Putting Bitcoin in the Swaps Box
(Bloomberg) -- T+1 settlement.
If I sell you a Bitcoin, what have I sold you? Is it a currency? A commodity? A financial asset? A security, even? Something new and different? There are tedious debates. I suppose you might find them interesting if you’re a philosopher of money, or of Bitcoin. But you might find them important—yet still tedious!—if you are a regulated financial institution thinking about trading Bitcoins. The regulations that apply to you contain lots of lists of things and what you can do to them, and you need to figure out where Bitcoin fits on those lists. You can do some things to securities, and other things to commodities, and still other things to currencies. What things can you do to Bitcoin?
On the other hand, if I agree to give you a Bitcoin in a month, and you agree to give me the money for it in a month, now we are getting somewhere. Now we know what I’ve sold you. The name for it is a bit squishy—“forward” is conventional, “future” is a variant (normally applied to exchange-traded contracts), and “swap” is a good general term—but nonetheless the applicable U.S. regulatory regime is much better understood. It’s a swap, and it’s regulated by the Commodity Futures Trading Commission, and if the relevant list of things says you can do stuff with swaps, then you can do exactly that stuff with Bitcoin swaps. (Unless Bitcoin is a security; securities-based swaps have their own regulatory regime.)
Anyway the Intercontinental Exchange might start offering Bitcoin trading, or at least, one-day physically-settled Bitcoin swap trading:
ICE has had conversations with other financial institutions about setting up a new operation through which banks can buy a contract, known as a swap, that will end with the customer owning Bitcoin the next day — with the backing and security of the exchange, according to the people familiar with the project.
The swap contract is more complicated than an immediate trade of dollars for Bitcoin, even if the end result is still ownership of a certain amount of Bitcoin. But a swap contract allows the trading to come under the regulation of the Commodity Futures Trading Commission and to operate clearly under existing laws — something today’s Bitcoin exchanges have struggled to do.
One-day physically-settled swaps! It sounds like a joke, a trick. We can sell you Bitcoins, but for regulatory purposes we have to wrap them in a plain brown paper bag called a “swap,” and you can’t open the bag until you leave the store.
This does not solve all of the world’s categorization problems. If you’re a regulated institution that is allowed to own swaps, and you buy a Bitcoin swap, then you own a Bitcoin swap and that’s fine, but if it’s a one-day physically-settled swap, then the next day you own a Bitcoin, and you’re right back where you started from. It does, however, crucially, solve the exchange’s categorization problems: It’s offering swaps trading, so it can go to the CFTC for approval of its offering, its processes, etc. Not only that, but there is a long history of commodity exchanges offering trading in futures and also helping with physical settlement processes. Metals exchanges let customers trade metals futures contracts, and also regulate systems of warehouses to store the actual metal so that futures customers can take delivery. Once you’re a regulated exchange, you can start building a regulated system for holding and delivering and keeping track of the underlying stuff.
Of course, when the underlying stuff is Bitcoin, there are some ironies there. For one thing, Bitcoin already has a system for holding and delivering and keeping track of itself. The point of Bitcoin is that it is a currency (asset, whatever) that doesn’t need any sort of third-party mechanism for storage or delivery: The Bitcoin blockchain is a decentralized ledger that keeps track of Bitcoins, and I can give you Bitcoins using that blockchain directly; a bank or exchange doesn’t need to be involved. But exchanges keep getting involved. (Separately, conventional financial exchanges keep talking about using blockchain technology to settle trades in stocks or bonds or whatever. I hope ICE will use a blockchain to keep track of its Bitcoin-swap trades, but not the Bitcoin blockchain.)
Another irony is that advocates of blockchain technology in finance often talk about the magic of instant settlement. One advantage of being able to transact directly over the blockchain is that you can do the transaction at the same time you agree to do the transaction. You don’t need to do a trade on the exchange and then spend days tracking down a custodian to get it to send your stocks to your counterparty; you just do a trade on the blockchain and, by virtue of that trade, your counterparty has your stuff. But for Bitcoins, the exchanges will actually create a settlement delay. I and others often talk about the idea that cryptocurrency advocates are rebuilding the financial system from scratch, and keep discovering why the old financial system had features—reversibility of transactions, centralized custody, securities-registration rules, flexible monetary policy—that cryptocurrency enthusiasts initially rejected. Perhaps delayed settlement will be one of those features that gets reintroduced to cryptocurrency because it is so useful. But that's not what this looks like. This looks like reintroducing a feature of old-fashioned finance solely for dumb mechanical compliance with old rules. You have the one-day delay not because it serves any useful purpose, but because it lets you check a regulatory box to call your thing a swap.
