Bitcoin futures and the meaning of finance – how did we get here?

Photo by Brandon Morgan on Unsplash
Photo by Brandon Morgan on Unsplash

One outstanding note in the cacophony of the bitcoin futures debate is an intriguing claim that I confess I didn’t understand at first: that bitcoin has no “natural sellers”. What’s unnatural, I thought, about people wanting to sell to realize profits? It turns out that’s not what the phrase means.

It means that nobody needs bitcoin. So why hedge it?

To go deeper, let’s look at why capital markets exist. They were developed to enable firms to raise money outside of bank loans. Bonds and equities pair those that need funds with investors who want a return.

Derivative markets emerged to protect cash flows. This both gives producers more security, and helps to raise funds – investors are more likely to “lend” to a company with protected income than to one subject to the vagaries of nature.

In essence, capital markets exist to help businesses flourish. Old-school capitalism.

Here’s where the “natural seller” part becomes important.

Farmers need to sell wheat. It’s what they do. Oil producers need to sell oil. Steel manufacturers need to sell steel. Gold miners need to sell gold. So, they all should protect those sales in the derivative markets.

No-one needs to sell bitcoin.

So what income flows are the derivatives protecting? Mutual fund redemptions, maybe. Pension plan payouts. But do we really think that mutual funds and pension plans should have significant exposure to bitcoin?

This question is important for whatever side of the bitcoin debate you’re on. If you’re a sceptic and think that it’s all a ponzi scheme, surely you don’t want institutional funds heavily invested in an asset that will no doubt crash. If you’re a bitcoin believer, do you really want the “money of the future” stuck in funds? Where’s the decentralizing potential in that?

So, it could be that the constructive purpose of bitcoin derivatives is to protect flows for funds that are either taking irrational risks or hijacking the finance of tomorrow. This is a far cry from ensuring that farmers can make a living and oil producers don’t go bust.

We could argue that all this started to go awry back in the ‘80s with the creation of synthetic derivatives that had as their sole aim to make a profit at the expense of others (trading being a zero-sum game). We could also argue that back then we got ahead of ourselves by letting markets run far ahead of the infrastructure. We know what happened next. (Ok, I’m simplifying, but the point still holds.)

And we could ask ourselves what good bitcoin futures will do the economy as a whole. To what productive use will their markets contribute? Are they adding stability, as per the original intent of derivatives? Or could they be adding yet another layer of complexity that masks a deepening fragility?

Of course, playing the long game, this could be what true bitcoin believers have known would happen all along. That the world will see (again) how unstable the current financial system is. And to what will people turn when widening cracks send central banks scrambling?

True, the bitcoin price would also likely tumble. But the technology would still work. People would still be able to independently transfer funds. And the advantage to having an alternative to an interconnected and unstable system would become more apparent than ever.

The threat of bitcoin futures

photo by Jesse Bowser on Unsplash
photo by Jesse Bowser on Unsplash

The financial press has been in a flutter of excitement over the launch of bitcoin futures trading on not one but two reputable, regulated and liquid exchanges: CME and Cboe.

CME Group (Chicago Mercantile Exchange) is the largest derivatives exchange in the world, as well as one of the oldest, with roots going back to the 19th century. It will launch bitcoin futures trading on December 18th.

Cboe Global Markets owns the Chicago Board Options Exchange (the largest US options exchange) and BATS Global Markets (the platform on which the Gemini-backed bitcoin ETF would have been listed had it been approved). It plans to beat CME to the punch by launching bitcoin futures trading on December 10th.

In theory this opens the doors to institutional and retail investors who want exposure to bitcoin but for some reason (such as internal rules, or an aversion to risky and complicated bitcoin exchanges and wallets) can’t trade actual bitcoin.

And that expected flood of interest is, from what I hear, part of the reason that bitcoin’s price recently shot past $11,000 (which, considering it started the year at $1,000, is phenomenal).

I’m missing something. I don’t understand why the market thinks there will be a huge demand for bitcoin itself as a result of futures trading.

