This post originally appeared in Money Stuff.
I want you to imagine a time, in the not-too-distant future, where the following things have happened (in this order):
- Bitcoin futures have started trading on the CME Group Inc.’s futures exchange, which they are scheduled to do by next month.
- JPMorgan Chase & Co. has offered its institutional trading customers access to the bitcoin futures contract through its futures brokerage, as it is contemplating doing.
- Everyone has decided that bitcoin is dumb and its price has collapsed, as JPMorgan Chief Executive Officer Jamie Dimon has said it will.
I do not want to speculate on the likelihood of these events. (Well, #1 seems pretty much inevitable, and I would bet on #2 myself, but you’re on your own on #3.) But you will concede that they are all at least possible. My questions are: Will the customers who lose money on bitcoin futures sue JPMorgan for letting them buy them? Will their legal briefs say “JPMorgan knew bitcoin was a fraud, and in fact its CEO said so, but JPMorgan nonetheless pushed bitcoin futures on customers”? Will there be congressional hearings? Will Dimon be called to testify? Will senators ask him why he sold bitcoins to clients after saying that people who buy bitcoins are “stupid”? Will he say:
- What clients are buying … is they are buying an exposure. The thing that we are selling to them is supposed to give them the risk they want. They are not coming to us to represent what our views are. They probably, the institutional clients we have, wouldn’t care what our views are, they shouldn’t care.
That did not go over especially well in the Senate in 2010, when Goldman Sachs Group Inc. CEO Lloyd Blankfein actually said it about the mortgage bonds that his bank sold in the lead-up to the financial crisis. Nonetheless it was true then, and it is true now, and it will be true in my imagined future. If you are buying bitcoin futures from JPMorgan it is because you want exposure to bitcoin. The fact that Jamie Dimon doesn’t want exposure to bitcoin may or may not be an interesting data point for you, but it is surely not dispositive. He has no inside information about bitcoin. Since Jamie Dimon announced that bitcoin was a fraud and will collapse, its price has almost doubled. He might still be right, but even if he is, you could have had a nice profit on a tactical trade since his announcement.
There is a notion, popular in some circles, that the point of an investment bank is to sell people securities that will go up: that it has a duty to its customers to carefully curate its product offerings and sell them only the stuff that it personally believes in. This is not the point of an investment bank. JPMorgan sits between people who want to buy a thing and people who want to sell the thing, and it intermediates their trades. Diversity of opinion — some people think the thing will go up, others think it will go down — is what makes a market. If JPMorgan could only trade with clients after satisfying itself that they are right, it would never do any trades.
Elsewhere in bitcoin futures, a reader emails:
- Can you answer something puzzling me? Just saw the bitcoin futures spec come out. And it is cash-settled. That is, against an index. Not physically settled. Now, isn’t this the one commodity that absolutely should be physically settled? It isn’t thousands of barrels of oil you have to move to Oklahoma. And isn’t the whole hype on blockchain that it is going to revolutionize settlements infrastructure because it is so much easier and cheaper than, oh, just for example, clearinghouses … like the one that will be handling the settlement of BTC futures?
Ha, it’s true. If you buy an oil futures contract on the CME, and you hold it when it expires, then someone hands you 1,000 barrels of oil, and you have to find a place to put them. If you buy a bitcoin futures contract, and you hold it when it expires, nobody hands you the 5 bitcoins underlying the contract. Instead, CME computes a daily “Bitcoin Reference Rate,” “which aggregates the trade flow of major bitcoin spot exchanges during a calculation window into the U.S. Dollar price of one bitcoin as of 4:00 p.m. London time,” and if the Bitcoin Reference Rate at the expiry of your futures contract is higher than the Bitcoin Reference Rate when you opened the contract, you get paid the difference (times 5), and vice versa. In dollars. You get exposure to bitcoin without ever actually handling bitcoins.
Of course this makes sense, because handling bitcoins is mostly terrible. The fate of every bitcoin exchange, I often say around here, is to have its bitcoins stolen, so CME is quite sensibly launching a bitcoin exchange without any bitcoins to be stolen. Individuals and institutions who handle bitcoins, meanwhile, have been reduced to writing their private keys on scraps of paper and putting those scraps of paper in safe deposit boxes. That is how securities markets worked, like, 50 years ago, but since then people have figured out ways to track stock certificates electronically, and have mostly gotten rid of the safe deposit boxes. If you’re an institutional investor who wants exposure to bitcoin, a futures contract that trades on an exchange that you already use is very helpful. A scrap of paper in a safe is hard to manage.
But it is awkward. If you are buying bitcoin futures, it is probably because you think that bitcoin will go up. If you think that bitcoin will go up, it is probably because you think it will be more widely adopted as a currency and a store of value and an alternative to the current financial system. But if you really thought that, you’d just buy bitcoins. You’re buying the futures because, deep down, you prefer the existing system. “The need for a bitcoin ETF,” I once wrote, and it is just as true of a bitcoin future, “is an argument against buying it.”
Oh also by the way eventually CME Group, like every other centralized financial intermediary, will announce with great fanfare that it is experimenting with putting its settlement system on “the blockchain.” (It already has a blockchain project for gold trading.) As we discussed yesterday, replacing clearinghouses’ central ledgers with distributed blockchains might be perfectly sensible in many cases, improving performance and reducing reconciliation issues. But of course these blockchains are not the bitcoin blockchain; they are private blockchains that only approved banks and institutions can use and that have trusted central administrators. I am looking forward to the day when CME’s bitcoin futures contract trades on a blockchain, but not the bitcoin blockchain.