Bitcoin Futures Threaten Destabilization, Warns Interactive Brokers Group CEO

In an open letter addressed to CFTC chairman J. Christopher Giancarlo and published today in the Wall Street Journal, Interactive Brokers founder Thomas Peterffy delivered a stern warning about bitcoin futures. “As a CME clearing member, we are deeply concerned [by] proposals that would allow Bitcoin and other cryptocurrency derivatives to be cleared in the same clearing organization as other products,” wrote Peterffy. “This letter,” he explained, “is to request that the Commission require that any clearing organization that wishes to clear any cryptocurrency or derivative of a cryptocurrency do so in a separate clearing system isolated from other products.”


As ETHNews previously reported, CME Group plans to offer bitcoin futures in the fourth quarter of 2017. This could occur as early as the second week of December, and the financial product has already drawn interest from major institutional investors like Man Group, a British hedge fund. For those keeping score, since October 2017, cryptocurrency derivatives platform LedgerX has been listing day-ahead swaps and monthly put and call options for bitcoin (BTC/USD).

To Peterffy, CME’s plan to limit price fluctuations for bitcoin futures would be like putting a Band-Aid on a bullet wound. Today, he painted a dark picture, recalling Silver Thursday, the 1980 silver market debacle perpetrated by brothers Nelson and William Hunt.

“There is no fundamental basis for valuation of Bitcoin and other cryptocurrencies, and they may assume any price from one day to the next,” wrote Peterffy. “This has been illustrated quite clearly in 2017 as the price of Bitcoin has increased by nearly 1000%.”

He rightly raised concerns about the immaturity of the cryptocurrency markets. Broadly speaking, cryptocurrency has not even been tested by a downturn in the American economy. Peterffy soberly offered a gloomy perspective, worrying about the ripple effects of bitcoin futures:

"Margining [bitcoin futures] in a reasonable manner is impossible. While the buyer (the long side) of a cryptocurrency futures contract or call option could be required to put up 100% of the value to ensure safety, determining the margin requirement for the seller (the short side) is impossible … If the Chicago Mercantile Exchange or any other clearing organization clears a cryptocurrency together with other products, then a large cryptocurrency price move that destabilizes members that clear cryptocurrencies will destabilize the clearing organization itself and its ability to satisfy its fundamental obligation to pay the winners and collect from the losers on the other products in the same clearing pool."

It’s tough to be a detractor when everyone else is swimming in their riches, but Peterffy remained steadfast. Judging by the tone of his letter, it seems like a safe bet that Interactive Brokers has no plans to invest in bitcoin.

As a counterpoint to Peterffy, one might argue that prices for all asset classes and derivatives are subject to manipulation and market failure. But, it’s also important to recognize that bitcoin arrives with a particular set of circumstances, and some of them are downright ugly. From flash crashes to trading bots, bitcoin – and its futures – come with a lot of baggage.

At the end of the day, it’s easy to accuse Peterffy of crying wolf – almost too easy. Investors and regulators would be smart to heed his warning. No matter how you cut it, mixing conventional markets with cryptocurrency seems like a risky proposition. As Peterffy suggested, insulating the rest of the financial system from the volatility of cryptocurrency would be the smart move.

A transcription of Peterffy’s entire letter is available below:

Dear Chairman Giancarlo:
I am the Chairman and founder of the Interactive Brokers LLC, a futures commission merchant and broker-dealer with over $ 3.8 billion in regulatory net capital and over $1.2 billion in client margin funds (Interactive Brokers Group is publicly traded on Nasdaq with a market cap of over $22 billion). As a CME clearing member, we are deeply concerned with proposals that would allow Bitcoin and other cryptocurrency derivatives to be cleared in the same clearing organization as other products.
This letter is to request that the Commission require that any clearing organization that wishes to clear any cryptocurrency or derivative of a cryptocurrency do so in a separate clearing system isolated from other products.
There is no fundamental basis for valuation of Bitcoin and other cryptocurrencies, and they may assume any price from one day to the next. This has been illustrated quite clearly in 2017 as the price of Bitcoin has increased by nearly 1000%.
Cryptocurrencies do not have a mature, regulated and tested underlying market. The products and their markets have existed for fewer than 10 years and bear little if any relationship to any economic circumstance or reality in the real world.
Margining such a product in a reasonable manner is impossible. While the buyer (the long side) of a cryptocurrency futures contract or call option could be required to put up 100% of the value to ensure safety, determining the margin requirement for the seller (the short side) is impossible.
Instituting daily price move limits on cryptocurrency derivatives does not solve the problem. In a runaway upward market for example (like the silver market in the 1980’s caused by the Hunt brothers), the futures price gets locked limit-up day after day with little or no trading and the short sellers are unable to cover, leading them (and potentially their clearing firms) to ruin.
If the Chicago Mercantile Exchange or any other clearing organization clears a cryptocurrency together with other products, then a large cryptocurrency price move that destabilizes members that clear cryptocurrencies will destabilize the clearing organization itself and its ability to satisfy its fundamental obligation to pay the winners and collect from the losers on the other products in the same clearing pool.
Accordingly, even clearing members who do not wish to clear cryptocurrencies because they judge the risk to be too great cannot isolate themselves and their customers from a potentially catastrophic loss from cryptocurrency risk at the clearing organization.
Thus, it is no answer for the proponents of clearing these products to suggest that objecting clearing members can simply charge very large margins or not offer cryptocurrencies at all. In a central clearing organization, all members are at risk for the activities of any member (and of the clearing organization itself).
Unless the risk of clearing cryptocurrency is isolated and segregated from other products, a catastrophe in the cryptocurrency market that destabilizes a clearing organization will destabilize the real economy, as critical equity index and commodity markets cleared in the same clearing organization become infected.
The only way to protect clearing organization and their members (and the financial system as a whole) from the unique risks inherent in clearing cryptocurrencies is to require that they be cleared in a separate clearing system, isolated from other products.
We would be happy to discuss this with you or to provide any further information at your convenience.
Sincerely,
(signed) Thomas Peterffy
Chairman