Cboe Clear Digital has received regulatory approval to clear margined futures, paving the way for the exchange to launch new contracts which participants can trade with more capital efficiency.

In June this year Cboe Clear Digital received approval from the Commodity Futures Trading Commission to launch margined futures contracts. As a result, Cboe Digital said it is the first U.S. regulated crypto-native exchange and clearinghouse combination platform to offer leveraged derivatives products.

John Palmer, president of Cboe Digital, told Markets Media: “The approval was for the clearing business and gives us the ability to provide margin treatment on clearing. This really unlocks capital efficiencies and leverage that derivatives offer to market participants.”

Before the approval Cboe Digital could only offer fully collateralized trading and clearing of Bitcoin and Ether futures, which require customers to pay the full amount of a futures contract upfront. Margined futures are more capital efficient as customers only have to post  a percentage of the contract value as collateral.

The next stage is to obtain CFTC approval for the contracts that Cboe Digital wants to list, trade and clear. Palmer said that from Cboe Digital’s perspective, the exchange will be launching vanilla contracts that are structured to look like what is already available and it is aiming to offer physically and financially settled Bitcoin and Ether contracts in the second half of 2023.

“The CFTC staff worked with us and I want to thank them,” added Palmer. “Their approach has been fantastic and it is a win for the industry in the sense that there will be additional opportunity and potentially, additional liquidity.”

Once approved, the contracts will have to be executed and cleared through a Futures Commission Merchant (FCM) in a fully intermediated model.

Christy Goldsmith Romero, CFTC Commissioner, said in a statement that she approved Cboe expanding its clearing of futures contracts on crypto assets, while staying within the traditional U.S. futures intermediated market structure which has performed well through multiple stress events, including Russia’s war against Ukraine, the pandemic, and the 2008 financial crisis.

“Cboe’s application stands in stark contrast to FTX’s application for a bespoke disintermediated direct-to customer market structure,” she added. “The proposed FTX model was never adopted by the Commission, but it put at risk customers’ bankruptcy priority, other customer protections, and financial stability.”

In 2021 FTX, the crypto exchange which has since filed for bankruptcy, completed its purchase of LedgerX and gained a CFTC-regulated designated contract market, swap execution facility and derivatives clearing organization. FTX US Derivatives proposed to replace the traditional distributed risk clearing model involving FCMs with an automated and centralized process that did not use intermediation.

Goldsmith Romero continued that Cboe has agreed to hold itself to a higher financial-resources standard than the law requires which recognizes the heightened risks associated with clearing in a nascent marketplace, like crypto, and acted to limit risk.

The commissioner requested additional measures for critical risk-mitigation in order to approve the application including strengthened cybersecurity and operational risk protection through regular updated Systems and Operational Controls 2 audits and opinions that Cboe and third party service providers have met or exceeded, standards; strengthening cybersecurity by amending its vendor management framework to improve third-party risk management of custodians and wallet providers; and Cboe changing its rulebook to not admit any clearing firm that has been found to have violated a provision of law identified by Congress as significant enough to prohibit a firm—without a hearing—from engaging in a CFTC-regulated business.

“Too often in recent years, crypto firms have sought to take a business model or market structure that exists in an unregulated environment and port it over to the regulated environment,” she added. “Cboe has not done that, instead operating within the parameters of the traditional futures market structure and regulatory framework.”

Palmer explained that Cboe Clear Digital has a separate default fund, and that risk and margining will be specific to the contracts that are traded and cleared with Cboe Digital, with cash initially used for collateral.

“We will launch with dollars and then get feedback from our participants on other types of collateral that we could potentially take in for margin purposes,” he added.

The roadmap for expansion potentially includes launching options and offering portfolio margining by offsetting futures and options positions, which increases capital efficiency.

“Once we launch, pending other approvals, we will be able to expand the pie which is a win for industry participants looking for regulated access to derivatives, ” said Palmer. “The industry is still figuring out how to operate in spot markets but there is a clear pathway for derivatives and we are really excited.”

Volume growth

Palmer continued that a differentiator for Cboe Digital is that it provides the unique ability to trade spot and margin futures with the same entity and the same technology, making it much more efficient for market participants.

Cboe Digital’s spot market supports trading in Bitcoin, Bitcoin Cash, Ether, Litecoin and the USDC stable coin. Spot crypto markets trade 24 hours a day, 7 days a week, but most futures markets still trade five days a week, and 23 hours a day.

Cboe Clear Digital has been built to trade 24/7, 365 days a year, but Palmer said for the futures market to extend its hours all intermediaries, such as FCMs, would have to support the shift. Cboe Digital launched in May 2022 after Cboe Global Markets completed its purchase of Eris Digital Holdings (ErisX), an operator of a US-based digital asset spot market, a regulated futures exchange and a regulated clearinghouse.

How will the upcoming launch of our U.S.-regulated, margined #Bitcoin and #Ether #futures contracts impact #crypto markets?

Read this Insights piece by John Palmer to find out: https://t.co/1RO0rCr5gG pic.twitter.com/98DhDyL5sR

— CboeDigital (@CboeDigital) June 23, 2023

Palmer said that since the acquisition closed, daily spot volume on Cboe Digital has increased between 10 and 15 times.

“A year ago we were trading between $5m and $7m a day and now we are doing anywhere from $50m to $70m a day,” he added. “In February this year Cboe Digital set new daily volume records of between $340m and $350m of spot notional which is a testament to our liquidity.”

Last November Cboe completed the syndication of minority equity interests with a group of thirteen firms becoming investor partners in the Cboe Digital business including B2C2, DRW, Galaxy Digital, GSR, Hidden Road, IMC, Interactive Brokers, Jane Street, Jump Crypto, Robinhood, Susquehanna International Group, tastyworks and Virtu Financial. Palmer said Cboe Digital has been onboarding these partners as liquidity providers.

“We’re actively engaging with the industry to showcase that liquidity, the competitive spreads and will be onboarding additional partners over the next couple of months,” Palmer said.

He continued that having a native spot platform attached to a futures platform provides those partners the opportunity to easily hedge, which will also improve liquidity and volumes.

There will be more competition for Cboe Digital in digital asset derivatives. In May this year Miami International Securities Exchange (MIAX) completed its acquisition of LedgerX from the bankruptcy proceedings of FTX  and LCH SA, London Stock Exchange Group’s European clearer, has announced it will provide a new segregated clearing service for digital asset derivatives venue, GFO-X, as more trading in the asset class is expected to move to regulated venues.

Palmer said seeing more participants in the space is a good thing for investors and for digital asset market structure.

“Competition provides benefits to the participants that are trading which is a win for the industry,” he added. “We are comfortable with operating markets in highly competitive asset classes and look forward to growing the pie.”