First, a brief primer on how futures work: let’s say that I think that the price of xyz, which is currently trading at $50, will go up to $100 in two months. Someone offers me the chance to commit to paying $80 for xyz in two months’ time. I accept, which means that I’ve just “bought” a futures contract. If I’m right, I’ll be paying $80 for something that’s worth $100. If I’m wrong, and the price is lower, then I’ll be paying more than it’s worth in the market, and I will not be happy.

Alternatively, if I think that xyz is going to go down in price, I can “sell” a futures contract: I commit to delivering an xyz in two months’ time for a set price, say $80. When the contract is up, I buy an xyz at the market price, and deliver it to the contract holder in return for the promised amount. If I’m right and the market price is lower than $80, I’ve made a profit.

Beyond this basic premise there are all sorts of hybrid strategies that involve holding the underlying asset and hedging: for instance, I hold xyz and sell a futures contract (I commit to selling) at a higher price. If the price goes up, I make money on the underlying asset but lose on the futures contract, and if it goes down the situation is reversed. Another common strategy involves simultaneously buying and selling futures contracts to “lock in” a price.

Futures contracts currently exist for a vast range of commodities and financial instruments, with different terms and conditions. It’s a complex field that moves a lot of money. The futures market for gold is almost 10x the size (measuring the underlying asset of the contracts) of the physical gold market.

How can this be? How can you have more futures contracts for gold than actual gold? Because you don’t have to deliver an actual bar of gold when the contract matures. Many futures contracts settle on a “cash” basis – instead of physical delivery for the sale, the buyer receives the difference between the futures price (= the agreed-upon price) and the spot (= market) price. If the aforementioned xyz contract were on a cash settlement basis and the market price was $100 at the end of two months (as I had predicted), instead of an xyz, I would receive $20 (the difference between the $100 market price and the $80 that I committed to pay).

Both the CME and the Cboe futures settle in cash, not in actual bitcoin. Just imagine the legal and logistical hassle if two reputable and regulated exchanges had to set up custodial wallets, with all the security that would entail.

So, it’s likely that the bitcoin futures market will end up being even larger than the actual bitcoin market. That’s important.

Why? Because institutional investors will like that. Size and liquidity make fund managers feel less stressed than usual.

The bitcoin market seems to be excited at all the institutional money that will come pouring into bitcoin as a result of futures trading. That’s the part I don’t understand.

It’s true that the possibility of getting exposure to this mysterious asset that is producing outstanding returns on a regulated and liquid exchange will no doubt entice serious money to take a bitcoin punt. Many funds that are by charter prohibited from dealing in “alternative assets” on unregulated exchanges will now be able to participate. And the opportunity to leverage positions (get even more exposure than the money you’re putting in would normally warrant) to magnify the already outrageous returns will almost certainly attract funds that need the extra edge.

But here’s the thing: the money will not be pouring into the bitcoin market. It will be buying synthetic derivatives, that don’t directly impact bitcoin at all. For every $100 million (or whatever) that supermegahedgefundX puts into bitcoin futures, no extra money goes into bitcoin itself. These futures do not require ownership of actual bitcoins, not even on contract maturity.

Sure, many will argue that more funds will be interested in holding actual bitcoins now that they can hedge those positions. If supermegahedgefundX can offset any potential losses with futures trading, then maybe it will be more willing to buy bitcoin – although why it would allow its potential gains to be reduced with the same futures trade is beyond me. And, why hold the bitcoin when you can get similar profits with less initial outlay just by trading the synthetic derivatives?

That’s the part that most worries me. Why buy bitcoin when you can go long a futures contract? Or a combination of futures contracts that either exaggerates your potential gains or limits your potential loss? In other words, I’m concerned that institutional investors that would have purchased bitcoin for its potential gains will now just head to the futures market. Cleaner, cheaper, safer and more regulated.

So, if the market is discounting an inflow of institutional funds into actual bitcoins, it’s likely to be disappointed.

What worries me even more is the possibility that the institutional funds that have already bought bitcoin (and pushed the price up to current levels) will decide that the official futures market is safer. And they will sell.

Now, it’s possible that the demand for bitcoin futures and the general optimism that seems prevalent in the sector will push up futures prices (in other words, there will be more demand for contracts that commit to buying bitcoin at $20,000 in a year’s time than those that commit to buying at $12,000 – I know, but the market is strange). This will most likely influence the actual market price (“hey, the futures market knows something we don’t, right?”).

