In December, the Chicago Mercantile Exchange (CME) chalked up a 3-year anniversary trading bitcoin futures. Since then, the exchange has also launched bitcoin options and is set for ether futures in February. We talk to Tim McCourt, CME Group’s global head of Equity Index and Alternative Investment Products, about how the nascent regulated crypto derivatives market is evolving.
While 2020 will be remembered for many things, one of them might be as the year that institutional investors started taking crypto seriously. And from the time that bitcoin futures launched in 2017, the CME team has been focused on making sure that these players can invest in and access the cryptocurrency markets, while also managing any crypto-related risks.
One of the metrics that McCourt highlighted is open interest: in December, average daily open interest was just under 12,000 contracts (5 bitcoins per contract). Year-to-date (YTD), that represents a 252% increase versus 2019. Moreover, the number of large open interest holders, defined as traders holding a position of at least 25 bitcoin futures contracts, is up nearly 136%.
In the beginning of December 2020, CME set a new record with 110 large open interest holders and average daily volumes grew during the month as well, up nearly 114% at 11,179 contracts, or 55,895 bitcoin equivalent, versus 2019.
In the crypto space, institutional investors are a diverse group, and include a number of new types of crypto-specific entrants, explained McCourt: “On top of the traditional folks, you now have all of these new product providers and funds that are crypto native. You typically will find people who are hedging their digital exposure as they may have accumulated a digital asset holding through transacting in the spot market, or they could also be bitcoin miners.”
It can be compared to a commercial grower using an agricultural future, he explained: “There’s a certain amount of inputs into extracting or mining bitcoin. You expect a certain amount of production over time and you would like to hedge the price…when you mine it in the case of bitcoin, or harvest it in the case of an agricultural product.”
There are also participants deploying systematic crypto-focused trading strategies, eyeing arbitrage opportunities between spot and futures markets, as well as between CME’s regulated venue and other unregulated venues that provide leveraged perpetual swaps. “The crypto ecosystem provides ample opportunity to arbitrage related products against each other, which again is very akin to other types of asset classes and trading strategies,” he added.
But what’s been really encouraging in 2020 is that traditional financial institutions are entering cryptocurrencies, including major hedge funds and asset managers: “[There is a] very balanced and blossoming ecosystem that is driving volumes and open interest growth. The more diversity of participants in your liquidity pool, the more efficient price discovery will be,” said McCourt.
In November, CME became the largest bitcoin futures exchange by open interest based in USD, surpassing OKEx, Binance and BitMEX. Part of that achievement has to do with being regulated by the Commodity Futures Trading Commission (CFTC): a distinct advantage in the competitive landscape because other venues have different rules regarding auto liquidation or the socialization of defaults, for examples.
CME has been working with the CFTC, its primary regulator, since November 2016, when the exchange launched the bitcoin reference rate, the underlying index for its futures products. And that regulatory path is now leading to the launch of ether futures trading, expected to start on February 8.
“We definitely have a good cadence with the regulator around cryptocurrency. We’ve been thoughtful and prudent, and are taking the same approach with ether. Customers appreciate transparency and validation, making sure we’re giving them ample time to prepare both in terms of enabling the contract for trading but also making sure they are all set up on their risk and clearing side,” said McCourt.
Ether versus bitcoin
One big reason for the demand for ether futures is that the token is the second-largest in terms of market cap and trading volumes. While it’s hard to say how the contract will unfold, the early focus will be on building the market and ensuring two-way price discovery is running efficiently. McCourt noted that there is an “adoption hurdle” to get over that requires an educational approach.
Despite both being blockchain protocols, bitcoin and ether have fundamental differences. For one, ether is moving to a proof-of-stake protocol, while bitcoin will remain proof-of-work. Proof-of-stake is an alternative process to verify transactions on a blockchain that aims to achieve distributed consensus versus the mathematical computations used by proof-of-work.
Another major difference is that bitcoin has a fixed supply: there will only ever be 21 million bitcoins available, whereas ether increases its supply at a predetermined schedule of 18 million tokens annually. Based on observations from the market, participants are often trading bitcoin and ether in parallel or as a spread trade, he added.
As for whether there are any other cryptocurrencies set for launch, he said that bitcoin and ether are more than enough to chew on at the moment, but did note that the focus will remain on crypto-fiat pairs for trading and reference rates.
Compared to 2017, McCourt said that 2020 is a “different kind of enthusiasm” that’s based on a mainstreaming of participants: “There’s certainly a welling up interest in demand in the market, and more tactile interest from institutional investors at this point in time is an enormous benefit to the entirety of the ecosystem around cryptocurrency.”