The Chicago Board Options Exchange, which is the largest U.S. options exchange (“CBOE”) and the Chicago Mercantile Exchange, which is the largest U.S. futures exchange (“CME”) will trade bitcoin futures contracts on December 10, 2017 and December 18, 2017, respectively. CBOE, which is registered as a national securities exchange with the Securities and Exchange Commission (“SEC”), will offer its bitcoin futures contracts through Cboe Futures Exchange, LLC (“CBOE Futures”). Both the CBOE Futures and the CME are registered as commodity exchanges with the Commodity Futures Trading Commission (“CFTC”), and each exchange has responded to institutional investors’ interest in trading bitcoin in regulated markets. Currently, bitcoin is solely traded on unregulated digital asset exchanges.1
Whether seeking exposure to bitcoin investments generally or interested in the specific products to be offered by the CBOE and CME, it is important to note the differences in the valuation methodologies used by the CBOE and CME to calculate the final settlement prices of their respective products. A futures contract is a legally binding agreement, generally traded on an exchange, to buy or sell a particular underlying asset, such as a commodity, currency, or other financial asset, at a predetermined price at a specified time in the future (the maturity date). In futures trading, the final settlement price is the price at which the underlying asset is valued in order to determine the profit/loss of each counterparty to the contract at the contract’s maturity date.
Currency futures, or FX futures, are predominantly settled through a periodic physical delivery process,2 in which bank accounts are established in both the U.S. and the country of the traded currency and are debited and credited upon maturity of the contract to reflect the contract’s final settlement price. In contrast, both the CBOE and CME bitcoin futures will be cash-settled,3 based on the daily U.S. dollar value of bitcoin. The CBOE, traditionally an equity derivatives exchange, will take an “equity” style approach to the valuation of its bitcoin futures. The final settlement price of the CBOE bitcoin futures will be the official auction price for bitcoin in U.S. dollars determined at 4:00 p.m. New York time by a single digital asset exchange, Gemini Trust Company, LLC. On the other hand, the CME, traditionally a commodity and currency derivatives exchange, will take a “currency” style approach that is similar to calculating the WM/Reuters FX benchmark forward & spot rates. The final settlement price of the CME bitcoin futures will be the aggregation of trade executions occurring on four4 digital asset exchanges between 3:00 p.m. and 4:00 p.m. GMT (London time).
The following chart summarizes the differences in the calculation of the final settlement prices.
| Final Settlement Price Calculation Comparison | ||
| CBOE5 Ticker: XBT |
CME6 Ticker: BRR |
|
| Valuation Approach | Equity | Currency |
| Contract Unit | 1 bitcoin | 5 bitcoin |
| Contract Term | Weekly, monthly (first three most near months), or quarterly | Monthly |
| Trading Limits | 20% – 5 minute pause in trading 20% – 5 minute pause in trading7 |
20% – 5 minute pause in trading 20% – 5 minute pause in trading 20% – 5 minute pause in trading8 |
| Fixing/Reference Rate | Gemini Exchange Auction Rate | CME CF Bitcoin Reference Rate |
| Exchange | Gemini9 | Constituent exchanges currently qualifying include Bitfinex, Bitstamp, GDAX, and itBit10 |
| Administrator of Fixing/Reference Rate | N/A (Based on the official Gemini auction price for bitcoin in USD) | Crypto Facilities Ltd |
| Calculation Period | 1 minute | 1 hour |
| Time Published | 4:00 p.m. New York time | 4:00 p.m. GMT (London time) |
In accordance with their valuation methodologies, the CBOE product may be favored by equity traders, who are familiar with the closing auction of the U.S. equity markets. The CME product may appeal to currency traders, who regularly manage risk around asset classes that have similar benchmark reference rates, or traders outside of the U.S. because the settlement price is determined at the end of trading in London. As trading begins, market participants will likely focus on the difference between the CBOE and CME bitcoin futures’ settlement prices and the potential arbitrage opportunities between the two bitcoin futures contracts and between each bitcoin futures product and the spot bitcoin prices on digital asset exchanges.
