Streetwise Professor

September 14, 2019

Bakkt in the (Crypto) Saddle

ICE is on the verge of launching Bitcoin futures. The official start date is 23 September.

The ICE contract is distinctive in a couple of ways.

First, it is a delivery settled contract. Indeed, this feature is what made the ICE product so long in coming. The exchange had to set up a depository, the Bakkt Warehouse. This required careful infrastructure design and jumping through regulatory hoops to establish the Bakkt Trust Company, and get approval from the NY Department of Financial Services.

Second, the structure of the contracts offered is similar to that of the London Metal Exchange. There are daily contracts extending 70 days into the future, as well as more conventional monthly contracts. (LME offers daily contracts going out three months, then 3-, 15-, and 27-month contracts). The daily contracts settle two days after expiration, again similar to LME.

The whole initiative is quite fascinating, as it represents a dual competitive strategy: Bakkt is simultaneously competing in the futures space (against CME in particular), and against spot crypto exchanges.

What are its prospects? I would have to say that Bakkt is a better mousetrap.

It certainly offers many advantages as a spot platform over the plethora of existing Bitcoin/crypto exchanges. These advantages include ICE’s reputation, the creation of a warehouse with substantial capital backing, and regulatory protections. Here is a case in which regulation can be a feature, not a bug.

Furthermore, for decades–over a quarter-century, in fact–I have argued that physical delivery is a far superior mechanism for price discovery and ensuring convergence than cash settlement. The myriad issues that were uncovered in natural gas when rocks were overturned in the post-Enron era, the chronic controversies over Platts windows, and the IBORs have demonstrated the frailty, and vulnerability to manipulation of cash settlement mechanisms.

Crypto is somewhat different–or at least, has the potential to be–because the CME’s cash settlement mechanism is based off prices determined on several BTC exchanges, in much the same way as the S&P500 settlement mechanism is based on prices determined at centralized auction markets.

But the crypto exchanges are not the NYSE or Nasdaq. They are a rather dodgy lot, and there is some evidence of manipulation and inflated volumes on these exchanges.

It’s also something of a puzzle that so many crypto exchanges survive. The centripetal forces of liquidity tend to cause trading in a particular instrument to gravitate to a single platform. The fact that this hasn’t happened in crypto is anomalous, and suggests that normal economic forces are not operating in this market. This raises some concerns.

Bakkt potentially represents a double-barrel threat to CME. Not only is it competing in futures, if it attracts a considerable amount of spot trading activity (due to a superior trading, clearing, settlement and custodial platform, reputational capital, and regulatory safeguards) this will undermine the reliability of CME’s cash settlement mechanism by attracting volume away from the markets CME uses to determine final settlement prices. This could make these market prices less reliable, and more subject to manipulation. Indeed, some–and maybe all–of these exchanges could disappear if ICE’s cash market dominates. CME would be up a creek then.

That said, one of the lessons of inter-exchange competition is that the best mousetrap doesn’t always win. In particular, CME has already established liquidity in the futures market, and as even as formidable competitor as Eurex found out in Treasuries in the early-oughties, it is difficult to induce a shift of liquidity to a competitor.

There are differences between crypto and other more traditional financial products (cash and derivatives) that may make that liquidity-based first mover advantage less decisive. For one thing, as I noted earlier, heretofore cash crypto has proved an exception to the winner-takes-all rule. Maybe the same will hold true for crypto futures: since I don’t understand why cash has been an exception to the rule, I’d be reluctant to say that futures won’t be (although CBOE’s exit suggests it might). For another, the complementarity between cash and futures in this case (which ICE is cleverly exploiting in its LME-like contract structure) could prove decisive. If ICE can get traction in the fragmented cash market, that would bode well for its prospects in futures.

Entry into a derivatives or cash market in competition with an incumbent is always a highly leveraged bet. Odds are that you fail, but if you win it can prove enormously lucrative. That’s essentially the bet that ICE is taking in BTC.

The ICE/Bakkt initiative will prove to be a fascinating case study in inter-exchange competition. Crypto is sufficiently distinctive, and the double-barrel ICE initiative sufficiently innovative, that the traditional betting form (go with the incumbent) could well fail. I will watch with interest.

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  1. Agreed. A step forward in the maturation of the market, especially re. regulatory protections, away from what you correctly identify as the somewhat dodgy crypto exchanges.