Also … will ICE build a warehouse to hold Bitcoins for its customers? Lots of exchanges have done that; a basic function of Bitcoin exchanges is to hold Bitcoins on behalf of their customers, rather than giving the customers the Bitcoins directly through the Blockchain. The problem is that there is a long and extremely consistent history of all those exchanges being hacked and having their Bitcoins stolen. If a giant regulated exchange like ICE—the parent company of the New York Stock Exchange—starts holding Bitcoins, it will be an irresistible target. If it does get hacked successfully, then that will be funny. (And a setback for Bitcoin trading among big institutions.) If it doesn’t, that will be funny in its way too. Bitcoin was designed by cryptographers to be secure and to supplant the regulated financial system; it’ll be funny if the way to securely hold Bitcoins turns out to be through the regulated financial system.
Incidentally: When I sell you a share of stock, what have I sold you? Well, conventionally, we would say that I have sold you a share of stock. But actually, if I sell you a share of stock on the stock exchange, what happens is that I agree to give you that share of stock in two days, and you agree to give me the money for it in two days. (It was three days until recently.) No one calls this a “stock swap” (or forward or future). They just call it a stock trade; a common term is “regular-way settlement.” You need a longer delay to transform a stock sale into a stock swap/forward/future. Perhaps a one-day settlement delay is enough to turn a Bitcoin trade into a Bitcoin swap, but it does seem odd.
Meanwhile in Bitcoin futures.
Have I apologized yet for how wrong I was about Bitcoin futures? In the weeks before Bitcoin futures started trading at Cboe Global Markets Inc. and CME Group Inc., a lot of people argued that Bitcoin futures would finally provide a convenient way to short Bitcoin, and that the shorts would rush in and deflate the price. Meanwhile I was galaxy-braining around being like “no no no you see this is a convenient way to buy Bitcoin, which was previously just as hard for careful conservative financial institutions as shorting it was, and so the introduction of Bitcoin futures will make the price go up.” And then the futures started trading and I took a victory lap, like, five minutes into the trading session, when Bitcoin hit a new record high.
And then it fell and has never recovered; Bitcoin is worth about half what it was when futures were introduced. If you read my posts about how futures would be good for Bitcoin prices and put all your money in Bitcoin … sorry about that? I don’t know, if you took anything here as investing advice then I think that is more your fault than mine, but nonetheless I confess that my call was pretty bad.
Here’s a Federal Reserve Bank of San Francisco Economic Letter about “How Futures Trading Changed Bitcoin Prices.” I suppose it is easier to be right about that question six months after the futures were introduced than it was a week before they were introduced, but still, the San Francisco Fed’s analysis is a little too textbook for my tastes:
Before December 2017, there was no market for bitcoin derivatives. This meant that it was extremely difficult, if not impossible, to bet on the decline in bitcoin price. Such bets usually take the form of short selling, that is selling an asset before buying it, forward or future contracts, swaps, or a combination. Betting on the increase in bitcoin price was easy—one just had to buy it. Speculative demand for bitcoin came only from optimists, investors who were willing to bet money that the price was going to go up. And until December 17, those investors were right: As with a self-fulfilling prophecy, optimists’ demand pushed the price of bitcoin up, energizing more people to join in and keep pushing up the price. The pessimists, however, had no mechanism available to put money behind their belief that the bitcoin price would collapse. So they were left to wait for their “I told you so” moment.
This one-sided speculative demand came to an end when the futures for bitcoin started trading on the CME on December 17.
Umm look I guess. On the other hand let’s say you had found a convenient and inexpensive way to short Bitcoin in, say, December 2016. No borrow costs, no creepy exchanges, just a perfect seamless way to sell Bitcoins now and buy them back in the future. If you did that on December 17, 2016—a year before futures were actually introduced—you’d have had a 100-percent loss by May. If you did it in May, you’d have had a 100-percent loss by August. If you did it in August, you’d have had a 100-percent loss by October. If you did it in October, you’d have had a 100-percent loss by November. If you shorted Bitcoins in November 2017, hoo boy.
I don’t entirely believe that the Bitcoin futures market is full of people taking naked short Bitcoin bets, is I guess my point here? The difficulty of shorting Bitcoin is not primarily about the mechanics of finding a way to short. It’s primarily about Bitcoin’s huge volatility and rapid rise and general ability to blow shorts up in like a day. You can find a lot of people pontificating that they’d love to short Bitcoin (here’s Bill Gates!), but they all … can … and … don’t? (Here’s Tyler Winklevoss telling Gates, go ahead, short Bitcoin, be my guest.) Even with the introduction of Bitcoin futures, there is no convenient way to express the view that “Bitcoin will eventually go to zero but I have no idea what these crazy kids will get up to for the next few years.” And that seems to be the actual short-Bitcoin thesis. If your thesis is “Bitcoin will go to zero in a month” then, sure, go ahead, short the futures, but I have trouble believing that there’s much money staked on that thesis. It seems a little nerve-wracking, you know?
How’s Mick Mulvaney doing?
