Bitcoin futures, which Cboe Global Markets and CME Group hope to list later this year, may accomplish what the global financial crisis could not: decimating a slew of trading firms and threatening the stability of Wall Street’s clearing outfits.
No single listed financial product has ever caused such mayhem, but Thomas Peterffy, one of the world’s most successful derivatives traders, is concerned that Bitcoin derivatives will introduce extraordinary volatility into the market that will be difficult to contain. “For the first time, I am extremely scared,” says Peterffy, founder and chairman of Interactive Brokers Group (ticker: IBKR).
JPMorgan Chase’s (JPM) Jamie Dimon and BlackRock’s (BLK) Laurence Fink worry that Bitcoin is a bubble and a money launderer’s best friend. Peterffy has a different concern: He fears that low margin rates will encourage speculation, endangering trading and clearing firms.
Futures margin rates range from 2% to 8%. When an investor’s losses exceed that range, brokers must immediately cover them, then try to collect from the client. This year, Bitcoin has traded from about $708 to almost $7,400. It could go higher, or it could collapse by 70% in a day. It’s hard to analyze the price because Bitcoin has no economic function, unlike commodities such as corn or futures on the Standard & Poor’s 500 index.
Peterffy worries that small trading firms will offer the lowest margin rates to attract business, thus becoming weak links in the market’s defenses against risk, such as that posed by various products that track the CBOE Volatility Index, or VIX. Many investors are betting that the VIX will stay low. That wager could prove catastrophic if volatility suddenly surges, and stocks fall.
“The weaker clearing members charge the least. They don’t have much money to lose anyway. For this reason, most Bitcoin interest will accumulate on the books of weaker clearing members who will all fail in a large move,” Peterffy says.
Peterffy wants the CME (CME) and the Options Clearing Corp., or OCC, to limit clearing members’ liability for peers at $100 million for Bitcoin futures. He also wants to isolate Bitcoin from other financial products, a step he says already has been taken for some volatility products. Interactive Brokers will offer Bitcoin futures trading if those conditions are met, and consider stopping doing business with some clearing firms if they’re not.
CME, Cboe (CBOE), and the OCC wouldn’t comment, other than to say that the risk of Bitcoin futures is manageable.
IN MANY WAYS, Bitcoin futures exemplify the challenges U.S. exchanges face. Once, markets were where companies managed risk or raised capital. Now, equity-oriented exchanges are essentially very fast computer systems, built to appeal to high-speed and quantitative traders. Commodities exchanges like the CME depend on trading volume in their listed products.
Nothing the exchanges have dealt with has caught the public imagination like Bitcoin. So, at a time when banks such as Goldman Sachs Group (GS) are reporting that clients aren’t interested in trading stocks, bonds, and derivatives, exchanges must pursue Bitcoin. Trading fees could be huge if the Commodity Futures Trading Commission allows the Cboe and CME to list Bitcoin futures.
The situation should humble the derivatives industry, which struggles for mainstream acceptance. “Investors are willing to commit millions, tens of millions, and hundreds of millions into Bitcoin,” says Vincent Au, a portfolio manager at hedge fund Gondor Capital, “yet people are scared of options.”
It has been said that Wall Street develops new financial products by throwing ideas against a wall, and trading anything that sticks. Bitcoin futures, if Peterffy is right, could bring down the wall.
Steven M. Sears is a Senior Editor and Columnist with Barron's. He is the author of "The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails." Mr. Sears previously reported for Dow Jones Newswires and The Wall Street Journal. He has reported upon most major modern financial events, including the Asian Contagion, the bursting of the Internet Bubble, the Credit Crisis, and Europe's sovereign debt crisis. He also was part of exchange executive teams that modernized the U.S. options market, and introduced electronic trading. Interact with him on Twitter @sm_sears.
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