And the launch of liquid futures exchanges increases the likelihood of a bitcoin ETF being approved by the SEC in the near future. That would bring a lot of money into an already crowded space.

Buuuut… it’s also possible that the institutional investors that are negative on bitcoin’s prospects (and there’s no shortage of those) may use the futures markets to put money behind their conviction. It’s much easier to sell a futures contract with a lower-than-market price than it is to actually short bitcoin. These investors may well send signals to the actual bitcoin market that sends prices tumbling.

And the leverage inherent in futures contracts, especially those that settle for cash, could increase the volatility in a downturn.

That’s pretty scary.

Let’s not even go into the paradigm shift that this development implies. The growth of a bitcoin futures market positions it even more as a commodity than a currency (in the US, the Commodity Futures Trading Commission regulates futures markets). And even more as an investment asset than a technology that has the potential to change the plumbing of finance.

So, while the market appears to be greeting the launch of not one but two bitcoin futures exchanges in the next two weeks (with two more potentially important ones on the near horizon) with ebullience, we really should be regarding this development as the end of the beginning.

And the beginning of a new path.

Confusion over faster payments, and what it could mean for bitcoin

The Spanish press has been reporting today on the rollout of TIPS, a payment system that allows instant reconciliation, even across borders within the European Union.

Only they’re wrong.

why pass up an opportunity to insert a Ryan Gosling gif?
(why pass up an opportunity to insert a Ryan Gosling gif?)

TIPS, which stands for TARGET Interbank Payment Settlement, launches in November of 2018. Seriously, the European Central Bank bringing forward the launch of a new payments system by a whole year would be pretty big news. Only, it didn’t happen.

email from ECB

Did a careless journalist just get the year mixed up?

Possibly, but it’s more likely to be a case of alphabet soup.

What does launch today is SCT Inst, which stands for SEPA Credit Transfer Instant, a different faster payments system.

Why the confusion? Because they’re similar, but not the same thing at all. And the difference may seem trivial, but it’s not.

Both promise almost instant payment finality within the Eurozone. Up until now, payments generally settled at the end of the day as totals were added up and net amounts were transferred. With the new, faster systems, settlement occurs on a transaction-by-transaction basis, generally within 10 seconds or so. Even across borders. I live in Madrid – if I make a transfer using this system to a friend in Paris, for example, it will get to her account almost immediately.

One drawback is that you can’t “change your mind” during the day, as you can with the current batch settlement system. But the benefits are many, and go beyond more immediate access to funds, a better service for clients and the possibility of new business models (more on this in a later post).

The main difference between the two systems is the promoting organization.

SCT Inst (the one that launches today) is organized by the European Payments Council (EPC), a not-for-profit group representing payment service providers (PSPs). It is not an EU institution. It was created by the banking industry in 2002 to develop harmonized electronic payments. In other words, it works for private companies, and it is these private companies that execute the payment settlement.

TIPS is organized by the European Central Bank (ECB), which represents central banks.

Private companies… central banks… not the same thing.

With SCT Inst, the private payment service providers settle the transactions, for a fee. With TIPS, the payments settle in central bank money – at 0.2 cents for the first two years, and a maximum of 1 cent thereafter. SCT Inst will have a hard time competing with that.

Plus, it’s fair to assume that the reach of TIPS will be greater, not just geographically, but also sectorially through the possible roping in of automated clearing houses (currently left out of SCT Inst).

However, SCT Inst is here today, and TIPS isn’t. Although the launch is relatively modest – almost 600 PSPs have signed up (about 15% of the possible pool), and it’s available in a limited list of countries: Austria, Estonia, Germany, Italy, Latvia, Lithuania, the Netherlands and Spain (so you’d think they’d report on it correctly?). Others are expected to follow in the next two years.

For participating institutions, it means an opportunity to offer a better service to clients. The focus is likely to be on consumer payments, at least to start with – the transfer limit is currently set at €15,000, which rules out most B2B payments.

TIPS and SCT Inst will co-exist. The TIPS documentation insists that messaging will be compliant with the standards adopted by SCT Inst. But it will be interesting to see how the launch and take-up affect the movement of funds, and which system ends up impacting the market more.