    And if they’d been a month earlier, they would have been ready to handle all the ‘safe-haven risk-off’ business that is about to rush in on Monday following the Saudi refinery attack. Huge news!

    Comment by EX-Global Super-Regulator on Lunch Break — September 15, 2019 @ 4:39 am

  2. There are many reasons that the expected crypto exchange shake out has yet to materialize: decentralization as a feature not a bug, differing uses and views on crypto that are based on geography, an over abundance of coins/tokens, and the fact that the overall market is still to small for many players to even care about it. However, the the biggest reason is time: it is very early days for crypto and while changes will be profound they will unspool over decades, not years. Those that want to learn more should attend the Voice of Blockchain event in Chicago on September 30 / October 1. I’ll be leading a panel on “Exchanges Grow Up” that features representatives from Beaxy, Kraken and Eventus Systems. Go to for details.

    Comment by Chuck Mackie — September 16, 2019 @ 8:35 am

  3. Cryptocurrency trading platforms are sticky because they generally serve as the wallets for their customers. There are charges for withdrawing coins and the process is time consuming. It is like futures clearing – you have figured out how to deal with BOTCC and moved everything to CME Clearing and now I should move it back to an undercapitalized BOTCC so I can trade on Eurex US? Gemini is leveraging stickiness with its recently announced initiative to process and settle OTC and outside brokered trades between customers – thus tending to keep those customers’ crypto on deposit from wandering out of Gemini.

    Coinbase, Kraken, Gemini, itBit, and the other major US platforms do not seem to be dodgy nor risky from financial and operational points of view. Bakkt’s unique selling point here is regulation, I suppose, but LedgerX, which offers its SEF customers regulated next day bitcoin settlements, hasn’t exactly thrived in this space.

    While you, the author, may disdain the cash settlement that is used for bitcoin futures at CME, there have been no reported problems with its functioning so far.

    The ex-US crypto platforms are very innovative and competitive among themselves and trading volumes seem to shift around, even accounting for fraudulent reporting.

    At any rate, Bakkt’s entry into the marketplace will be worth watching.

    Comment by Thom Thompson — September 16, 2019 @ 8:35 am

  4. Why aren’t currencies settled in physical delivery? Why take a negative interest rate bond when you could just hold a pallet of paper? Certainly holding has carrying costs, but the negative rate bonds seem to exceed those now?

    Comment by Dave — September 16, 2019 @ 10:46 am

  5. What are your thoughts about Tassat (, (fka TrueDigital), which has essentially the same plan (an exchange with delivery settled contracts)?

    Comment by Rick Wilson — September 17, 2019 @ 3:09 pm

  6. Not mentioned so far, regarding the crypto-exchanges’ resistance to market consolidation, is the fact that most of their profit comes from transaction fees on obscure, faddish, low market-cap altcoins: the big money is in $h*tcoin churn. The smaller ones will list just about anything if someone is willing to pay a listing fee. Who pays these listing fees? Doubtless the early miners who built up a stash when the computational difficulty was low and subsequently need a market to dump into. Traders who play in this space don’t care if fees are low; they want to get in *early* in an attempt to ride something like BTC’s 10,000-fold rise.

    I don’t think our esteemed blogging host was going for comic understatement when writing “some evidence of manipulation and inflated volumes on these exchanges,” but let me say that, besides price, the financial data on these markets is about as credible as the official economic data from the communist bloc. Even the market cap figures are meaningless. Only about 1/30th of the Digix tokens are in circulation (and only that amount are backed by gold), for example. The rest are held by the sponsoring organization (simply because it is easier to code an ERC-20 token with a single fixed supply…nothing untoward there), but Coinmarketcap naively uses the full amount on the blockchain and multiplies by the price to get a market cap 30x the true value, and everyone else uncritically repeats the figure. And this is a case where the number of tokens in circulation is published on the website from an auditor’s report, arrgh! And that example is merely accidental. Intentional manipulations are all all over the place, price pump and dumps, front-running orders, you-name-it, and in at least one case, different exchanges trading different forks of the blockchain history (completely defying the consensus protocol, but where else are you gonna sell?).

    A logical customer for a proper BTC futures market would be a crypto mining outfit. They can borrow dollars (to buy mining equipment for example) against their future income in Bitcoin, not all that different from a gold mining firm. I suspect, however, that price speculators will introduce mind-blowing quantities of churn.

    Comment by M. Rad. — September 19, 2019 @ 10:22 pm

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