoke and exclusive liquidity streams that lack transparency, are priced per counterparty, and face settlement risk.
Anecdotally, markups in the OTC market may be as much as 4-8%, or 400-800 basis points (bps), whereas transparent central limit order book fees and spreads can be in the range of 0.40% (0-40 bps) – up to 800 times less.
The Basis Trade
Despite improving liquidity and price discovery, the price of spot and futures will diverge from time-to-time, creating an arbitrage opportunity. So, in addition to hedging, market participants will also have the opportunity to trade the basis, driving further liquidity to the futures markets.
Additionally, while basis trading can be performed using cash-settled futures products, a physically-settled contract offers increased efficiencies by settling with the physical commodity, in this case a digital asset like Bitcoin, instead of settling to an index price that may be difficult to replicate and may change rapidly after settlement.
At Cboe Digital, we believe bringing a physically-settled futures contract on Bitcoin and Ether where our unified technology platform across spot and futures will allow us to drive settlement and therefore the transfer of the underlying asset during the settlement process, to hours and potentially minutes, then seconds. This will unlock additional opportunities for participants to trade the basis between spot and futures more confidently, further opening the door to new participants and strategies.
Market Evolution
We believe that U.S. regulated derivatives products are the next step toward building a trusted digital asset industry. We are confident that derivatives products will bring new and excited investors to the ecosystem, improve capital efficiencies, and price transparency and provide new trading opportunities.
Disclaimers:
There are important risks associated with transacting in any of the Cboe Company products or any digital assets discussed here. Before engaging in any transactions in those products or digital assets, it is important for market participants to carefully review the disclosures and disclaimers contained at: Disclosures and Disclaimers Related to Cboe Options and Futures Products and to Digital Assets
These products and digital assets are complex and are suitable only for sophisticated market participants. These products involve the risk of loss, which can be substantial and, depending on the type of product, can exceed the amount of money deposited in establishing the position. Market participants should put at risk only funds that they can afford to lose without affecting their lifestyle.
Cboe Clear Digital, LLC is licensed to engage in virtual currency business activity by the New York State Department of Financial Services.
The information contained herein does not constitute a prospectus, nor is it a recommendation to buy, sell or retain any specific financial instrument or security. The information is provided to you for informational purposes only and is intended as a broad overview of certain aspects of Cboe Clear Digital and the market and should not be considered investment, legal, or tax advice.
The information provided should not be relied upon as a substitute for extensive independent market research before making your actual trading decisions. Opinions, market data, recommendations or any other content is subject to change at any time without notice. Cboe Clear Digital will not accept liability for any loss or damage, including without limitation any loss of profit, which may arise directly or indirectly from use of or reliance on such information. We do not recommend the use of technical analysis as a sole means of trading decisions. Users of this information should seek advice regarding the appropriateness of investing in any financial instruments or investment strategies referred to in this document and should understand that statements regarding future prospects may not be realized.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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