I confess that I have some more digging to do to unravel the relationship map (it looks like spaghetti), after which I hope to uncover more differences.

Meanwhile, we should focus on the big step forward that SCT Inst represents, and the bigger push that its colleague/competitor TIPS will give the payments sector. And on the removal of one of bitcoin’s supposed advantages: that cryptocurrency will replace fiat transfers because of speed.

Enough with the bitcoin images

You want to know the one thing about cryptocurrency reporting that drives me mad? It’s not just from the mainstream press either – the specialised press is even more guilty, if that’s possible.

It’s this:

bitcoin cnbc

If I counted on my fingers the number of articles a week that use an image with a physical bitcoin, I would need more hands.

Why do so many articles insist on representing bitcoin as a physical thing? It’s not.

And insisting on presenting it that way – as if us humble humans are incapable of grasping the concept unless we can see it – is condescending.

It speaks to our comfort with the visual.

Most of our development as humans has been building on what we can see. The realm of ideas has traditionally been left to the philosophers, while money and power typically went to the engineers. It’s one of the many reasons art has had such a pull on us over the centuries. Ideas that we can’t see are hard to wrap our heads around.

And everyone knows that money means coins, right? (It doesn’t.)

To be fair, understanding finance is not for everyone – ledgers and compound returns are not straightforward. And if seeing a bitcoin helps us accept that it is real (or, as real as anything gets in the money world), then, sure, let’s use images.

No.

As long as we hang on to the notion that money has to be physical, we won’t fully understand the underlying implications. And, it puts physical boundaries around an abstract concept while anchoring us in the limitations of the past.

The very press that strives to help us understand how this new technology will impact the way we see the world, is perpetuating the old paradigm. It needs to stop.

Narratives and reality

Catching up on reading from last week, I came across an article in the FT by Izabella Kaminska, who takes issue with economic impatience.

“While there is little doubt that too much short-termism has negative effects, one should not assume that it follows that extreme long-termism is always for the best. The latter can be dangerous when long-term thinkers fall for fanciful narratives or investor cults.“

She goes on to say:

“Nowhere is this mindset more clearly displayed today than in the realm of cryptocurrencies, where narrative trumps reality on a daily basis. “

To claim that happens daily is a stretch. But overall, maybe she’s right – the cryptocurrency space is full of hype and idealism, which doesn’t last long when the window of righteousness is opened and the obstacles of modern life rush in.

Although, the claim doesn’t make sense. The problem is with the definition of “reality”. No-one seems to have a clear idea of what it is anymore.

I’m not even sure if that is possible – because isn’t reality what we say it is? And these days, with so many channels of communication available to us, to import and export, reality is a mish-mash of interpretations, theories and facts distorted by bias.

We all have our own version of reality. My reality is not the same as a Texan truckdriver, Syrian teenager, or Nepalese grandmother. Nor can it ever be. So if “narrative trumps reality”, which reality are we talking about?

What’s more, as Yuval Noah Harari points out in his seminal work Sapiens, narrative is not only the unifying force of societies – it also creates its own reality. The forging of common myths bound groups together in imagination and tradition, giving us the internal organization necessary to conquer and invent. Objective reality is the ground we stand on, the bricks that house us and the food that nourishes. Subjective reality is our interpretation of their meaning, our understanding of our purpose and our determination of “obvious truths”. Narrative breeds subjective reality.

“Large numbers of strangers can cooperate successfully by believing in common myths. Any large-scale human cooperation – whether a modern state, a medieval church, an ancient city or an archaic tribe – is rooted in common myths that exist only in people’s collective imagination.”

So, “narrative trumping reality”? It’s a great soundbite. But is isn’t true. Narrative creates reality.

The history and future of money on display

I’m just back from a trip to London without my computer (hence the silence). While, there, I paid a visit to the British Museum for the first time in ages. I remembered the imposing façade, but had not seen the luminous inner court that makes you feel like you’re floating in light. I found myself doing laps in a sort of daze… And it was only morning.

