On Monday, June 24, the CFTC licensed LedgerX as a futures market and it joined the ranks of the CFTC triply crowned: swap execution facility (SEF), derivatives clearing organization (DCO) and now designated contract market (DCM). CME and ICE also have SEFs tucked into their conglomerates. The futures market designation lets LedgerX deal with a broader swath of cryptocurrency traders than SEF trading allows because access to SEFs is limited under federal law to eligible contract participants (ECPs), which are natural or legal persons who have at least $10 million in investable assets (lower amounts if they are hedging). ECPs are the much-sought but until now elusive bitcoin trader called an “institution” or “institutional investor.”
LedgerX focuses exclusively on bitcoin trading and clearing. The SEF has offered day-ahead forward contracts and longer-dated options cleared by its own clearinghouse since November 2017. So far, trading volumes have been modest in the contracts listed on the SEF.
LedgerX Co-Founder Juthica Chou told CoinDesk, an online news service focusing on cryptocurrencies, that the launch of its deliverable futures contracts will wait until LedgerX’s new Omni trading system has been fully rolled out. Currently, SEF trading is a combination of a central limit order book platform called LedgerX PIT, a separate bilateral negotiation system, and block trading. The Omni platform will usher in some different business approaches. For one, it will connect “customers” directly. Secondly, transactions on it will be free for everyone except market-makers who, according to another co-founder, Paul Chou, are better able to calculate and incorporate fees into their bids and offers. There is a $10,000 or one bitcoin deposit required from customers to apply for Omni.
LedgerX’s use of the term ”customers” bears careful watching. Customers will only be able to trade on the futures market and not on the SEF. And customers will have to clear their own trades in the LedgerX clearinghouse. The company has not indicated what if any changes it is making to its clearing house procedures to accommodate these new customers. Customers, it seems, can use a broker for execution but not for clearing. Other than the $10,000 application deposit, financial standards for customers (who are also effectively clearing members) are specified on the website or CFTC documents.
LedgerX futures contracts must be fully collateralized according to the rules that come into effect on July 9. FCM clearing in this case does not permit credit enhancement, although it would seem to be more convenient for customers not to have to deal with clearing.
Customers are the great commercial innovation introduced by LedgerX’s futures market designation, although the quirks of bitcoin, regulation, and custody law, among other things, keep LedgerX from making customer access to trading easier.
Even without a futures license, LedgerX might have offered longer-term deliverable bitcoin forwards for trading by ECPs alongside their next-day forwards and option contracts. It seems that there must not have been enough demand for deliverable forwards from institutional investors for LedgerX to list them. At the same time, a number of other U.S. platforms, SEFs and exchanges claim that institutional business is just waiting for them to get registered or licensed or up-and-running before institutional trading business deluges them.
LedgerX is taking a critical step by opening up trading to non-ECPs, to regular customers. The futures and options markets in the U.S. have been so successful by mixing regular customers and professional traders and having them trade on an equal footing.
One part of the experiment worth watching is how the separation of trading and clearing evolves. Will brokers seek trading business that is not associated with clearing business? How will they compete? Will customers find it worthwhile to deal with brokers at all when they clear for themselves? If they can clear bitcoin derivatives for themselves on LedgerX will they demand to clear other products for themselves on other exchanges?
Another question is what will be the impact of physical delivery of bitcoin on trading volume. The CME’s bitcoin futures are cash settled. Cash settlement is the solution to the problem of messy physical delivery processes because it simply avoids them. In the case of bitcoin futures, traders in the CME contract do not need to deposit bitcoin, give up their private keys, worry about custody, etc. Successful futures contracts generally are characterized by few deliveries relative to trading volume. Most futures traders and customers never go through the delivery process on the contracts they trade, so a final settlement in cash is fine with them. The LedgerX contracts will be more attractive to customers who are involved in bitcoin already and interested in using a regulated exchange to merchandise their holdings.
As an industry first mover, LedgerX is addressing regulatory and financial problems peculiar to bitcoin that no one else has solved. How will the non-institutional traders react to the opportunity that LedgerX offers them? Is there enough demand for safe, transparent, well-regulated derivatives trading of physical bitcoin that non-institutional customers will overcome the remaining hurdles to create deep and liquid futures, swaps and options trading?