CME Group Inc. (CME), one of the world's largest providers of derivative products, announced on Oct. 31 that it would launch bitcoin futures by the end of the year, assuming the product passes regulatory review. On Dec. 1 CME announced that the contract would be available for trading on Dec. 18.

The bitcoin futures contract will be based on a once-daily U.S. dollar rate, the CME CF Bitcoin Reference Rate, which stood at $6,066.36 as of Oct. 30 (as of Nov. 30 it stands at $9,352.50). The rate is published in partnership with Crypto Facilities Ltd. and is based on the prices that appear on major crypto asset exchanges Bitstamp, itBit, GDAX and Kraken. (See also, What Is Bitcoin?)

The introduction of derivatives contracts based on bitcoin has the potential to reduce the risk of trading the notoriously volatile cryptocurrency, which routinely experiences double-digit intraday price swings. According to a statement by CME Group CEO Terry Duffy, the futures contract "will provide investors with transparency, price discovery and risk transfer capabilities." On the other hand, derivatives trading has the potential to exacerbate risk and volatility in the underlying asset, as happened with mortgages in 2007 and 2008.

According to CME, trading in the bitcoin spot market has reached a notional value of $1.5 billion per day. The price of bitcoin has surged from under $1,000 at the beginning of the year to $10,654.53 as of Dec. 1 at 9:22 a.m. EST, according to CoinDesk's Bitcoin Price Index. (See also, Basics for Buying and Selling Bitcoin.)

Previous attempts to launch financial instruments based on bitcoin have met with skepticism from regulators. The Securities and Exchange Commission (SEC) rejected two proposed bitcoin exchange-traded funds (ETFs) in March, though Grayscale Investments' Bitcoin Investment Trust (GBTC), trades over the counter. 

Details from CME

Speaking at the Consensus: Invest 2017 in New York City on Nov. 28, CME Group managing director of equity products Tim McCourt provided additional details regarding CME's bitcoin futures product. He said the contracts would launch in December, pending regulatory review, and expressed the hope that building a derivatives market around bitcoin would "provide investors and market participants with the transparency and price discovery needed to pursue risk transfer opportunities that don't exist in the bitcoin cash market today."

All trades in the contract will be backed by a clearinghouse to mitigate counterparty risk, McCourt said, and all trades will be cash-settled in U.S. dollars against CME Group's bitcoin reference rate. Circuit-breakers will be put in place to prevent losses from piling up: trading will pause at 7% and 13% up-or-down moves, and trading within a given day will be limited to a hard 20% range. A 25% deviation tolerance, meanwhile, will erase the bitcoin reference rate for the day if the price on one exchange deviates wildly from the prices on others; McCourt says this limit will maintain the "integrity of the index" and provide "resistance to manipulation."

Materials distributed by CME Group at the conference specified that the contract size will be five bitcoin.

Disclosure: the author owns bitcoin.

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