For the first time ever, the U.S. Commodity Futures Trading Commission (CFTC) has given permission to a private company to exchange and clear any number of cryptocurrency derivatives.
After three years of work, New York-based startup LedgerX was today granted a rare derivatives clearing organization (DCO) license allowing it to clear and custody financial instruments backed by bitcoin, ether and any number of blockchain-based cryptocurrencies.
The instruments, designed to mitigate investment risk, are the latest signal that the cryptocurrency markets are maturing, with the total value of the asset class crossing $115bn earlier this year.
But the guidance from the agency in charge of ensuring the integrity of all futures and swaps markets in the US could have bigger implications than just letting a single company finally open for business.
LedgerX co-founder and CEO Paul Chou told CoinDesk:
"It means a lot, not just for the industry, but globally, because the CFTC will set the example of what a well-licensed clearinghouse and exchange based around digital currencies will look like."
As part of the DCO license, LedgerX will be required to surveil the institutional investors it works with and create increased transparency about those customers for the regulatory agency. Eligible participants include broker dealers, banks, futures commission merchants, qualified commodity pools and qualified high net worth investors.
With the granting of this license, these groups will now be able to enter into complex contracts with one another, with values derived from the underlying cryptographic asset.
As a result, Chou believes the creation of these assets will mark a pivotal moment for cryptocurrency markets, giving investors more sophisticated ways to hedge, and possibly, helping to stabilize long-volatile cryptocurrency prices.
"We have a lot of in-progress talks with customers that are looking to work with retail customers that want to buy derivatives on bitcoin, binaries, all these exotic options," he said.
Though frequently described as a bitcoin exchange and clearinghouse, LedgerX's license did not require an overly broad definition of cryptocurrency. Rather, the permission is open to any of a series of instruments derived from the cryptographic primitives used to build a number of protocols.
Similar to how G5 currencies are typically viewed as safe investments due to their relative stability, Chou imagines three to five cryptocurrencies will be deemed "viable" candidates for the exchange and clearinghouse, based on market capitalization and functionality.
Initial coin offering (ICO) tokens sold to raise funds will not likely be considered for inclusion on LedgerX, given their gray area between CFTC-regulated commodities and SEC regulated securities.
Rather than having to reapply for each currency and each derivative contract, LedgerX will "self-certify" that the new opportunity is compliant.
"Instead of evaluating different governments," as with the case of a G5 currency, said Chou, "you'll be evaluating different technologies or approaches underneath these digital currencies."
The CFTC decision comes at a time when many in the cryptocurrency industry have been anxiously awaiting clear guidance — including other regulators.
In March, another lengthy cryptocurrency regulatory application was refused by the Securities and Exchange Commission (SEC), citing among other things, a lack of "surveillance-sharing agreements," and a requirement that "markets must be regulated."
Currently under review by the SEC, the application would let Tyler and Cameron Winklevoss list a bitcoin-tied exchange-traded fund (ETF) on the BATS BTX Excahnge.
Given LedgerX's lengthy requirements to report on its customers and the regulatory body's history of co-regulating certain instruments, Chou believes today's decision could provide just the answer the SEC and other agencies in Asia and Europe have been waiting for.
"I think the CFTC will set an example both for other regulators here in the U.S., but also globally as well," he said.
After years of working and waiting, progress had been moving swiftly leading up to today's news.
It was just earlier this month that the CFTC formally registered LedgerX as a swap execution facility (SEF) after operating with a temporary license for about two years, making the New York-based firm only the second cryptocurrency outfit to be regulated under the provision.
A close observer of the developing story might have even found a clue back in May, when LedgerX announced it had raised an $11.4 million Series B led by Miami International Holdings and Huiyin Blockchain Venture Investments.
It turns out, the money for the startup that had already raised a $1.5 million seed round and an undisclosed Series A was intended to meet capital requirements implemented by the Dodd-Frank Act. In order to ensure agreements can be fulfilled in case of an emergency, the act requires that a DCO hold operating costs to run its business for a year.
Going as far back as September 2015, former CFTC commissioner Mark Wetjen has been sitting on the board of LedgerX parent company Ledger Holdings, and since January 2016, Chou has served on the CFTC technology advisory committee.
In a statement, Wetjen said:
"These are exciting times to have a new digital asset class emerge. I hope that the effort LedgerX put forward in the U.S. can set the stage for a global approach to this new digital asset class."
By moving the trading and settling of cryptocurrency assets into one heavily observed operation, Chou expects he'll be able to generate revenue from an entirely new source: data analytics to an unprecedented depth.
In addition to charging other exchanges for his service, Chou expects the CFTC's heavy surveillance requirements will result in cryptocurrency markets data that can be cross-referenced with points from previously existing data sets.
When the platform formally launches later this year, these services and more will only be available to eligible contract participants. But, Chou described his business model as "multi-stage," eventually serving those who were previously unable to afford such services.
"At first we're going to target a lot of institutional customers that want to invest in this asset class," said Chou, who added:
"Then later, pretty much everybody."
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