We continue the theme of traditional financial institutions are beginning to develop their products and services with virtual assets. We previously wrote about Central banks and the goals they seek to achieve, developing a national digital currency. In line — banks and stock exchanges, producing and selling digital derivatives.
10 September, it was reported that the international financial conglomerate Citigroup is developing a new trading mechanism, the most popular virtual currency. The Bank, acting as agent, will produce the so-called receipts to digital assets (digital asset receipts (DARs)), which will allow investors to directly invest in bitcoin without having to hold the coins in the accounts. New derivative financial instrument is conceptually similar to an American Depository receipt (ADR), the largest Issuer of which is Citigroup.
Underlying the ADR shares of foreign companies that are not traded on American stock exchanges and OTC trading platforms. The investor receives a receipt, and the shares of foreign companies deposited in American banks-depositories.
In the case of digital assets, storage will be engaged in a separate custodial services and clearing — Depository Trust & Clearing Corp (DTCC), in which an intermediary carries out the calculations on wall street. The Corporation’s participation in this project will surely add to the popularity of DARs, as investors can track their investment in their usual system.
In spite of the prolonged bearish trend, financial institutions are actively developing new financial derivatives of digital currency and Citigroup is not the only one. Chicago stock exchange CME and CBOE launched futures trading on bitcoin even in the winter of 2017. Goldman Sachs, contrary to rumors, continues to work on non-deliverable forward, and Morgan Stanley plans to offer its customers the opportunity to open short and long positions at prices of swaps total income.
The interest of financial institutions in the derivatives due to the possibility to attract new customers, expanded existing customers, to charge a Commission for transactions with derivative instruments. Investment Director at Arcadia Crypto Ventures Nitin EAPEN believes that financial institutions will develop other derivative instruments with virtual currencies:
“It’s a natural evolution, and derivatives is a method of risk transfer. Some of these instruments, such as options and insurance products will be developed as smart contracts and reduce the number of intermediaries.”
Traditional financial market the main advantage of derivatives to investors is to hedge the risk of price fluctuations. In turn, the sector of digital assets is constantly faced with the problem of high volatility. Thus, according to Coinmarketcap, less than two months in the period from 17 Dec 2017 7 Feb 2018 main virtual currency has fallen in price by 63% — the rate has dropped from $19 536 to $ 7 387.
Such jumps of prices attract speculators and traders, but may discourage investors who are interested in strategic investment in the long term. These include institutional investors and holders of big capital. The emergence of derivative financial instruments with a basis in e-currencies will make the digital market more attractive.
Derivatives solves the problem of having to hold and store electronic coins in private wallets, which are subject to frequent break-ins by hackers. In the case of derivatives digital assets will be stored in qualified custodians and specialized custodial services, which have a high degree of security.
In addition, DLT-industry remains relatively unregulated sector of the economy, and this uncertainty is of concern for serious investors. Derivatives can accelerate the process of institutionalization of space and, accordingly, promote greater transparency in price formation. However, these hedging instruments will support the establishment of insurance and arbitration, both of which are fundamental to the traditional financial players. Gianluca of GIANCOLA, co-founder of one DLT-ecosystems, believes that the settlement of derivatives should help to reduce the volatility of increasing maturity of the market.
“Digital community will benefit from the arrival of a large number of new players, which will increase market liquidity and allow you to carry risks with no slip price”
— said Mr. EAPEN. In his opinion, digital institutions such as Coinbase and Binance, will support the introduction of derivatives, while the old giants, who did not join the new trend and I missed the opportunity to attract new customers, such as, for example, the broker TD Ameritrade, will be talking about unreliable and fraudulent nature of such tools, putting psychological pressure on investors tactics FUD (instilling fear, uncertainty and doubt).
A logical continuation of the development proposals of derivatives may be to allow a bitcoin ETF. Despite the fact that the SEC rejects the bids, the Commission on securities and stock exchanges of the USA does not deny the possibility of imposing asset market in the future, and therefore, legalization of the asset is a matter of time.
“ETF will eventually be legalized. The Genie out of the bottle, and it is an asset class that cannot be stopped. Regulators want to control the base (virtual money). They equate it to stock or bonds, but is a beast in itself, and the Central government will not be able to tame his own rules. If they are late, automated contracts will be developed, and financial institutions will miss an opportunity to serve customers in this business,”
— considers g-n EAPEN.
But not all participants in digital communities want ETF received legal force. So, a consultant to institutional hedge funds and bitcoin enthusiast Michael GRAUB hopes that the decision on legalization of the asset will be postponed for as long as possible, but recognizes that such a position is a minority in a digital society.
“The reason that bitcoin doesn’t need wall street, but wall street bitcoin is needed. Wall street is only interested in spread trading, to charge a Commission. They will try to offer derivative products and, probably, will be able to extract their income in the short term, but ultimately the owners of these derivatives will realize that they actually possess, rather than physical paper bitcoin will fail. The main essence of bitcoin is to be your own sovereign Bank, free from any censorship”
This at first glance attractive financial tool there is another side of the coin. Virtually every derivative, with the exception that the options granting the right, contains the obligation to buy or sell a particular product. Ideally, each such financial obligation shall be secured by real assets.
However, practice shows that software often does not cover even the tenth part of the debts. Thus, in 2008 in connection with the mortgage crisis, the bankrupt investment Bank Lehman Brothers, the collapse of which was due to high leverage — the ratio of debt to equity was 31 to 1 in 2007 the Main assets the Bank held mortgage-backed securities and derivatives on them. At the time of default, the Bank was the largest counterparty in the credit default swap market (CDS). After the announcement of the bankruptcy of the Bank payments on CBC-position of the Bank amounted to $5.2 billion — 7.2% of the gross positions which DTCC is estimated at $72 billion.
What derivatives have become one of the causes of the crisis in 2008, when the total amount of derivatives totaled $600 trillion. The total value of real assets was about $600 billion, which provided only 0.001%.
Michael GREUB has every reason to fear the arrival of the players on wall street, because they are the key holders and investors in derivative instruments on the traditional financial market, and, therefore, of their investment in the digital industry will be made through borrowed capital.
That is, there can be a situation in which the share of financial liabilities in the market of digital currency is secured not only by electronic coins as other debt obligations. In this case, the process of the close correlation hitherto relatively independent of the digital space with traditional financial industry.
Co-founder and technical Director of the Blockchain Training Alliance Ernesto LEE says:
“Derivatives are essentially hedging or “sales risk” in the asset by tying it to another asset. Therefore, introducing this financial instrument in the cryptocurrency economy, you also enter the associated risk. This risk has a natural “built-in” potential of infection, because derivative instruments tie assets together and, consequently, the collapse of one negatively affects the other”.
The expert also adds that DLT technology underlying digital asset, provides a solution to the problem of trust in transactions, but not in derived digital tools that can cause the growth of speculation and fraud. This can lead to the formation of a bubble in the market of virtual assets in conditions of limited supply of bitcoin and the large number of unsecured debt.
It’s pretty hard to rate, will the new investment tool more benefit or harm of a digital community. Big money big investors come together with their debts. Whether bitcoin balance, time will tell.