The listing of bitcoin futures on the CBOE and the CME indicates a growing trend towards mainstream acceptance of cryptocurrency-based products as legitimate investments. However, the regulatory environment surrounding cryptocurrency investments is still uncertain. The CFTC has asserted authority over virtual currencies (including cryptocurrencies) after determining that virtual currencies are commodities.11 Similarly, the SEC has claimed jurisdiction over certain cryptocurrencies that meet the definition of investment contract, and are therefore securities.12Both regulators have only recently begun to exercise their jurisdiction over cryptocurrencies and cryptocurrency-based investments. Furthermore, the CFTC has received criticism for not seeking public comment prior to the listing of bitcoin futures contracts.13
Seward & Kissel LLP will continue to provide insight on any developments regarding cryptocurrency investments or the regulatory treatment of cryptocurrency investments. If you have any questions regarding cryptocurrency investments, please reach out to your Seward & Kissel contact attorney.
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1 Bitcoin is traded on all five of the largest digital asset exchanges based on daily trading volume. The five largest digital asset exchanges are: (1) Bitfinex, with a total 24 hour trading volume of $4,080,800,404; (2) Bithumb, with a total 24 hour trading volume of $2,797,042,100; (3) Bittrex, with a total 24 hour trading volume of $2,339,258,784; (4) GDAX, with a total 24 hour trading volume of $2,072,293,220; and (5) Poloniex, with a total 24 hour trading volume of $1,229,077,509 (dollar figures are presented as of December 7, 2017).
3 Brazilian Real Futures and Russian Ruble Futures are also cash-settled.
4 Under the methodology guide for the CME CF Bitcoin Reference Rate, additional digital asset exchanges can be added in the future.
5 See XBT-Planned Cboe Bitcoin Futures Contract Specifications, CFE.CBOE.com
6 See Bitcoin Futures Contract Specifications, CMEGroup.org
7 Trading in XBT futures will be halted for two (2) minutes if during regular or extended trading hours for XBT futures: (a) the best bid in the XBT futures contract closest to expiration is 10% or more above the daily settlement price of that contract on the prior business day; or (b) the best offer in the XBT futures contract closest to expiration is 10% or more below the daily settlement price of that contract on the prior business day. After trading commences following such a halt, trading in XBT futures will be halted for five (5) minutes if during regular or extended trading hours for XBT futures: (a) the best bid in the XBT futures contract closest to expiration is 20% or more above the daily settlement price of the contract on the prior business day; or (b) the best offer in the XBT futures contract closest to expiration is 20% or more below the daily settlement price of that contract on the prior business day. See Cboe Contract Specifications.
8 The CME’s trading limits are designed to coordinate with the New York Stock Exchange (“NYSE”) circuit breaker provisions. The NYSE implements a circuit breaker halt for a 7% or 13% decline occurring after 9:30 a.m. Eastern time and up to and including 3:25 p.m. Eastern time, or in the case of an early scheduled close, 12:25 p.m. Eastern time, resulting in a trading halt for 15 minutes. A 20% decline, at any time, triggers a halt in trading for the remainder of the day. See NYSE Trading Information.
9 Gemini Trust Company, LLC (“Gemini”), which is owned by Cameron and Tyler Winklevoss, was the first U.S. exchange licensed for bitcoin and ether trading. Gemini is regulated as a trust company by the New York State Department of Financial Services. It has a total 24 hour trading volume of $461,988,800 (dollar figures are presented as of December 7, 2017).
10 Bitfinex is the world’s largest bitcoin trading platform based in Taiwan with a 24 hour trading volume of $4,080,800,404. Bitstamp is a bitcoin exchange based in Luxembourg with a 24 hour trading volume of $692,330,070. GDAX is a U.S.-based digital asset exchange with a 24 hour trading volume of $2,072,293,220. itBit is also a U.S.-based digital asset exchange with a 24 hour trading volume of $82,976,131 (dollar figures are presented as of December 7, 2017).
11 A CFTC Primer on Virtual Currencies, LabCFTC
12 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, Securities Act Release No. 81207 (July 25, 2017)
13 Open Letter Regarding the Listing of Cryptocurrency Derivatives, Futures Industry Association (Dec. 6, 2017)