DEFINITION of LedgerX
LedgerX is a clearing house that specializes in cryptocurrency derivatives. LedgerX is registered as a swap execution facility (SEF) and derivatives clearing organization (DCO).
BREAKING DOWN LedgerX
Cryptocurrencies have become wildly popular since the launch of bitcoin in 2009. Hundreds of cryptocurrencies have been created since then, with many designed to help fund companies and projects that traditional finance may have shied away from. This has caused a headache for regulators, who are trying to determine whether existing rules governing stocks, bonds, and other financial instruments will be sufficient to cover digital assets.
Regulators are tasked with ensuring that investors are protected, but because the rulemaking process can take many years to reach a conclusion, they are playing a game of catch-up with technologies that are rapidly evolving. For example, it wasn’t until 2017 that the Securities and Exchange Commission (SEC) was able to define when a cryptocurrency token would be considered a security.
In July 2017, the Commodity Futures Trading Commission (CFTC) granted LedgerX a derivatives clearing organization (DCO) license, allowing it to register as a clearing house for derivatives contracts. It took an estimated three years for the CFTC to reach its decision.
The shift from buying and selling individual tokens to derivatives is a major step toward cryptocurrencies being accepted as mainstream financial instruments. The underlying assets in the derivatives cleared through LedgerX will be cryptocurrencies.
Derivatives allow investors to gain exposure to cryptocurrencies without having to purchase a bitcoin or ethereum token, just as investors can purchase currency futures, equities options, or exchange traded funds (ETFs). This makes investing in cryptocurrencies more affordable, as gaining exposure by buying an individual token could cost the investor thousands of dollars in some cases.
Clearing houses like LedgerX provide a level of transparency, predictability, and safety for futures and options contracts that is unavailable in options offered through non-clearing houses. They allow investors to buy or sell cryptocurrency puts and calls, which may help reduce the occurrence of wild fluctuations in cryptocurrency values by allowing investors to bet against the extremes.
In order to be successful, LedgerX needs to attract high contract volumes in order to make investors believe that cryptocurrency derivatives are viable investments. This is not dissimilar to exchanges where cryptocurrencies are sold: established exchanges such as Coinbase benefit from a virtuous cycle in which their popularity draws in more investors and increases trading volumes, which in turn draws in even more investors and higher volumes. LedgerX reported that it saw contracts worth $1 million traded during its first week of operations.
While LedgerX has historically been associated with bitcoin trading, its CFTC license allows it to clear derivatives that use other cryptocurrencies as their underlyings. Candidates for expansion would have to be well-established, with high market capitalizations and a stable technology platform. Initial coin offerings (ICOs), which are used to raise funds outside of more traditional options such as loans, are less likely to be included because of regulatory uncertainty, as the SEC and CFTC would have to agree on how to define them.