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Two regulated exchanges--the Chicago Board Options Exchange and CME Group--have been trading bitcoin futures since mid-December. Nasdaq says it intends to start trading bitcoin futures in 2018.
Bitcoin futures allow institutional investors to get exposure while avoiding the operational risks in holding bitcoins directly. But it may be some time before defined benefit pension funds adapt to the new asset class because of its volatility, the fiduciary risks, and potential price manipulations, sources told Bloomberg Law. Bitcoin is known for its unpredictability. In mid-December, after a 19-fold increase since January 2017 to almost $20,000 per bitcoin, the price dropped by almost 40 percent within five days. But even before this plummet, a double-digit surge or dive within hours was common.
The fluctuations haven’t stood in the way of pension funds expressing an interest in bitcoin, Matt Moran, vice president of CBOE Global Markets, told Bloomberg Law. Moran said he’s received calls from funds and expects to be getting more, but it doesn’t mean they’ll be buying bitcoin futures overnight. “It might take years for some pension funds to move to a newer type of asset,” he said.
CME declined to comment on whether any pension funds traded, or showed an interest in, its bitcoin futures.
Bitcoin isn’t correlated with other markets such as stocks and bonds, and therefore it gives pension funds another way to diversify the risks, said Carlo P. Las Marias, co-founder of CoinAlpha, a cryptocurrency hedge fund.
Moran agrees. “We’re not talking about a 100 percent allocation. A question to be asked is: Could 1 percent allocation make sense as a diversifier?” he said. Although bitcoin can be volatile, the Employee Retirement Income Security Act’s prudent investment rule asks pension funds to look at how an investment interacts with the entire portfolio. ERISA funds are also supposed to diversify portfolios to minimize the risk of large losses, he said. Moran was a trust counsel for ERISA plans at a bank before joining CBOE.Forty years ago, even stocks were viewed by certain state pension plans as being too risky; in the next five to 10 years, it might not be prudent to invest in just stocks and bonds, Moran said. “So there is a lot of interest in getting into alternative investments to diversify portfolios,” he added.
Although bitcoin futures would diversify the portfolio, bitcoin has well-documented volatility, and plan sponsors might not want to take the risk with even a small allocation, Keith Clark told Bloomberg Law. Pension plans focus on future liabilities and contributions due because benefits are defined in documents, said Clark, a partner of DWC ERISA Consultants, and an adjunct professor at the University of Minnesota, Carlson School of Management.
Regulation of bitcoin futures is no different from regulation of other futures products, said Kari Larsen, co-head of ReedSmith LLP’s global FinTech team.
Larsen’s practice focuses on innovative commodities and she was counsel for the CFTC enforcement division. Bitcoins are considered commodities by the Commodity Futures Trading Commission, which has exclusive jurisdiction over commodities futures, she said.
Trading of bitcoins on non-futures exchanges isn’t entirely unregulated either, Larsen said, with a “patch-work quilt” of regulations by the Securities and Exchange Commission, CFTC, FinCEN, and state authorities applying to some exchanges; but non-U.S. exchanges that don’t provide access to U.S. investors are largely unregulated by the U.S. regulators.
But Clark said the lack of government control of bitcoin itself is still going to be a concern for plan fiduciaries, who are required by law to act in the best interests of the plan participants. Bitcoin isn’t a tangible product and isn’t controlled by any government, and having futures trading doesn’t change this, he said.
Bryan Hedrick, a fund manager for a pension fund in the Dallas Fort Worth Area, said he doesn’t think pension funds will invest in bitcoin futures in the foreseeable future, even though most state plans including his don’t forbid futures in particular.
“There are just so many unknowns that it’s not worth the time,” he told Bloomberg Law.
Hedrick said bitcoin hedges nothing and can’t be compared to precious metal or agricultural commodities, which have been traditional hedgers against inflation. The only way Hendrick could see bitcoin futures in a pension fund is if they’re invested in a holistic, actively managed futures strategy that includes all kinds of futures, he said.
There’s also a risk that reference rates of these futures contracts are subject to potential manipulation, because the bitcoin market is still small and less liquid than stocks and bonds, Las Marias said. A reference rate is set in futures contracts to indicate the price of the underlying asset and determine how much traders win or lose.
$10 million worth of trading might not do much in a market that’s worth more than $1 trillion, but it could move the bitcoin price as it represents a larger percentage of volumes traded for the day, Las Marias said.
Kevin Batteh, partner of Delta Strategy Group, thinks bitcoin has enough liquidity that price manipulation isn’t an overriding concern. Price difference created by manipulation on one exchange could be offset by people exploiting price difference between exchanges; not to mention that the reference rates of the futures involve multiple exchanges, he said. Batteh was a chief trial attorney with the CFTC Enforcement Division and a counsel for the CFTC commissioner.
In contrast, Las Marias said it’s actually hard to exploit price differences among exchanges. It takes very long to move fiat currencies like U.S. dollars between exchanges; therefore, price variance is still high.
“The cryptocurrency market has grown so fast and people are thinking ‘Is it a bubble?’ So the possibility of it crashing is still pretty high,” Las Marias said. “It might take a while until it becomes a major asset class widely adopted by institutional investors. The path of getting there is hard to say, but I think it’s eventually getting there.”
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