Peeling off into the gloom of history, I came face to face with a surprising combination of permanence and progress that layers cultures on top of and next to each other, creating an incongruous sense of continuity. An ideal way to feel small and yet part of something important.

british museum

My main objective was to check out the History of Money exhibition, sponsored by Citibank. The room is small but packed with information, examples and anecdotes. The displays are intriguingly split down the middle into “The history of money” and “The history of coinage” – most attempts at synthesising the timeline conflate the two.

early coins

I confess that I had assumed that coins were tokens representing money. According to the curators, it turns out I was wrong – only metal tokens classify. The cowrie shells used in China are on the “money” side of the room (an interesting detail: the Chinese word for shell – bei – is still used to talk about money today).

Yet we refer to digital currencies as “coins”. The official definition (according to Google, of course) agrees with the curators, that coins are metal. Merriam Webster takes a broader view, allowing a coin to be “something resembling a coin especially in shape”, or “something used as if it were money (as in verbal or intellectual exchange)”. I’m on the side of the broad definition. But this is worthy of debate.

cowrie shells

There is so much in the history of money that points to what money could look like tomorrow. The earliest coins (minted around 650BC in Lydia) appear to have been “authorised” by the king (central authority). But the system didn’t hold for all cultures, and in the 1600s, London saw the issuance of local, business-specific tokens exchangeable for coffee, ale, fruit, etc.

We worry today about our ability to manage a host of different tokens. But back then, without electronic wallets, people seemed to manage. True, this was during a time when the government had stopped issuing small change, so there was a market opportunity (and not much alternative). But still, it speaks to our ability to organise when there is incentive to do so.

business tokens

Also on exhibit was the first global currency: the silver eight-reales, or “pieces of eight”, which later became the basis for the dollar. Issued by the Spanish empire from the end of the 16th century, they became the standard trade coins for most of Europe and Asia.

While it wasn’t the only currency in circulation at the time, it shows that a virtual alternative could end up accepted around the world for a specific purpose. Could this point to global acceptance of a niche use for bitcoin, or perhaps a specific use-case cryptocurrency?

british notes

There is so much more to unpack from the exhibition, which warrants further study. For instance, how even in some euro countries, more than one currency circulates. Did you know that in Northern Ireland some commercial banks have the right to issue bank notes, even today? And it turns out that the islands of Jersey, Guernsey and the Isle of Man issue their own versions of the British pound.

In a stroke of coincidence or perhaps insightful intent, the Money gallery is right next to another whose concept is also based on a fundamental innovation in measurement: clocks and watches. The idea of standard measures for the passage of the abstract idea of time is as fundamental to our modern world as that of measuring value and debt. Food for thought.

Is bitcoin money?

by Ondrej Supitar via StockSnap
by Ondrej Supitar via StockSnap

I’m currently reading “Money: The Unauthorised Biography” by Felix Martin, which I thoroughly recommend. Thought-provoking, illuminating and beautifully written, it debunks our preconceived notions and highlights the surprising evolution of this social technology that we use every day.

In the first chapter, Felix explains that the coins and notes that we carry around are not money. Money is the system of credit and debt that is sometimes represented by circles of metal and rectangles of paper. But usually not – most transactions are not represented by anything physical.

Rather, coins and notes are tokens that help us keep track of debts. The big innovation was to start exchanging those debts for others. Frank owes me, and here’s a token that represents that. I owe you, so here, take Frank’s token. Now he owes you. This conceptual leap is what kickstarted trade and the concept of an “economy”.

Looking back through history, that is what money has always been: a system of recording debts, and a representation of trust. That we associate money with coins is simply survivor bias – coins tend to weather the test of time better than other types of physical token.

One of my favourite anecdotes from the chapter is the siege of Malta. When the Turks cut off the fort from its supplies of gold and silver, the mint had to resort to making coins from copper – it inscribed each with the motto Non Aes, sed Fides – ”Not the metal, but trust.”

The system of recording that trust is what we call money.

Enter an entirely new way of recording that trust: bitcoin.

So, yes, bitcoin is a type of money. Perhaps not a currency – the online dictionary defines “currency” as “a system of money in general use in a particular country”. Since bitcoin is not confined to a particular country, that rules that out. (JP Koning points out that “currency” used to mean “something that could legally be used by the new owner if stolen”. So that would probably include bitcoin – but that definition has fallen into disuse, so we’ll go with the more modern one for now.)