Mick Mulvaney, who was installed as the head of the Consumer Financial Protection Bureau as a grim joke, has played a series of pranks there:
Since taking over in November, he has halted all new investigations, frozen hiring, stopped data collection and proposed cutting off public access to a database of consumer complaints. He dropped most cases against payday lenders — a primary focus of the consumer bureau — and also proposed scrapping a new rule that would have heightened scrutiny of an industry accused of trapping vulnerable customers in a cycle of debt. And he has tried hard to persuade Congress to take away funding authority for the bureau from the Federal Reserve — so that Congress can cut it.
Good ones, good ones. And here’s kind of a meta joke:
Mr. Mulvaney seems happiest when describing new ways to undermine the consumer bureau by, say, removing its online complaint system from public view — or using the agency’s obscure statutory name, the “Bureau of Consumer Financial Protection,” to undo years of branding.
“The reading of the statute actually revealed some very fun things,” an excited Mr. Mulvaney told his friendly audience of bankers last week. “C.F.P.B. doesn’t exist! C.F.P.B. has never existed!”
We’ve talked before about the dumb fight between Mulvaney and Leandra English, the former deputy director of the CFPB, who tried to mount a coup and declare herself director. That fizzled out, unsurprisingly, but Mulvaney’s comments suggest the compromise that should have happened. Mulvaney should be head of the BCFP, which will have no funding, do no investigations, hire no one and do nothing. He’d love it! English can be head of the CFPB, which will employ all the people who used to work at the CFPB to do all the investigations it used to do. And then they can argue about whether it exists.
Conflicts of interest.
We have talked before about the dumbest and most obvious conflict of interest in financial advising, which is that if you are a financial adviser it is in your financial interests to sell more financial advice, while that is not always in your customer’s interests. It is a conflict that is not limited to financial advising—it is just as applicable in car sales or clothing sales or anything else—and one that is difficult to resolve, since it is not some weird arcane scam but is inherent in the nature of capitalism. Still you could do this:
One of Australia’s biggest banks has scrapped sales-based bonuses for its financial planners and vowed to drop planners who provide inappropriate advice.
In a first among the country’s largest lenders, Australia & New Zealand Banking Group Ltd. said Monday that it is implementing initiatives to improve the quality of financial planning and of remediation for customers when things go wrong. … ANZ said it would end sales incentives for bonuses and assess planners solely on customer satisfaction, the bank’s values and risk and compliance standards.
It only gets you part of the way there. I assume that an ANZ financial adviser who never sells anything will eventually be fired. You gotta do some business, to stay in business. I look forward to the first case of a financial-advice conscientious objector who goes to work as a financial adviser, never sells any financial products because she doesn’t believe in them, gets fired, and sues.
We talked last week about Shawn Carter, a/k/a Jay-Z, who was subpoenaed by the Securities and Exchange Commission to testify in a securities investigation. I joked, “He’ll probably show up at the SEC’s offices and they’ll begin ‘Mr. Carter, would it be accurate to say that Iconix had 99 problems and an accounting write-down of Rocawear intangible assets was one?’” But Jay-Z’s lawyers made more or less the same point, seriously, in responding to the subpoena:
Jay-Z, whose given name is Shawn Carter, was willing to testify for a full day, but not “day-to-day until completed” as the SEC is seeking, his attorneys wrote in a court filing dated Monday. The lawyers cited Jay-Z’s concern that the agency’s request “is driven more by governmental fascination with celebrity and headlines than by any proper investigative purpose.”
I do not want to impugn the motives of the SEC here, but … right? Like, I mean, they are conducting an investigation into accounting irregularities. That is fine as far as it goes, but it’s a little dry. It’s not gonna thrill your kids when you talk about it at the dinner table. Breaking up the forensic accounting analysis with a little time spent hanging out with Jay-Z is obviously pleasant. Though not so much for him. “Suffice to say, the professional and publicity demands on his time are enormous,” add his lawyers. Nor is it obvious that his testimony is that relevant. As Bloomberg points out, it’s a “probe of a firm he did business with more than a decade ago.” It feels like one day would be enough?
Here is a heartwarming story about a recently deceased secretary at a big New York law firm who lived frugally, saved her money, invested wisely, and left a $9 million fortune when she died, almost all of which will go to charity. Because my readers are miserable cold-hearted cynics, like five people have sent me this story to be like “surely this was insider trading?” No? I feel like I read enough of these stories that focus on the magic of frugality and compound interest that I am not inclined to suspect the secretary. On the other hand:
“She was a secretary in an era when they ran their boss’s lives, including their personal investments,” recalled her niece Jane Lockshin. “So when the boss would buy a stock, she would make the purchase for him, and then buy the same stock for herself, but in a smaller amount because she was on a secretary’s salary.”
What if they were all insider trading? (She apparently started there in the 1940s, when that might have been a bit more socially and legally acceptable than it is today.) Still I don’t buy it. Also, I don’t spend a ton of time arguing that insider trading is a victimless crime, but, you know. So what if she was insider trading? What if she spent 67 years accumulating $9 million from the stock market, a little bit at a time, and then gave it all to charity? Is that actually worse than not doing it?
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