So far, hedge funds are virtually the only institutional investors to put funds at risk in digital currency assets.
Pension funds and other traditional institutions have continued to avoid the asset class, even as they watch returns soar from the sidelines. The total value of cryptocurrencies has more than doubled in value this year, reaching a market cap of $118 billion as of Monday – including $54.9 billion in Bitcoin and $25.1 billion in its upstart rival Ethereum, according to cryptocurrency tracker CoinMarketCap.
But more traditional institutional investors may consider investing in digital currency after the Commodity Futures Trading Commission decision July 24 granting New York-based LedgerX a license to operate as a derivatives clearing organization for digital currencies. When the company launches its exchange and clearing house this fall with Bitcoin puts and calls, it will mark “an important milestone for the ecosystem broadly,” said Paul Chou, co-founder and chief executive officer of LedgerX. “This is the first time that we’ve seen, either here in the United States or globally, a national regulator recognize a clearing house that’s dedicated to clearing digital currencies.”
LedgerX’s stamp of approval from the CFTC is garnering kudos. “What LedgerX has accomplished is truly unique and groundbreaking,” said Daniel Gallancy, founder and chief executive officer of SolidX, a New York-based blockchain technology company. SolidX’s bid to list a Bitcoin exchange-traded fund (ETF) on the New York Stock Exchange was rejected by the U.S. Securities and Exchange Commission in March, shortly after the agency turned down the listing of a bitcoin ETF by investors Cameron and Tyler Winklevoss on the Bats BZX Exchange. The SEC said in April it would review an appeal of its decision to reject the Winklevoss twins’ ETF.
Gallancy pointed out the many traditional financial products have yet to benefit from proper clearing and still settle bilaterally – meaning the trade is settled directly and privately between the two parties rather than going through a clearing house. What LedgerX has accomplished is to leap-frog over non-cleared products, he explained. “Bitcoin is maturing into an institutional class [asset], and LedgerX’s efforts have helped make it happen,” he added.
The CFTC also on July 7 granted LedgerX registration as a swap execution facility for digital currencies, giving it a federal green light to operate an options exchange. LedgerX is only the second company in the digital currency world to be granted such a license by the CFTC. The first, TeraExchange of Summit, New Jersey, was licensed in 2015.
Wider benefits are expected from the potential success of LedgerX as an exchange and clearing house, according to Steven Lord, founder of virtual currency community Modern Money Group and managing editor at FINalternatives. It could be “potentially very supportive” of a Bitcoin ETF eventually gaining approval from the SEC, he explained.
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Some competition may even be on the horizon for LedgerX from the Chicago Board Options Exchange (CBOE). The company announced August 2 that it had entered into a licensing agreement with Gemini Trust Company LLC, founded by the Winklevoss twins, that could pave the way for the CBOE Futures Exchange to launch cash-settled Bitcoin futures tied to Gemini’s pricing data. It could be launched as early as the end of the year, pending an ongoing review by the CFTC. LedgerX declined to comment on the CBOE-Gemini arrangement, pending more details about it. “Since CBOE is focusing on futures and LedgerX on options, the two firms may be focusing at least initially on separate parts of the same market,” said one market insider.
Institutional investors are likely to move beyond their current “experimental stage” of interest and dip their toes into the asset class, according to Gil Luria, director of research at D. A. Davidson Companies, a broker dealer in Great Falls, Montana. Luria said that some institutional asset managers are currently experimenting with Bitcoin and digital token investments in their personal accounts.
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Without naming names, LedgerX’s Chou said the company has seen a lot of interest from institutional asset managers who would like to have access to digital currencies. However, compliance teams at those same institutions “are uncomfortable with the gray market regulatory framework” at digital currency exchanges, both abroad and in the U.S., he said. The CFTC clearing license approval for LedgerX is changing that dynamic because it “is bringing a large amount of comfort to institutional investors from a regulatory point of view,” Chou added.
The federal regulatory framework brings with it both legal and operational protections, explained Mark Wetjen, managing director at Depository Trust & Clearing Corp (DTCC), a former CFTC commissioner, and a current board member at LedgerX. Institutional investor know they will have legal rights under federal regulation.
“There’s going to be a rule book governing the clearing house and trading venue that lays out those rights,” Wetjen said. The rule book will be vetted by the CFTC and operations and rules will be subject to questioning and examinations by the CFTC, he added.
Still, soaring cryptocurrency prices and a surge in investments in digital currencies and initial coin offerings may be a reason for caution, according to billionaire investor Howard Marks, co-chairman of Oaktree Capital Management in Los Angeles. He warned investors against jumping into the asset class for fear of missing out.
“They’re not real,” he warned, speaking of digital currencies, in a July 26 memo to clients. He compared the current zeal for cryptocurrencies to the tulip frenzy in Holland in the 1600s and other manias.
Marks’ skepticism provides a counterweight to the always positive outlook seen by digital currency evangelists, whose predictions often fall short of what has been promised. The commercial adoption of Bitcoin for retail purchases, for example, remains modest.
Even so, analysts who follow the industry say the comparison with past bubbles is not a sustainable argument. “There’s a dramatic difference between tulip mania and Bitcoin,” said Lord, who admits that speculation may have driven prices too high. Blockchain technology, he contends, has demonstrated functional utility for financial transactions and has attracted significant investments in research. That utility will allow Bitcoin to survive even if prices come crashing down. “That cat’s out of the bag,” Lord said, referring to the rising number of applications for blockchain, “and you’re not going to get it back in.”