According to the US Commodities and Futures Trading Commission (CFTC), bitcoin is a commodity. If you’re talking about bitcoin the coin, then yes, it could be. Commodities (gold, silver, cacao beans) have often been used in the past to represent money. BUT bitcoin is more than just a commodity, just as the euro is more than just copper coins. (Interestingly, paper – which also represents money – is not considered a commodity.)

And anyway, the CFTC ruling is mainly aimed at the regulation of derivatives, not so much at the use of bitcoin as money.

The topic is tangled, though. If bitcoin is a commodity (like silver), what makes it usable as money (like silver)? An official stamp of some sort – after all, monetary systems have always been controlled (or at least overseen) by a central authority. For the first time, we have a money that escapes the traditional parameters.

Also, commodities have always existed independently of the monetary system they move on (for instance, copper is not just used for money, knots on a string can mean something other than debt). Until now, anyway.

The confusion highlights the need for a new attitude. Maybe it’s time we updated not only our vocabulary but also our understanding of the monetary system. It’s not going to be easy.

Biases, barriers and bitcoin

I stumbled across a fascinating video this morning, about cognitive biases and money. Watching this, I realized that many of us bitcoin holders fall into the same trap.

The video talks about how we mentally segregate our “assets” into different compartments, which affects how willing we are to spend them. This is curious, since in the end it’s just money, right? And money is fungible, right?

So, why are we willing to spend some types of money and not others?

The video gives the eye-opening example of the movie ticket, the result of a study by renowned behavioural psychologists Kahneman and Tversky. If you go to the cinema and pay for a $10 ticket with a $20 bill, in exchange you get the ticket and a $10 bill. Now, say you lose the ticket. Do you buy another one with your remaining $10 bill? Most participants in the survey said no, they’d just go home.

But say instead the cashier gives you two $10 bills, and you are to hand in one of them to gain entrance to the theatre. If you lose one of the $10 bills, would you use the other one to see the movie? Most say they would.

This is notable, since the end result and cost is the same. (I think time and hassle should also be taken into account since they are an invisible cost, significant to some – but the point holds.)

Put any kind of barrier, even just one of form, between us and our money and we spend it less readily.

We all have things that we wouldn’t part with, even if it would get us in to see Hamilton. That’s because they have more than monetary value to us. They give us pleasure, they stimulate a memory, perhaps we know we couldn’t replace it easily… But a movie ticket? Not much sentiment attached there.

Now, sidestepping over to bitcoin, I have often pondered why some pundits point to bitcoin’s lack of acceptance in stores as a sign of failure. I couldn’t see the sense in spending something that you think might go up in price. You spend it, it’s not in your wallet anymore, and you lose out on the appreciation.

Through a different lens, I see now that that is totally stupid a narrow way of looking at things. And what’s more, misses the point of bitcoin.

It’s money. And it should be used. Holding onto it because “it’s bitcoin” denies it that use, which contradicts the interest that got us into the asset in the first place.

Plus, it might go down in value, so spending it now would be a good asset management decision. Or it might go up, but you can always buy more with the money that you would have used had you not used bitcoin. By using the cryptocurrency you perhaps saved money or time, so that would also have been a sensible decision.

But we’re not sensible, as Kahneman and Tversky – and all of us who prefer to hold bitcoin rather than spend it – show.

Most bitcoin these days is held for speculation. We buy it thinking it will appreciate in price. With that, from the beginning we are not regarding it as money. Those of us who buy in because we love the concept and we want to try out using it, end up falling victim to the rising market mentality of “can’t miss out on appreciation”. We stop seeing it as money and start seeing it as a ticket to riches.

We can offer in our defense the fact that merchants don’t take bitcoin. True, but take a look at the number of merchants who did and stopped because no-one was using it, or the number of merchants that don’t even bother because no-one is using it. It’s hard to deny that we are perpetuating the problem.

For bitcoin to reach its potential, it needs to circulate, and it needs to be used for more than portfolio diversification. The longer we let the current trend of market obsession continue and the longer we let our cognitive bias rule, the more we delay bitcoin’s debut as a global currency.

