Bitcoin Q&A: CME Bitcoin Reference Rate - YouTube

[AUDIENCE] My question is about [the Chicago Mercantile Exchange].

On December 10th, if I'm correctly informed, the CME is going to start futures trading [of bitcoin].

Since this year, we have seen already two forks, almost three.

Forking is something quite new to a futures exchange; the underlying assets usually don't fork.

I haven't seen gold or oil contracts forking. The implications can be quite heavy.

For instance, on BitMEX, when the futures close on December 31st, they are not going credit any 2X coins,

so the futures were trading well below spot price.

When the email was [sent about 2X being cancelled], there was about [a five-minute period where]...

you could [trade and] easily profit on that.

How will forks affect the futures market?

[ANDREAS] Okay, that's a really great question.

I know a lot of people have questions about the Chicago Mercantile Exchange.

I'll tell you a few things about it. First, I'll start with a disclaimer.

I work on the oversight board of the Chicago Mercantile Exchange's Bitcoin Reference Rate.

I took this position eight or nine months ago. It is unpaid, just in case you were wondering.

Of course. The point of this is simple.

Before the Chicago Mercantile Exchange embarked on this idea of doing a futures market, one of the things...

you need is the ability to have a consistent, predictable, publicly audited reference rate, meaning a price.

A price, both every 30 seconds as well as point price once a day, that you use to underpin the legal contracts.

So if two people are disagreeing on what the price of bitcoin was yesterday, they need a way to answer that,

which is essentially non-reputable and that they're both bound to.

The Chicago Mercantile Exchange therefore started this process by building these two reference rates.

The Bitcoin Real-Time Index (BRTI) is a spot price that updates every 30 seconds and gets published on...

traditional trading feeds like Bloomberg and Reuters.

That allows a trader anywhere in the world to answer the question: "What is the price of bitcoin today?"

With a high degree of certainty.

The other one is a point price, which is [updated] every day at 2:00pm CT.

It is a moving average taken at a point in time that is considered the daily rate.

The role of the Oversight Committee-

I'm sorry, this is a long disclaimer, but it gives you some context as to how these markets operate.

The role of the Oversight Committee is to create and oversee the application of rules...

regarding which exchanges are used to pull data about the current bitcoin price.

We created these rules in a open public consultation, that involved publishing the minutes of all our meetings,

with three independent experts that have nothing to do with the CME.

I'm one of them, an Imperial College professor is another, and a customer of the CME is the third.

We published these rules.

[One of them is that] you have to publish a price consistently and not stop publishing a price.

You [also need] to have trading fees. We immediately excluded exchanges that did not have trading fees,

because they can [potentially] run bots that create fake volume.

Out of these rules came that system.

The part of the CME that is [running] the futures market is completely unrelated to this.

I found out about it on Reddit. They didn't and couldn't tell me in advance, because...

what we do is public and auditable, so I found out about it [online like everyone].

I think it's fascinating. I think it's inevitable. I think it was going to happen anyway.

You've got to understand that this is a cash-settled market, meaning nobody holds actual bitcoin.

For the CME to operate this market, they need to have a corresponding long position for every short position.

Both have to be capitalized in U.S. dollars against the CME.

CME customers, who have very strict requirements for capitalization, have collateral deposited and audited...

on a daily basis.

That collateral can be used to take certain positions, but not too-big positions.

They can't go over their collateral beyond a certain level. They have to be matched with buyers and sellers.

They also have some trading circuit breakers, which ensure that if the price of bitcoin drops or climbs...

more than seven percent [in a day], they cease trading.

Which means, at this point in time, they would be ceasing trading three times a day. [Laughter]

But hey, that's the tolerance of risk they could have.

Some of the people who objected to [a bitcoin futures market] were the traditional investors in the CME.

They said, "This is too risky of an investment to include in the CME,"

which is hilarious because the CME has been in the business of managing risk...

for 200 years, trading physical commodity futures in very risky and volatile markets.

The price of wheat is doing great, [then] you have a drought that was unexpected,

the price of wheat collapses,

and now you have to pay out billions of dollars to farmers who [took] positions in these futures markets.

That's what they're used for.

Who is going to short Bitcoin? That is a question I get [asked] a lot, related to the CME futures.

Who the hell would short Bitcoin? [Laughter]

Well, there's a couple of options. When trading opens on December 10th, we might see quite a lot of shorting.

Part of the reason bitcoin is so volatile is because you can't take a position against it.

If it starts pumping, the price can really just go to extreme heights without any downward pressure.

It's unbalanced in that way, so who would short it?

Maybe some traders and investment banks, they're gonna short Bitcoin.

They're going to do so at great risk, just like people who try to short the stock market [bubble] right now...

do so at great risk.

I think the most interesting possibility is,

the people who take short positions with the least amount of risk are miners.

Miners actually hold the underlying asset, so unlike the people who are naked shorting,

they're not naked shorting; they have the collateral to make good on that option call if they lose the bet,

without loss, and their risk is not unlimited.

If I'm a miner, and I have to pay electricity [bills] next month, I don't know what the price of bitcoin will be...

and I'm earning bitcoin today, that's a very risky position.

If the price collapses suddenly, I may go out of business -- not because of profitability but because of cash flow.

That's not a smart business.

So I take 10% of my bitcoin and I put it in a short position.

If the bitcoin price does collapse, that gives me a cushion, a margin.

It allows me to recover some of my losses from the price decline, so I can pay electricity [bills] next month.

If I calculate my cash flow [needs] and operating costs,

I could figure out exactly how much bitcoin I need to short in order to have a good risk-reward premium.

Basic market economics.

If the price climbs tremendously, everybody who's short loses their shirt and I'm losing on my 10%

but I'm gaining on [the other] 90% of bitcoin that I hold.

I can take that position with very little risk and make money on it.

I expect we're going to see miner participation, in a big way, in futures markets.

Well-capitalized, properly-managed futures markets.

Some people say, "This brings legitimacy to bitcoin."

As you may have known from watching some of my talks, I am uniquely allergic to the world legitimacy.

It makes me want to vomit when war-mongering, war profiteering bankers use the word "legitimacy"

to criticize Bitcoin.

That takes a lot of audacity.

In this case though, I think it's important to recognize that the CME is not Wall Street.

The Chicago Mercantile Exchange comes from a 200-year tradition of mercantilism.

There are people who trade in actual commodities.

These markets trade not just oil, but probably their biggest product is pork bellies, wheat, corn, ethanol,

and hundreds of other commodities.

Their primary purpose is to protect risk for producers of these commodities.

They're not the type of Wall Street mentality that is about printing money out of nothing,

and creating derivatives on top of derivatives.

I don't think these people are as alien to our culture as many believe. I've met a few of them.

Before we go bundling all investment bankers [together], I think it's important to recognise that.

I have no influence or interest in the CME futures market. I know it is creating a lot of interest.

I think the period between December 10th and December 31st is going to be very exciting;

twenty-one days of extreme excitement.

The most likely thing to happen is we're going to see a lot of [trading] volume.

You think we have volume in bitcoin now? [Laughter]

When you watch a trader eat a sandwich, while he presses 'Enter] on a $10 billion trade,

you realize how small this game is.

We're going to have a lot of volume, and that's not bad; that is the first step to reducing volatility in bitcoin.

That's what we need: massive liquidity. I'm glad it was the CME that did it first.