By John Hintze and Ted Howard
CFTC approval of LedgerX platform makes corporate use of digital currencies much easier.Â
Adopting new payment methods such as PayPal and Apple Pay typically involves complications. But solutions are emerging to facilitate their use. Companies that have agreed to accept digital currencies like Bitcoin and Ethereum have faced similar hurdles, and a recently approved derivative exchange and clearinghouse may prove to be just such a facilitator.
Today, a wide range of companies accept bitcoin as a source of payment, ranging from Microsoft to Virgin Galactic to numerous online travel agencies and gaming companies. Unsurprisingly, many of their businesses are technology-powered, but non-tech firms have also jumped onboard—Helen’s Pizza in Jersey City, NJ, has sold slices for the $2.50 equivalent in bitcoin since 2014, and it gives customers a 10% discount for using the digital currency.
From a corporate treasury perspective, however, digital currencies are highly volatile: September alone saw one bitcoin bounce from around $5,000 at the beginning of the month, to $3,200 by mid-month, and back above $4,000 a few days later. It’s now close to $6,000. For that reason, they’ve tended to use services provided by firms such as Coinbase and BitPay to convert bitcoins immediately into fiat currencies of their choice.
Soon, financial derivatives allowing companies to mitigate that volatility risk will be available. In July, the Commodity Futures Trading Commission (CFTC) granted approval to LedgerX, first as a swap execution facility and later that month as a clearer for those trades. The trading platform plans to offer bitcoin-based put and call options contracts as well as “day-ahead swaps” by the end of September, with derivatives for other digital currencies such as ethereum to follow.
LedgerX is not the first trading platform to offer digital currency-based derivatives. Derivabit was a short-lived trading platform for bitcoin options that regulators shut down for failing to follow regulatory procedures, and the Bitcoin Mercantile Exchange and Deribit offer offshore alternatives for trading digital currency-based derivatives. LedgerX’s distinguishing features, however, are that it has been approved by a US regulator not only to trade but also to clear transactions, much like major derivative exchanges such as the CME Group and the Intercontinental Exchange.
That should provide a green light for many accredited institutional investors. “These licenses offer a degree of comfort so far unseen in the digital currency space,” notes Paul Chou, CEO and cofounder of LedgerX, in a recent blog. “Aaron Brown, who analyzed digital currencies as the head of financial markets research at AQR Capital Management, said that LedgerX is essentially making digital currencies resemble more traditional financial products in the eyes of institutional risk and operations managers. And much as companies hedge interest-rate or volatility, they’ll be able to project revenues in bitcoin or another digital currency and then use derivatives to hedge swings in the currency’s value.
“A company that projects one bitcoin per day in revenue could send all those bitcoin to LedgerX, and use them to collateralize the selling of options to smooth the dollar cash flows,” Mr. Brown said. “For example, [it] could sell call options and buy puts. If bitcoin soars, the calls get exercised, and the company sells the bitcoin for the call exercise price. If [the price of] bitcoin falls, the company exercises the put, and sells the bitcoin for the put exercise price.”
Another significant distinction of LedgerX, noted Richard Johnson, vice president, market structure and technology, at Greenwhich Associates, is that trades are physically settled, whereas derivative trades on other digital currency-based trading platforms have been cash settled.
“That’s a benefit because if an institution executes a forward or options contract on LedgerX, it will have the option of taking delivery of the bitcoin, whereas other trading platforms do not allow that,” Mr. Johnson said.
In the case of corporates, however, they may not want to hold the digital currency, perhaps because it would require significant systems changes, or their auditors might decline to accept price validations due to accounting complications. Instead, Mr. Brown said, institutions may choose to roll day-ahead swaps. They allow for participants to reach an agreement on a price for bitcoin a day ahead of the transaction, a critical risk mitigation tool because bitcoin can’t be purchased in advance, and so its price may change between when the transaction is agreed upon and when it is settled. By perpetually rolling those swaps the end user will never have to take delivery of digital currency.
“It would be similar to rolling an oil futures contract. Instead of owning oil and having to worry about storing it, environmental problems, and so forth, an end-user can roll the futures contracts when they come due and retain all the economic exposure to the commodity without actually owning the messy, smelly stuff,” Mr. Brown said.