Gu Yanxi: The near-term and long-term value of Bitcoin derivatives trading services

According to a recent report by Coindesk , LedgerX is applying to trade Bitcoin-based futures. LedgerX is the first exchange in the United States to receive CFTC-approved transactions and clearing licenses for encrypted digital currency derivatives. It was granted such a license by the CFTC in July 2017. Just a few weeks after it was given these licenses, CBOE immediately began trading for Bitcoin-based futures. A few weeks later, CME also began to apply for trading on bitcoin-based futures. LedgerX began trading Bitcoin-based options in December 2017. CBOE and CME also began trading Bitcoin-based futures products in December 2017.

The US bitcoin-based derivatives trading market has evolved to this day and is undergoing major changes. CBOE has stopped trading its bitcoin futures products in March 2019. However, other financial institutions are beginning to get involved in this field. ICE, one of the three largest exchange groups in the United States, is initiating the formation of a new exchange, Bakkt, ready to trade a bitcoin futures product on a date that is physically delivered. Bakkt has been well received by the US investment community and its A round of financing has been valued at more than $700 million.

So, is Bitcoin-based derivatives trading a very good business opportunity? Is it worth more institutions involved? I think that in the short term, this is a business opportunity due to speculative market demand. But because of the characteristics of Bitcoin itself, the prudence of regulation and the emergence of alternatives, this is not a long-term business opportunity.

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Nakamoto's original intention was to design Bitcoin as a kind of digital cash. He hopes to use a new monetary mechanism to solve the inherent flaws in the current monetary mechanism. However, he must have not expected that Bitcoin did not become a substitute for real money as he hoped, but developed into a popular speculative trading product. Moreover, this speculative transaction has even risen to the trading needs of derivatives in recent years. The success of BitMex has inspired many private institutions to participate in the provision of bitcoin-based derivatives trading. Since July 2017, Wall Street has also been involved in this area, seeking to make it a regulated and recognized trading product, thus enabling more funds to participate in Bitcoin derivatives trading.

Speculative demand is a major driving force behind the development of human society. In fact, more than 90% of the trading volume in the US securities market is generated by speculators. It is through these transactions by speculators that the market's fair pricing of various assets is achieved. The motive of speculators is profit-seeking. For speculators, any product that is profitable through speculative trading is very attractive to them, whether it is based on soybean futures, Google stocks or Bitcoin-based derivatives.

In the eyes of speculators, the greatest value of a trading product is not what is the bottom of the trading product, but whether it can be profitable through speculative trading. Products that offer such opportunities are good products for them, and they have a strong incentive to participate in the trading of such products. Bitcoin seems to be a very good product in the eyes of speculators. In addition, due to the global tradability of Bitcoin, it attracts many speculators. This of course also includes financial institutions on Wall Street.

The existence of speculative trading is that it can provide market fair pricing for various assets in economic life, whether they are soybeans or Google stocks. And this fair pricing directly affects the holders of these assets. The liquidity generated by speculators through transactions also facilitates the circulation of these assets. In short, speculators' transactions are beneficial to actual economic activity. But Bitcoin has not become a new type of currency so far, and its value is the result of consensus, without any underlying asset support. In other words, Bitcoin does not have a significant effect in the real economy. Now, there are private companies that are applying to trade their derivatives in order to meet the speculative trading needs in the market. When it comes to derivatives trading, its impact on the stability of financial markets will be greater, and regulation will be more cautious. After all, the 2008 financial crisis is not far behind.

The 2008 financial crisis, on the surface, was caused by subprime mortgages, but in essence it was caused by the low interest rate policy that Greenspan implemented at the beginning of 2000. When the market is flooded with large amounts of low-cost funds, these funds will surely flow to more risky investments. Real estate clearly offers such an opportunity. This was the case in the United States in 2008 and earlier in Japan. But in the US financial crisis, a tool to accelerate the development of this financial crisis is undoubtedly based on various derivatives of subprime mortgages. Due to the widespread use of these financial levers, when the market price of real estate began to fall, these leverages undoubtedly magnified the problems in the financial market many times, thus making the financial crisis more widespread. If there were no widespread use of derivatives in that financial crisis, the extent of the harm would be much smaller. But the derivatives at the time were based on real estate, a tangible asset, and Bitcoin was an intangible asset. There are now strong incentives in the financial markets to trade derivatives on top of them, which is a matter for regulators to be treated with caution.

Even without regulatory issues, freely developing according to market choices, transactions based on Bitcoin-based derivatives will not last too long. The first is because of the nature of Bitcoin itself. After all, its value is the result of market consensus. The consensus in the market fluctuates very much, so the price of Bitcoin fluctuates accordingly. Such large volatility is not first suitable for setting an option product on top of it. So LedgerX's first product is a one-year product, not a regular option product that has been listed for the last two months and quarterly.

Bakkt plans to list the trading of one-day futures products based on bitcoin spot delivery. On the one hand, because it is a real-time delivery of futures products, it will definitely ensure that the price of bitcoin spot products is more real, but it will also increase significantly. The volume of transactions, which means more income from the exchange. This should also be one reason why its valuation is so high at this early stage. Given that Bitcoin has been widely accepted in the trading market, there is still a high probability of a rebound despite the current low tide. The ensuing activity of the trading market will certainly bring a lot of revenue to institutions that offer Bitcoin derivatives trading.

But blockchain and encrypted digital assets have evolved to this day, and it is producing new products, new business models and new opportunities that are completely different from the past. One of the most important factors is the digitization of assets and the digitization of financing and transactions in the corresponding primary and secondary markets. The development of these trends is much larger than the development impact of Bitcoin itself, and the development of these trends is leading to the marginalization of Bitcoin.

In the US financial market, a new type of digital stock exchange has begun to be established. These exchanges are a traditional stock exchange that cooperates with the ST trading platform to apply together. These new digital stock exchanges have advantages over many traditional stock exchanges, so it is inevitable that they will attract trading traffic to these new stock exchanges (see my article, Nasdaq's Dusk). ). Since these new digital stock exchanges are supported by real assets and equity, these trading products have a more stable value base. So they will be more attractive to speculative traders.

Based on these factors, I believe that Bitcoin derivatives trading services will have value in the short term, but the duration will not be too long. The characteristics of Bitcoin itself, the attitude of regulation and the emergence of alternatives in the market will all affect its development.

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