CME Group’s announcement that they will begin trading Bitcoin futures catapulted the Bitcoin market to new highs two weeks ago. Many Bitcoin investors are waiting with bated breath for trading to commence and are expecting further price growth. Indeed, when the world’s largest futures market recognizes Bitcoin as a legitimate asset and decides to integrate it into their offerings, it would seem to be a very good thing.
What does it actually accomplish?
But why? Other than CME Group’s imprimatur, which is undoubtedly valuable in itself, what specific good is going to come from this new marketplace? After all, creation of a large and regulated futures market will make it far easier for deep-pocketed traders to short Bitcoin, potentially causing the price to tumble.
Cointelegraph had the opportunity to speak with David Johnson, CEO of Latium and experienced foreign exchange (FX) trader, to get his take on what CME Group’s announcement means. Johnson believes the biggest boost to Bitcoin will come not from the trading of futures per se, but from what that trading enables: retail adoption.
A lesson from the airlines
The airline industry is one of the biggest buyers of oil futures in the world. The reason is obvious; they need to “lock in” the price of jet fuel so they can charge passengers an appropriate fare. If airlines were subject to the daily whims of the oil market, they would find it nearly impossible to operate effectively.
The process of locking in prices on a commodity or asset is referred to as “hedging.” The airlines don’t want to buy massive amounts of jet fuel and have to store it for long periods of time; all they want is a stable price. Therefore, they go to the futures market and buy or sell specific types of options which effectively guarantee the price they will pay for fuel for a period of time.
Right now, most companies that accept Bitcoin as a form of payment use third-party payment processors to receive the Bitcoin and immediately convert it to cash, and deposit the funds in the company’s bank account.
This works, up to a point. Unfortunately, these companies don’t have a long track record and are quite small. Huge retailers, like Walmart or Amazon, probably would be wary of doing business with them.
CME Group’s futures market changes all of this. According to Johnson, major companies with careful risk management strategies have been slow to get involved in Bitcoin because of the risk. There is a risk to storing Bitcoin.
There is counterparty risk in dealing with a small payment processor without a long and trusted reputation. There is risk of inadequate liquidity to exchange Bitcoin for cash. There’s regulatory risk, as your counterparties might not be in full compliance.
If you want Amazon or some other mega-company to start accepting Bitcoin, the first step is to create a way to mitigate these risks. Johnson says this is the single most important thing the new futures marketplace will bring.
Large retailers will be able to accept Bitcoin, have it immediately converted to cash or hedged, and do so on a massive, trusted, regulated exchange.
Johnson believes the full effects of the new marketplace won’t be seen for six to eight months, as liquidity builds and large retailers become aware of it. More places to spend Bitcoin, of course, will make it more useful to ordinary consumers and will presumably increase its price, in time. Many in the community have long believed that retail adoption is one of the keys to boosting Bitcoin’s price; without a place to spend cryptocurrency, it’s nothing more than a speculative instrument.
CME Group will also provide an on-ramp for traditional institutional investors. Some of them have hundreds of billions of dollars at their disposal, but they generally have strict rules about what they can invest in. At present, such institutions have shied away from Bitcoin due to the difficulty of storing the currency or dealing with small, unregulated Bitcoin exchanges without a long history of doing business.
While an institutional investor might not be able to buy Bitcoins directly, there will likely be far fewer restrictions on buying futures contracts. Institutions can, therefore, bet on Bitcoin price without actually owning the asset.
That brings us to a rather interesting point: this is a futures market. No actual Bitcoin will change hands on CME’s marketplace. In effect, market participants will be trading “paper” Bitcoins. Commodities experts like Ted Butler have long railed against the “paper silver” and “paper gold” that trade on regulated exchanges and have accused these markets of distorting the price for actual physical metals.
It remains to be seen what effect this market will have on Bitcoin.
Almost as important as retail adoption, CME’s exchange will almost certainly bring about the SEC’s approval of a Bitcoin exchange traded fund (ETF) at some point in the future. The regulator had already said earlier this year when rejecting the Winklevoss twins’ proposal, that approval would be likely if regulated futures markets were established:
”When the spot market is unregulated–there must be significant, regulated derivatives markets related to the underlying asset with which the exchange can enter into a surveillance-sharing agreement.”
An ETF would be big news because it would provide another way for institutional – and retail – investors to gain exposure to Bitcoin.
In the case of an ETF, the fund must actually hold the underlying asset, meaning that if the ETF has traded shares equivalent to 100,000 BTC, they must actually own 100,000 BTC. This much buying pressure could only spell good news for Bitcoin price.
Many in the Bitcoin community have long wanted to invest part of their 401(k) or IRA in Bitcoin, but have found it difficult or impossible to do. Those that succeed invariably pay high fees (to create a self-directed IRA) or sizeable premiums (to buy shares of GBTC).
A Bitcoin ETF would be a low-fee and simple way of adding Bitcoin to your traditional retirement portfolio. It would be as easy as calling up your broker and asking them to place the order…or doing it yourself online.
Johnson noted that regulation is inevitable and instead of fighting it, Bitcoin owners should embrace smart regulations. In fact, he suggests that Bitcoin businesses and investors come up with their own body of rules that regulators could easily adopt.
That would be a much better option, Johnson notes, than having regulators unknowledgeable about Bitcoin try and create regulations which might well be impossible to follow.
For Bitcoin to continue its growth, integration into existing infrastructure is essential, Johnson said. Wall Street’s growing acceptance of the currency and regulators’ increased understanding will go a long way toward bringing Bitcoin out of the shadows and boosting its price.
Mainstream media attention, Wall Street acceptance, possible retail adoption and ETFs all spell a bright future for digital currency. As cryptocurrency becomes more mainstream and further integrated into financial markets and daily life, one wonders if Tim Draper might be correct:
“In five years, if you try to use fiat currency, they will laugh at you. Bitcoin and other cryptocurrencies will be so relevant … there will be no reason to have the fiat currencies.”