It’s strange how sometimes you can be searching for an answer to one question and end up understanding a completely different one a bit better.

Bitcoin, volatility and safe havens

So much for the “safe haven” theory…

Previous bitcoin bull runs have been accredited to turmoil and fear in financial markets. Much has been written about the cryptocurrency replacing gold as a “safe haven” (which I don’t agree with – it’s more of an “appealing alternative”), as pundits point to the jumps after the Brexit vote and the Trump election.

What, then, explains the bull run when Wall Street’s “fear index” is at its lowest point in over 20 years? Bitcoin is up 75% so far this year, and 26% so far this month. Among the reasons given are the increase in demand in Japan, in response to the recent legislation legalizing bitcoin as a “payment method” (but not yet a currency). The renewed possibility of a bitcoin ETF approval is also cited (although it is unlikely), although a stronger influence could well be FOMO (fear of missing out).

This is quite spectacular:

coindesk-bpi-chart

Maybe the “fear index” is wrong? Does anyone really believe that uncertainty and risk are at minimums?

The VIX index, as it is called, measures volatility. The assumption up until now has been that volatility = fear, and when things are going belly up, volatility peaks. What if volatility no longer measures fear? What if market liquidity, speed, derivatives and algorithms have ruptured the historical relationship?

I’m not a market expert, but I can’t see how volatility wouldn’t go up in times of trouble. So I find this completely perplexing.

One thing to bear in mind – just because bitcoin is not at this stage relying on its “appealing alternative” status, does not mean that it loses it. The fundamentals and characteristics that make it interesting have not gone away. It’s just that it has other good stuff going on.

Could a bitcoin ETF happen in the near future?

Now that the market excitement over the possibility of a bitcoin ETF seems to have been put to bed with the SEC rejecting both the Winklevoss and the SolidX proposals, it’s worth thinking about what needs to change for an official bitcoin investment vehicle to happen.

Forbes published today an interesting article by Moe Adham that unpacks the SEC decision. He pins the causes on two things:

    1) The lack of “surveillance-sharing agreements with significant markets”, in this case between the listing exchange (BATS) and a commodity exchange operator (Gemini, which does not have a significant market position). The concern is that the market insignificance of the exchange on which the underlying asset will be traded could leave it vulnerable to manipulation.
    2) The Gemini Exchange is not regulated enough (it is, though, one of only two regulated bitcoin exchanges in New York – but apparently that’s not enough).

Moe then goes on to hypothesize on what would need to happen before a US-listed bitcoin ETF is approved:

    1) The majority of bitcoin trading needs to happen on US-based exchanges.
    2) US-based bitcoin exchanges need to be regulated.

I agree with Moe that both of the above are unlikely to happen in the near future, but I don’t believe that those are the necessary conditions.

In its ruling, the SEC specified that the main reason for the rejection was:

“because the Commission believes that the significant markets for bitcoin are unregulated.”

While this may be true today, it’s unlikely to remain the case for long. As we have seen, several other major markets have made moves to regulate their cryptocurrency exchanges, and we will most likely see this trend pick up steam.

Even if the SEC were to insist on most exchanges being US-based (which I think even they would agree is an unreasonable condition), it’s not totally out of the question. Almost 40% bitcoin trading now happens in US$, making it the largest market, according to Cryptocompare.

via Cryptocompare - Bitcoin ETF
via Cryptocompare

Although only two of the top five US$-BTC exchanges are based in the US (Poloniex and Coinbase), one of them (Coinbase) already has a New York BitLicense. Poloniex, on the other hand, pulled out of New York rather than have to apply for a BitLicense. But that might change, either because Poloniex shifts priorities or because the requirements become less costly and cumbersome.

In the bitcoin sector, regulation is a trend that can only move forward.

With increasing exchange oversight and greater liquidity in the major trading markets, bitcoin prices will become more reliable and transparent, solving another of the SEC’s concerns.

So, I’m more optimistic than Moe that we will see a listed bitcoin ETF in the near future.

I don’t, however, think it will happen in the US first. Another country is far ahead in terms of regulation and acceptance by the financial system, and its regulators are more likely to approve a liquid, listed bitcoin investment vehicle in the short term.

Where?

Japan.