It was reported that the Intercontinental Exchange (NYSE:ICE), parent company of the New York Stock Exchange (NYSE), is developing an online trading platform that would allow large investors to trade Bitcoin directly.
For a large financial institution such as ICE or Goldman Sachs (NYSE:GS), figuring out how to develop a cryptocurrency trading platform is a potentially complicated analysis that begins with the question of whether or not a cryptocurrency is a security. If a cryptocurrency is deemed a security by the Howey test, “there are a lot more regulatory requirements.”
While people agree that the Howey test can act as the ultimate clarifier of which cryptocurrency is a security and which is not; the distinction is also important for another reason.
Ultimately, the Howey test gives guidance on which regulatory agency polices which cryptocurrency. At this point, securities fall under the US Securities and Exchange Commission’s (SEC) jurisdiction.
Non-security cryptocurrencies or commodities are in the realm of the Commodity Futures Trading Commission (CFTC). The distinction is important because each agency has taken a different approach to policing cryptocurrency.
The SEC has gone after “low-hanging fruit.”
These are the “pump-and-dump” ICOs that are scams or otherwise illegitimate in their offerings to investors.
And, at least with ICOs, both agencies appeared to be on the same page in January 2018.
And just last week I learned that the SEC has created a fake ICO, whose token is being used as a way to demonstrate potential signs of fraud in ICOs to cryptocurrency investors.
Outside of the SEC’s scam scrubbing, the regulator’s behavior that is not exactly encouraging for private sector participants:The Commodity Futures Trading Commission (CFTC) and Securities Exchange Commission (SEC) say they want to have an active dialogue with industry participants to understand the latest trends and developments. Unfortunately, we see a lot of regulators initiating those conversations with industry players by way of subpoena. Whenever you receive a subpoena from a regulator, you have to be concerned that it could be a lead-in to an enforcement action. This dynamic doesn’t exactly promote a free and healthy exchange of ideas.
In late April, SEC Chairman Clayton said Bitcoin is not a security, and because Bitcoin will not likely be classified as a security, larger financial institutions like CME, CBOE, Goldman Sachs and now ICE are able to move forward with giving their clients exposure.
Not being a security also means that the CFTC is the federal agency that most often acts as a watchdog over Bitcoin transactions.
The Big Q: How will the CFTC will handle bad actors and fraud in bitcoin transactions?
The Big A: That is still being debated.
Outside of cryptocurrencies, the CFTC’s prerogative to cut down on fraud and market manipulation.
An underlying concern of the CFTC is that there are a number of people who can fairly easily impact prices with their trading. It makes it very difficult to regulate markets,but innovation is happening in futures and derivatives markets.”
If reports that ICE is considering using a model of trading Bitcoin with swap contracts, this type of trading would remain under the regulatory realm of the CFTC.
Swaps are a type of derivative contract where 2 parties trade based on a notional principal amount.
Generally, 1 of these amounts is fixed, while the other is variable, commonly based on an interest rate, floating currency exchange rate or index price. Swaps do not normally trade on exchanges but instead are over-the-counter contracts between different organizations. So, that suggests that ICE would likely use an interest rate swap, though they are most likely still figuring out what they will pin Bitcoin prices to.
Using the swap mechanism allows ICE to position themselves squarely under CFTC regulations, but getting that regulatory certainty looks like it will come at the cost of speed. One of the ideas behind Bitcoin and other digital currencies that made them so attractive as a concept was the idea that market participants could securely transact with one another almost instantly, without the need for intermediaries. But, if you have to create a swap product with a 1-day settlement frame to get regulatory clarity, then you lose a lot of what made digital currencies attractive in the 1st place. Lots of questions arise from that issue.
A Key reason why regulators have not moved more quickly to establish clear law around Bitcoin is that there remains debate and uncertainty about regulators, the CFTC in particular, to police the markets.
The implications of the rise in Bitcoin-based swap contracts also means that the instantaneous transaction, so highly placed in the early value of Bitcoin, might over for mainstream investors to gain less-risky exposure.
Lots of investors are weighing the risk of maybe not getting their money back when they need to unwind a trade. Traders who don’t want to deal with this will opt-into these trading platforms run by accredited institutional investors.
There is clearly more risk in operating on less regulated and decentralized exchanges. There may well be more lucrative opportunities as well, but there are all sorts of risks that a lot of traders want to avoid.
Bitcoin futures have garnered the attention of regulators and that will inevitably alter the sector, in what way is still an open question.
Weighing the risks of unregulated and decentralized exchanges draws back to the fundamental conflict that has been revolving around the cryptocurrency space since the Bitcoin white paper was published. i
Big Q2: Will Bitcoin remain truly decentralized or will the desire to hedge against risk lead the majority of traders to accredited and regulated institutions?
Big A2: For many who are invested in Bitcoin, not just for profit, but also ideological reasons, the answer appears obvious. Yet whether these early BTC adopters of a movement or no more than fringe factions will be decided by the market.
Another factor in ICE and other market institutions hopping into Bitcoin trading is an increase in the space’s technological innovation brought by increased competition.
The involvement of big financial players will affect the market, so established cryptocurrency exchanges are optimistic about the future.
The director of marketing at the Hong Kong–based cryptocurrency exchange, BTCC, believes that exchanges like BTCC “will remain the go-to cryptocurrency market for retail clients for the foreseeable future.”
He also pointed out that many legacy financial exchanges will have “high barriers of entry and inaccessible or confusing user interfaces.”
Citing “real-person 24/7 customer support and deposit options such as credit cards,” he believes that cryptocurrency exchanges will continue to create value that institutional exchanges are unable to offer. “In addition, legacy fiat exchanges are geographically bound, while exchanges like BTCC offer customers worldwide easy access to BTC/USD trading.”
Further, there are many regulatory hurdles for institutional exchanges, many of which have not yet been created.
Even if an exchange is authorized, investment companies and broker dealers and issuers of ICOs must become accredited before they can move forward.
The ICE Group indicated that plans for such a platform could dissolve at anytime based on the unregulated changes in cryptocurrency market.
The CEO of NASDAQ (NASDAQ:NDAQ) Adena Friedman said that Nasdaq would be open for Bitcoin trading when “people are ready for a more regulated market.”
Currently, Bitcoin is trading at: 8,303.4854, -216.50, or -2.54%, as of 4:14a BST, the market is open
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