While regulation has been lacking in the virtual currency world, TeraExchange, a registered SEF, said it’s launching the first regulated platform for Bitcoin derivatives along with a spot Bitcoin price index.
As a swap execution facility, registered with the Commodity Futures Trading Commission, TeraExchange is structuring the Bitcoin swap marketplace to be regulated under CFTC rules.
“This is the first regulated exchange, that has a regulated product and a regulated index in Bitcoin’s history,” said Christian Martin, CEO of TeraExchange, in an interview today.
In an announcement on Friday, TeraExchange said the Bitcoin derivative and the Tera Bitcoin price index were created to meet the growing demand of global merchants, payment processors, miners, and hedge funds for an efficient hedging tool. Institutional market makers have already offered to provide continuous markets over a range of tenors going out one to two years, said Martin.
In March of 2014 TeraExchange announced that an affiliate of the firm had created the first unregulated USD/Bitcoin Swap, which sparked a considerable increase in demand for regulated Bitcoin derivatives trading and hedging, the company said on Friday.
The process of creating a Bitcoin derivative
TeraExchange began the process of working with the CFTC in February this year.
As an approved SEF, TeraExchange was able to self-certify the product and list it on its SEF. “The CFTC approves that certification process. To be clear, the CFTC does not approve the product,” explains Martin. “We spent 8 or 9 months making sure the CFTC was comfortable with our product.
“At the end of the day, it was no different than listing an interest-rate swap contract. We were sensitive to the newness of Bitcoin, and with the newness comes diligence and time.”
Bitcoin price index as global benchmark
In addition, TeraExchange developed the Bitcoin price index, which is part of its commercial offering. “The index was an important tool for us to develop because the index takes into account global data points, global underlying exchange input, and smoothes it all out so that any one input isn’t any more important than others,” says Martin. “In that regard, our index is not susceptible to manipulations,” which is one of the gating factors of the CFTC.”
In the release, Martin pointed out that HTE index "will help the growing Bitcoin trading community mark-to-market positions while establishing trust and stability in this growing global marketplace." TeraExchange is the index administrator and calculation agent.
The Tera Bitcoin Price Index employs a dynamic algorithm that compiles and filters data on a real-time basis from a number of widely utilized global Bitcoin exchanges, according to the announcement.
Going beyond data sharing, Martin says that TeraExchange has information sharing agreements with these global exchanges, which allows for reciprocation in case either party suspects any of the players in either market are looking to become bad actors. “We have the ability to share information with other exchanges; they can share it with us; and the CFC has that window.”
According to Planet Bitcoin, some of the leading Bitcoin exchanges include Coinbase.com, Cryptsy.com, Bter.com, and Coins-e.com. There at least 70 sites, bourses, and platforms around the world that offer trading in Bitcoin and other cryptocurrencies, according to the site.
Hedgers and liquidity providers
Citing a considerable increase in demand from Bitcoin players, Martin told us potential hedgers include merchants that are accepting Bitcoin payment as well as payment processors and miners that are distributed affirmation systems within Bitcoin. All of these players are natural consumers of Bitcoin, and they need a hedging instrument.
Looking beyond the incumbent players, there are regulated institutions such as banks and hedges that can only trade on regulated exchange and with regulated products, according to Martin. “We think there is an open door now for the regulated institutions to come trade our product because they can.”
For example, the miners are an affirmation system for Bitcoin transactions, and they are paid for their services in Bitcoin, so they want to hedge those exposures.
After performing analysis on the incumbent market players and its direction, Martin says, market makers would emerge as liquidity providers.
In a couple of weeks, Martin expects to see dedicated daily liquidity providers and transactions commencing in a secondary market. “These are dedicated funds for the sole purpose of trading and expressing their views in Bitcoin,” says Martin, noting this group includes hedge funds and asset managers “that have long histories of making markets in other products that are excited about Bitcoin.”
In the early days, just like any product, the spreads will be wider, so the original market makers will stand to profit. “This is a whiteboard opportunity for market-markers in other products that are excited about Bitcoin.”
To access the Bitcoin swaps marketplace, traders will use the same front-end for TeraExchange, which also executes interest-rates swaps, CDS, and NDFs for currencies.
Part of the strategy is that players attracted to the new Bitcoin product will also check out the other swaps on the SEF platform. Now this includes Bitcoin as another product available on its front-end.
“That’s our strategy across all products. Our front-end is a marketing tool to trade cross-asset class. This is another way to do that,” says Martin.Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio