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Among the uncertainty, crypotocurrency derivatives should still be treated seriously by investment professionals

 
Peter M.J. Gross
The past, and future, of cryptocurrency derivatives
The past, and future, of cryptocurrency derivatives (Source: Getty)

Last year saw a major change in the way that news outlets covered bitcoin and other cryptocurrencies. Though cryptocurrencies have generated outrageous headlines in the years since their initial introduction, 2017 marked a milestone in their transition from fringe investment to alternative asset.

Bitcoin derivatives, which would make the investment accessible to a broader pool of potential investors, have been under discussion since 2013. But regulatory approval has been difficult to obtain. Two exchanges in the United States, CBOE Global Markets and CME Group, received authorisation and began listing bitcoin futures in December, and news outlets have been watching the settlements of those contracts closely to see what it could mean for bitcoin derivatives and for cryptocurrencies in general.

Previously, government regulators paid little attention to cryptocurrencies. A 2014 survey conducted by the US Law Library of Congress found that “only a very few” countries had specific regulations that applied to bitcoin. Recent moves suggest that governments are changing their stance and taking cryptocurrencies more seriously, especially as derivative products are explored in greater depth:

  • In Japan, cryptocurrencies have been recognised as legal tender, and 11 companies have been approved as operators of cryptocurrency exchanges. However, regulators have suggested that cryptocurrency derivatives would not be allowed unless the country’s existing laws are changed.
  • Canada may be in 'the pole position to win the race' to launch the first bitcoin exchange-traded fund (ETF).
  • South Korea has moved to tighten its controls on cryptocurrency activity. Cryptocurrency exchanges in the country have been prohibited from issuing new trading accounts, and the South Korean Financial Services Commission has indicated that it remains ready to intervene in the future.
  • Reports from China’s state media and remarks from Russian president Vladimir Putin have left investors concerned that the two countries will increase regulatory control over cryptocurrency activity within their borders.

Regulatory scrutiny has triggered volatile moves in cryptocurrency prices, which were already renowned for their extreme fluctuations. In 2013, the price of a single bitcoin moved from $34 to $140 in one month. Four years later, the price of a single bitcoin soared from under $10,000 to more than $17,000 in the course of a week. Since then, it has dropped down below $9,000.

Volatility cuts both ways, and each discussion about a new high in the price of bitcoin is often followed by — or sometimes part of — a story about unprecedented price drops.

The broader family of cryptoassets, which includes cryptocurrencies like bitcoin, has been developing in new and unexpected ways. An analysis of cryptoassets in 2017 found that bitcoin was outperformed by 13 other entries, among them Ethereum, a currency on a blockchain-based platform for applications, and Ripple, which is intended as a new payment system for banks.

As more funds flow between these cryptoassets and the conventional financial system, invesment professionals will need to deepen their understanding of these innovations and develop strategies that take their influence into account.

Join us in Hong Kong this May for the 71st CFA Institute Annual Conference to delve further into the debate on cryptocurrencies and participate in the conversations that will guide and shape the future of global investing.

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