30 Nov 2021

Eurex

Eurex provides investors a trusted path to crypto

As traditional institutional investors increasingly look to diversify their portfolios towards cryptocurrencies, it is critical to address the challenges of entering these markets. With its client base in mind, Eurex launched Bitcoin ETN Futures, giving Europe its first regulated market in Bitcoin-related derivatives. Introduced on 13 September 2021, the future paves the way for investors on what Eurex has dubbed 'a trusted path to crypto'.


Driving Eurex's launch of this product has been the feedback from traditional financial institutions approaching this asset class. Eurex plays a leading role in the derivatives landscape. As Surbhi Singh of Equity Sales at Eurex puts it, "At Eurex, we care about the end-customers and provide a safe environment and a trusted market. And while Eurex may not be the first on the market, it offers a leaner and cleaner product."

In a recent webinar, panelists from Eurex, the ETC Group, and BitGo discussed the key features of this innovative product and addressed security compliance and regulation. The panel also looked at the current trends in the crypto space and what can be expected in 2022.

Moderator Cornelius Trenz, Head of Marketing at Eurex, kicked off the session by polling participants on their current interest in cryptocurrencies. The audience's view of the crypto markets was overwhelmingly positive, with a majority (51%) already trading or invested in cryptocurrencies and an additional 23% declaring to be open to future investment in crypto.

Reacting to the poll, panelist Surbhi Singh is positive about the findings. "I think it's brilliant that more and more investors are adopting virtual currencies." According to Ms. Singh, there is a clear trend among investors increasingly picking up cryptocurrencies. While professional investors have already been participating since 2013, a viewpoint shift is occurring by the traditional financial institutions from rejecting crypto to embracing it. The question is now 'How do we interact with this asset class?'.

Ms. Singh sees a growing, resilient market with leading countries embracing the currencies. On a nearly weekly basis, more and more companies, institutions, and banks are announcing that they, too, are adopting cryptocurrencies."We see decentralized apps; we see NFTs and central banks rolling out their own currency. Just in the past year, about 2 trillion was invested in digital assets of which 900 million belongs to Bitcoin."  

Considering these rapidly changing developments, the industry wants to get regulated. For this reason, Eurex must offer its investors a solution. Panelist Sascha Semroch, Product Development at Eurex, describes the key features of the newly launched derivatives product. "Eurex set out to make an offering for institutional clients in Europe." For that reason, Eurex chose an underlying exchange-traded note (ETN) that fully represents the movements of the coin while traded and settled on a regulated exchange. So far, the biggest hurdle for traditional financial institutions was related to the custody of Bitcoin. By choosing a paper asset representation of the Bitcoin, Eurex overcomes this hurdle for traditional financial institutions. And if desired, the ETN can then be redeemed for the Bitcoin token. 

Another aspect is liquidity and accessibility. Two market making firms quote the entire trading day, making the product tradeable. There is no additional infrastructure needed; the future trades like any other Eurex product. Eurex physically delivers 1,000 shares on expiry day and uses the 17:30 Xetra auction price to determine the final settlement price. This feature gives an indirect settlement into Bitcoin. Upon delivery, you get the paper assets as a representation of a claim into Bitcoin. The pricing is very close to the bitcoin euro rate. Reflecting the short-term trading of Bitcoin futures, Eurex offers the next three monthly expiries and the following quarterly expiry. Sascha Semroch also notes that the five-euro tick value for 1,000 shares means it is attractive for tick traders, traders who ask for the bid/ask spread and high-frequency traders.  

Mr. Semroch sees the closed and secure environment in which the futures and its underlying are traded as one of the prime features of the products.  The futures and the underlying trade on a regulated, European market with Eurex Clearing as the central counterparty and the notes in custody with Clearstream Banking. In short, a financial institution does not require anything extra to be able to trade. “It's only a matter of one's own compliance and risk management. For Eurex NCM's, the onboarding approach is to ask their clearing firm to support the product and provide the risk management compliance approvals.” 

