As bitcoin futures legitimize the cryptocurrency's standing in the firmament of financial markets, U.S. regulators have sounded a warning on exchanges like Cboe Global Markets Inc. (CBOE) and CME Group Inc. (CME) that handle the trades.
The Financial Stability Oversight Council, a panel of top regulators led by Treasury Secretary Steven Mnuchin, urged last week that industry supervisors pay close attention to the oversight of clearinghouses, which process transactions made on the exchanges and guarantee that traders will get paid out on winning bets.
Big banks that trade on the exchanges, including JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS) , have pressed regulators to make sure that they have adequate financing to handle a big bust. The companies' role in global markets has taken on added significance in recent years as more banks use the exchanges' clearinghouses to process private trading contracts known as derivatives, a type of financial instrument that can be used to speculate on interest rates and commodities.
The warning comes as the Chicago-based exchanges Cboe and CME vie to offer futures contracts on bitcoin, the cryptocurrency whose volatile and soaring price has attracted hordes of speculators and drawn comparison to the Dutch tulipmania bubble of the 17th Century. The CME started trading bitcoin futures this week, following the launch of the Cboe's rival contract last week.
Exchanges' clearinghouses work under the principle that big banks will share in the burden of guaranteeing transactions, raising the possibility that a default by a big trader could spread losses to a broader swath of the financial industry and potentially trigger a systemwide liquidity crisis.
Because the exchanges "clear a very large volume of transactions, and because of the extent to which they are interconnected with other large and interconnected financial institutions, it is critical" that the organizations be "robust and resilient," the oversight council wrote in an annual report published Dec. 14.
The warning is part of regulators' recent efforts to more proactively identify growing risks in the financial industry before they lead to a crisis like the mortgage meltdown of 2007-2008. Amid that debacle, big banks needed multibillion-dollar bailouts from the U.S. Treasury Department and collectively took more than $1 trillion of secret emergency loans from the Federal Reserve to stay afloat.
Regulators' response to that crisis was to push banks to use clearinghouses to process more trading contracts, so that the industry would hold more of its own responsibility for assuring the financial system's stability, rather than relying on the government. But banks have warned that the new setup has simply concentrated more risk in a few clearinghouses whose own collapse could the entire industry at peril.
The Futures Industry Association, a trade group comprising big banks and brokerage firms like Interactive Brokers Group LLC, wrote an open letter on Dec. 6 to Commodity Futures Trading Commission Chairman Christopher Giancarlo warning that bitcoin trading could expose the clearinghouses to major risks -- that could then contaminate the broader financial system.
The CFTC allowed Cboe and CME to create futures markets in bitcoin without a careful review, the association wrote in the letter. The bitcoin market suffers from a "lack of transparency and regulation" to assure it's not "susceptible to manipulation, fraud and operational risk."
Prices for bitcoin have surged more than 20-fold this year, reaching $19,770 early Monday on the CME.
In light of "public statements regarding the riskiness of the underlying cryptocurrency products, we believe that the launch of new exchange-traded derivatives in cryptocurrencies deserves a healthy dialogue between regulators, exchanges, clearinghouses and the clearing firms who will be absorbing the risk of these volatile, emerging instruments during a default," the letter reads.
The exchanges who are looking to profit from bitcoin trading should bear more of the risk of a default, instead of banks that may not even be participating in the cryptocurrency market, the group wrote.
JPMorgan CEO Jamie Dimon, for his part, has described bitcoin a "fraud" and "worse than tulip bulbs."
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