Crypto Derivatives: Why the Market is Praying for More Futures

Since 2017, bitcoin has had an absolute monopoly on the market of regulated crypto futures. But there’s a challenger on the horizon — ethereum.

In early May, CoinDesk – citing anonymous sources – reported that the U.S. Commodity Futures Trading Commission (CFTC) may soon approve contracts for ethereum futures.

Almost two years ago, the Commission gave the green light to similar derivatives of BTC. Since then, the crypto industry has been divided by controversy over whether the need for this type of product justifies its effects on the price of assets.

Moreover, there are only futures with cash-settlement on the market for now. This means that on the settlement date, the trader receives not BTC, but its equivalent price in fiat currency. Several companies, including the Intercontinental Exchange (ICE) and LedgerX, are attempting to implement bitcoin futures with physical delivery of an asset. But so far, the regulator has not approved their proposals. It is possible ethereum will help here.

Green Light for ETH futures?

According to Coinmarketcap, ethereum is the second highest valued coin on the crypto market by market capitalization, as of May 8 exceeding $18 billion. But with BTC in first place with a $104,5 billion cap, ethereum has a long way to go.

In addition, ether is the third largest crypto by daily trading volume. On May 8 it stood at $7.3 billion. Given its evident popularity among traders, ETH futures may well become a marketable product on the crypto market.

Yet there is one issue: although CoinDesk sources claim the CFTC is ready to approve ETH futures, the CFTC has not officially confirmed this information. In fact, the regulatory board has been considering this subject for almost a year and gathered input from market participants only in December 2018.

In total, the Commission received 35 input from market participants about ethereum and features of this cryptocurrency. How this input influences the CFTC’s stance on ethereum is not yet known.

Another problem in the implementation of ETH futures is the very nature of cryptocurrency. Two US regulators – the Securities and Exchange Commission (SEC) and the CFTC – are currently arguing over how to evaluate cryptocurrencies in the legal field.

Some experts believe that ethereum falls in the category of “securities”, which means it should be regulated by the SEC. Yet the representatives of the regulator themselves are not eager to take on this responsibility. In 2018, the director of corporate finance of SEC, William Hinman, stated that he did not regard ETH as security. However, this has not stopped the SEC from recognizing some ERC-20 tokens issued on ether as securities. The SEC has not voiced an official position on the matter.

Things with BTC, on the other hand, are much easier. The currency has long been recognized as a commodity asset, which falls under CFTC regulation. The commission also approved BTC futures at the end of 2017.

As for ethereum derivatives, the CFTC is ready to take them under its jurisdiction, but the approval of companies themselves will depend on the individual applications.

Where are prices headed?

Although there is no official statement on the approval of ETH futures, the price of the cryptocurrency has already responded to the hint of positive news. According to Coinmarketcap, ETH went up by 9% the day after the CoinDesk message, reaching $175.97 per token. Growth continued the following day and on May 7, the price reached $179.

A week later, the price skyrocketed to $262. Last time ETH reached this mark in early September 2018.

Not everything is so simple in the long run, and BTC has proven it. Back in May 2018, the Federal Reserve Bank of San Francisco released research on the impact of futures on the BTC price.
It found that until December 2017, when the first BTC futures appeared, traders simply did not have the opportunity to bet on a price fall. Of course, they could make a short selling; that is, liquidating an asset before buying it. But that’s not an effective tool to earn on a price decline. In contrast, those who were confident in the growth of value could easily buy bitcoins. In this situation, speculative demand for BTC was fueled only by optimists who were confident of sustained growth. Skeptics simply couldn’t stand up against them.

With futures, the doubtful received a powerful weapon. They could now bet on the fall of BTC, buying and selling contracts with a lower value in the future than the current spot prices.
According to research, the new tool created downward pressure on the price of BTC. In addition, futures contracts caused a drop in demand for bitcoin on the spot market, and, consequently, fueled its collapse.

A similar situation may well happen with ethereum, especially if the “crypto winter” will continue.

Cash or asset?

For the time being, there are only cash-settled BTC futures on the crypto market. The CFTC is ready to approve such contracts for ethereum, but the industry is getting ready for a new product – futures with the physical delivery of an asset. The only hurdle is the regulator.

For example, Intercontinental Exchange planned to launch a similar product called Bakkt in December 2018. But with the approach of the deadline, the start was postponed to the beginning of 2019. After 4 months, Bakkt still hasn’t appeared on the market because the CFTC has not approved the proposal of the company.

The problem is that the company plans to provide in-house custodial services. To this end, Bakkt acquired the Digital Asset Custody Company (DACC) in April. DACC is developing a crypto-storage facility for institutional investors.

As for settlements, Bakkt wants to carry them out through the clearinghouse of its parent company ICE. These two factors put the company in the “gray zone” of regulation because, as a rule, clearing and custodial services must be separated between unrelated firms.

According to Jeffrey Sprecher, CEO of ICE, the regulator is still trying to understand the best way to regulate BTC and the new product.

Another hurdle is the crypto winter itself. With the collapse on the market, investor interest in cryptocurrency also faded, and futures are no exception. Cboe Futures Exchange, which was one of the first to launch BTC contracts, has put their futures service on pause and stopped adding new contracts to the listing in mid-March.

However, this has not frightened away new players. Apart from the Bakkt, three companies — LedgerX, Seed CX and ErisX — have unveiled plans to develop BTC futures with physical delivery.

Futures for the future

The fact that ethereum futures may soon appear is great news for the crypto industry. And the short-term movement of the price has already shown the market approves it.

With ethereum futures, traders will receive a new tool and will be able to earn on the ETH price decline in the future. And the ability of futures to put pressure on the price is nothing out of the norm for financial markets.

But the introduction of futures without the physical delivery of an asset, whether it be ethereum or another cryptocurrency, is unlikely to cause a stir among investors. The market is waiting for contracts with physical delivery. Here, as always, BTC should lay the road for others. But before this can be done, it must get the green light from the regulator. It is possible that after the introduction of ETH contracts, the CFTC will be more supportive of new crypto derivatives.

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