The wait is almost over for LedgerX, a New York-based bitcoin swaps startup with a board boasting a who's who of financial sector bigwigs.
After two years of building, the firm that had already raised $1.5m from Google Ventures, Lightspeed Venture Partners and others, says it is now ready to push for its final approval from the US regulator, the Commodity Futures Trading Commission (CFTC).
If granted, LedgerX would be able to launch a federally regulated bitcoin options exchange and the first clearing house to list and clear fully collateralized, physically settled bitcoin options for the institutional market.
In fact, LedgerX quietly overcame what its team believes is its last hurdle toward that goal in December.
The problem was, to protect LedgerX’s future customers, the startup was required to hold a minimum amount of capital relative to its expected business volume – cash the startup didn't have. In response, LedgerX managed to raise an undisclosed amount of capital from Miami International Holdings, Inc.
The startup's co-founder Juthica Chou told CoinDesk the cash infusion was the last piece of the puzzle that needed to fall into place before the CFTC could make its final decision.
Of course, the regulatory body that oversees US futures and options markets could still say no.
Speaking with CoinDesk at LedgerX's New York headquarters, Chou explained why her company raised the capital, and what a federally regulated clearing house for bitcoin could mean for the stability of the cryptocurrency's price.
"It's really been our focus to really have a clearing house for bitcoin. Because it is a bearer asset, clearing and settling is riskier, and we think that having a regulated clearing house, under a great federal regulator like the CFTC, will bring legitimacy to the ecosystem and allow a lot of new sets of institutional customers to participate."
An industry first
While bitcoin-to-bitcoin derivatives already exist, as do cash-to-cash derivatives, this suite of investment products would be the first to let US dollars settle to bitcoin, according to Chou. Such a product could potentially help decrease price volatility for the cryptocurrency, which has a current market cap of $16.1bn.
Initially, LedgerX plans to release physically settled 'puts and calls' – the most basic, or 'vanilla' options that a swaps execution facility (SEF) can offer – for a tenure of between one and six months.
Though the firm isn’t allowed to take on customers until after it receives CFTC approval, Chou said she breaks down her potential clients into three categories: institutional companies that are naturally long on bitcoin, institutions that are naturally short, and traders that sit in the middle to provide liquidity.
In the end, though, one of the most valuable side-effects of receiving the CFTC license could end up being the data generated by LedgerX, according to Chou.
Currently, she said, industry data is focused on realized volatility data. But with LedgerX's emergence on the market, the company could launch options products that result in potentially valuable implied volatility data.
"I think that data will be important to LedgerX, but also really important to customers."
While LedgerX may indeed achieve a series of industry firsts, it is by no means alone in offering bitcoin swaps.
New Jersey-based TeraExchange, for example, was granted a temporary registration as a swap execution facility (SEF) in September 2013. Since settling with the CFTC for failing to enforce certain prohibitions, the platform now offers a short-term bitcoin forward, settled in US dollars, as well as offering a bitcoin price index.
While TeraExchange tends to focus on linear swaps, LedgerX hopes to list options which could allow customers to monetize bitcoin's volatility, even while possibly minimizing that same volatility.
Another distinction Chou makes is that, if LedgerX is approved, customers will be able to receive actual bitcoin as settlement and not just dividends in US dollars equal to the value in bitcoin.
TeraExchange declined to comment for this report.
The newly confirmed acting chairman of the CFTC, Christopher Giancarlo, laid out his plans to only lightly regulate blockchain-related products last week at the SEFCON conference in New York, dedicated to the swaps industry. Notably, LedgerX co-founder Paul Chou sits on the CFTC tech advisory committee, while former CFTC commissioner Mark Wetjen sits on LedgerX's board of directors.
Perhaps the biggest impact an eventual CFTC approval could have on the market is the creation of an SEF that is also a derivatives clearing organization (DCO). As a DCO, LedgerX would become the first federally regulated entity to guarantee bitcoin clearing and settlement of trades.
Juthica Chou said:
"The round was designed to help us meet minimum financial requirements necessary to become a derivatives clearing organization and a swap execution facility of the CFTC."
A more stable bitcoin?
The result of an increasingly diverse derivatives market could be a less volatile bitcoin price, according to Chou and other industry observers.
ARK Invest analyst and blockchain products lead Chris Burniske is quick to point out that there are many kinds of swaps that LedgerX and others could build, and not all of them would necessarily result in increased liquidity.
But over time, a more diverse ecosystem of bitcoin derivatives could give institutional investors and traders more control over their risk, increasing "appetite for volatile assets like bitcoin" and resulting in deeper bitcoin market liquidity, he said.
"More liquid markets generally work to decrease volatility," said Burniske, "as order books can better absorb buy and sell shocks."
And while Chou says LedgerX plans to start 'vanilla', she added that the firm expects to expand its offering once the license is granted and business stabilizes.
"I think we’ll see a number of interesting derivatives products, some of them not completely reinventing the wheel, and some of them pretty different than what we’ve seen in any other commodity."
Leaping hurdle image via Shutterstock