LedgerX Thinks Bitcoin is Ready for Options (Again)

New York City startup LedgerX has submitted applications to the U.S. Commodity Futures Trading Commisions (CFTC), to register as a "swap execution facility and derivatives clearing organization." If approved LedgerX would be allowed to list physically-settled digital currency option contracts, particularly Bitcoin denominated contracts.

James Newsome1 told the Wall Street Journal in an interview:

It's no different than with corn farmers. They've got all this corn, the grain markets have been volatile. They could enter into hedging contracts knowing exactly what it's worth, and not worrying about volatility.

Newsome now operates a lobbying firm Delta Strategy Group, which LedgerX has retained to help persuade the CFTC. Newsome also stated the firm has taken an equity stake in LedgerX in exchange for discounted rates in the services being provided.

In order to have its application approved, LedgerX needs to prove that the underlying Bitcoin market2, isn't easily manipulated. The company also has to show that it can operate an exchange that can easily identify suspicious behavior in market making activities.

Earlier this year MPEx shutdown its BTC options contract market making operations citing multiple concerns. One chief concern was the physical delivery of put contracts – in short if the Bitcoin price falls to 0, the BTC required to cover the contract is infinite3. The only alternative is to settle the contract in terms of fiat.

The last month MPEx offered options contracts, Mircea Popescu describes the amount of capital he would need to cover put contracts for that month:

As has been widely reported, on February 4th the MPOE bot purchased on the open market a large volume of very deep in the money Put options. As the bot hadn't previously sold these, this obviously means the seller had underwritten them.

To think things through : 25k Puts struck at ~4700 dollars per BTC represent an unilateral obligation to pay up to infinity Bitcoin, or else perhaps through a settlement as much as 12 million dollars. In cash.

As a reminder, LedgerX has raised 15 million in Series A and seed funding from Google Ventures and Lightspeed Partners.

Of other concerns, the current high volume exchanges such as BTC-e and Bitstamp have a dubious history, and data feed providers have been notoriously littered with problems:

nanotube: mircea_popescu: bitcoincharts average got messed up one day, because anx.hk accidentally pushed dogecoin trade data in place of bitcoin – thus producing high volume at really low price, and screwing things up. I think charts has removed anx.hk for the moment.

Although two years have passed since pirateat40 defaulted, the havoc it caused cannot be forgotten. During this time Mircea Popescu believed there to be insider trading on his options market:

A good amount of CALLs were bought in July (over 1k), added to which a good amount bought since (over 2k) as well as a good amount of in the money PUTs were sold short (P180T, P190T, P200T, in total over 5k). The CALLs were executed shortly before the closure announcement of Bitcoin Savings and Trust. The PUTs were rebought on the market soon after the announcement, purchases continuing to the reversal of the position (the bot went from +5k to -5k on its book on those three MPSICs). The total losses resulting from these operations are roughly 4`500 BTC, which pretty much cover the month's poor results.

Other exchanges offering leveraged trading and options contracts have been hacked or blatantly scammed customers.

Perhaps like CDOs, Bitcoin may not be ready for options contracts.

  1. former chairman of the CFTC 

  2. Bitstamp, BTC-e, BTC China, et. al 

  3. the real world consequences of dividing by zero 

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