By Ted Howard
New CFTC-sanctioned derivatives exchange brings cryptocurrencies closer to institutional use.
Swap execution facility trueEX recently announced that it plans to launch a regulated “derivatives marketplace for digital assets” aimed at bringing confidence and transparency to a market institutional investors would quickly learn to love. But while blockchain is a tool that many are exploring, most so far have sidestepped bitcoin as an asset class.
The sidestepping is partly because cryptocurrencies are volatile and have wide bid-offer spreads; it’s also because there are other, more mundane corporate finance tasks to handle. As a priority, blockchain ranked well behind corporate functions like data analytics, mobile, artificial intelligence, cybersecurity, and robotic process automation, according to a PwC 2017 Global FinTech Survey.
But corporations should be paying attention because the tech is cropping up everywhere, from possible central bank sovereign cryptocurrencies to smart contracts to cross-border payments and now to derivatives.
“Corporate treasurers should be watching blockchain closely, because within a couple of years it will be on everyone’s agenda,” said Caitlin Long, a blockchain expert who jumped to the sector from a senior Morgan Stanley position working with corporate treasurers. “A few corporates have quietly been using bitcoin since 2014, but mostly in small markets where banking systems are not well-developed.”
TrueEX, which has the first exchange approved by the Commodity Futures Trading Commission (CFTC) as a designated contract market (DCM) for swaps, plans on offering contracts for bitcoin non-deliverable forwards (NDFs) settled in US dollars. The contracts themselves still await final approval from the CFTC.
One of the other hurdles is liquidity. Bitcoin and digital currencies, in terms of market size, are still in the billions while all other mainstream asset markets are in the trillions. Nonetheless, trueEX says this is the beginning of a solid foundation for blockchain-based currency use to grow.
“Institutional investors and commercial partners are ready for a regulated and liquid marketplace to gain exposure to and hedge these increasingly important digital currencies and commodities,” Sunil Hirani, founder of trueDigital Holdings, an affiliate of trueEX, said in a release announcing the launch. “But the marketplace is sorely lacking the necessary foundation, infrastructure and platforms that institutional investors have come to expect in other important markets.”
Ms. Long agreed with that assessment. “The first step toward building the infrastructure necessary for risk-averse institutions to enter the cryptocurrency market, such as corporate treasury departments, was the entry of risk-seeking institutions, such as hedge funds, to work out the kinks,” which happened a few years ago, she said.”
TrueDigital Holdings is also entering into a partnership with ConsenSys, which provides blockchain resources, tools and talent to companies. The company mainly deals with Ethereum, which is the most widely known cryptocurrency after bitcoin. With this partnership, trueDigital is hoping to create “a benchmark rate for Ether” as well as build the infrastructure needed for the broad adoption by institutions..”
“NDFs on digital assets are the logical next step for institutional investors who are seeking exposure to bitcoin and other digital currencies,” Brooks Dudley, vice president of risk at ED&F Man Capital Markets, said in a statement.
Still, it could be some time before the currencies gain traction with corporates. And there remain many aspects of using the technology that need hashing out. For instance, there will be accounting factors to consider. According to PwC, under current US accounting rules, “cryptocurrency is not cash, currency, or a financial asset; rather, it should likely be accounted for as an indefinite-lived intangible asset.” Thus, suggests PwC, “declines in the market price of cryptocurrencies would be included in earnings, while gains beyond the original cost.… would not be captured.”
Ms. Long counters that this accounting treatment only applies if a company wants to hold onto the cryptocurrency itself. “But that’s not what most companies would do,” she said. “If a company exchanges the cryptocurrency for cash simultaneously upon receiving it—via a third party—then the cryptocurrency never touches the company’s books and the adverse accounting treatment doesn’t apply. The simultaneous sale also means the corporate avoids exposure to price volatility.”
Then there are various jurisdictional issues. Some countries, like China, are trying to tightly control the market; others like the UK are keeping a close eye on it but at the same time, trying nurture what could eventually be a lucrative (a fee, tax, and license-generating goldmine) market.
“This, too, is another reason that corporates should welcome the arrival of institutional trading venues. Cryptocurrencies should be thought of in the same vein as any illiquid currencies, except that they permit instantaneous settlement without counterparty risk and can be self-custodied. I believe they will start appearing on corporate treasury FX screens fairly soon, and companies will start using them when they provide cheapest execution.”