Comment Text:
CFTC:
There appear to be several questions that need to be answered regarding whether or not LedgerX’s application should be approved.
Does the bitcoin marketplace need hedging instruments?
It most certainly does. Per Tony Gallippi’s comments and remarks by other bitcoin market participants, there is no doubt that bitcoin’s volatility would be easier to tolerate if there were a hedging market. In short, a hedging market would be wonderful.
Would LedgerX actually be providing the marketplace with hedging instruments in a way that is fair and open to all participants?
Well, it’s hard to say. It appears as though larger market participants have a distinct advantage over smaller ones and that LedgerX’s SEF membership requirements problematic. That said, it’s certainly better than nothing. The bitcoin market would be better off with some hedging than with none, even if the hedging platform doesn’t “permit fair and open access”.
Is the collateralization mechanism acceptable?
A fully-collateralized DCO would be great, in that it would prevent anyone from losses caused by the actions of other DCO participants. There simply is no risk of default in a fully-collateralized DCO.
The problem appears to be the use of bitcoin as collateral. It might be safe to use bitcoin as collateral but it’s hard to know for sure. If security is 100% perfect then collateral in the form of bitcoin works nicely. But 100% perfect security is a myth. It just plain doesn’t exist. Without 100% perfect security, the DCO is no longer fully-collateralized. Losses could be sizable and the whole thing would fail.
The other side of the coin is the USD collateral: it would be nice to understand LedgerX’s plan for keeping all the USD collateral safe. What happens if LedgerX’s bank fails while holding participant collateral? There have been 484 bank failures in the US over the past six years.
The collateral issue should not be trivialized. A normal DCO wouldn’t be faced with risks like these. The best way to proceed is for LedgerX to create a cushion fund with commitments from members. That would make it just like any other DCO.
Are the settlement prices and indices acceptable?
LedgerX’s has explained that settlement prices are not based on an index but rather provided by participants and liquidity providers. It is difficult to understand what that means. An option needs to have a clearly stated strike price, and exchange-traded options need to be fungible. LedgerX needs a reliable index from the bitcoin spot market, and the spot market can’t be subject to manipulation.
LedgerX has indicated they’ll conduct market surveillance in the bitcoin spot market. That sounds good, but it will not be easy to implement. Gaining inside access to the various bitcoin exchanges around the world is not going to be easy. New exchanges pop up all the time and old ones die. Some exchanges have been around for a long time but have unknown ownership and management structure (btc-e.com is the best example). LedgerX will struggle to determine the difference between price manipulation and a natural movement in price without cooperation from the various exchanges.
The problems related to settlement prices and indices are not beyond a solution. Right now, however, LedgerX hasn’t provided a realistic approach.
Has disclosure been sufficient and adequate for public commentary?
It seems that disclosure has been inadequate. The comments submitted thus far have demonstrated the opacity of the situation. But that can be remedied with an extension to the comment period.