As for the default fund of the CCP, it should be noted that the crypto futures are part of the overall default fund. A separate liquidation group is created for the crypto futures, meaning that the clearing members who do not have positions in crypto derivatives will not be asked to participate in the default auction.

Bradley Duke, CEO of the ETC Group and issuer of the ETN, elaborates on the ETN and its features. He sees that traditional financial institutions want exposure to the crypto asset class in a regulated market that genuinely reflects the price of Bitcoin. As easy as that sounds, that is not so easily achieved. Most other products trade at a premium or discount but thanks to the ETN’s full fungibility, there are decent arbitrage opportunities for market makers in this product, resulting in a relatively steady tracking error between 5 and 20 basis points. Secondly, he argues, institutional investors look for liquidity. According to Bradley Duke, the ETN is by far the most liquid Bitcoin ETP in Europe and often also most liquid worldwide, which can be attributed to the high number of regular market makers in the product. He also stresses that the product is fully backed by Bitcoin and that the coins are entirely unencumbered, meaning that they are not used for anything other than covering the issued notes. Moreover, this product is 100% backed by Bitcoin. ETC group is formed around investor security. Unique to the product is that an independent administrator has to approve each transaction whenever there is a movement of crypto and securities.

Bradley Duke also addressed the difference and similarities between the highly publicized launch of the Bitcoin ETF in the U.S. First, as a result of regulation, the product issued by ETC group can't be called an ETF but, it is in fact very similar to an ETF but then with better tracking as it is based on the coin and not on a future of the coin. Bradley believes this makes the ETN a better investment vehicle than what is available in the U.S. The product addresses other concerns as well.  Bradley also points out that the ETN has become a source of price discovery for Bitcoin as it has been becoming an aggregate price of various sources of Bitcoin. This is because the APs who are making markets in this product all source their Bitcoin in various places. By design, institutional investors will never have to receive or be obliged to take cryptocurrency unintentionally or unwanted. The trading profile is the reason Eurex selected BTCetc. It is a product that trades significantly tighter than its nearest competitor.  It dominates in average daily trading volumes. Secondly, the assets under management are significant, with 1.5 billion USD worth of Bitcoin behind the product. And, finally, it is ETC's assessment that BTCetc is eligible for Ucits. 

Also on the panel is Darren Jordan, Managing Director EMEA at BitGo, to explain how BitGo ensures safe custody. BitGo mitigates many risks by removing the single point of failure. The concept of blockchain is very new and quite different from equities and bonds.  However, many components are in line with existing custody practices. Since 2013, the challenge has always been regulation, governance, security, and operational processes.  As far as security, BitGo removes the single point of failure. BitGo pioneered the concept dubbed "multi-sig security," enabling solutions for failures with cryptographic keys, system and storage compromises, fraud and regional failures. 

BitGo was specifically designed from the ground up for the safekeeping of digital assets with regulation as a key. BitGo has multiple licenses in various jurisdictions and legal entities throughout Europe. There is also a fiduciary responsibility of a regulated entity with a minimum reserve requirement holding client assets in segregated accounts. By design, funds cannot be easily transferred, and two independent auditors provide governance.  Although the insurance market is very new to this platform, BitGo has obtained insurance provided by Lloyd syndicate. According to Darren, it's absolutely essential that a custodian can hold these assets securely. Otherwise, you're exposing yourself to many risks, which could be catastrophic.  

In their final remarks, the panelists drive home the point that this is a difficult asset class requiring a lengthy educational process when making your investment decision. One should not enter this market lightly. Also, looking at the rapid developments over the past year, there is a definite shift towards the institutional players and significantly longer-term holders. 

As Darren Jordan puts it, "We have to appreciate that this is a brand-new asset class. There's a need now for some diversification with digital asset space" Looking ahead, he sees exciting changes. "Hopefully, in 2024, when MiCA comes into play, we will look to see regulatory harmonization across the EU member states." 
Looking ahead in the ETD universe, Bradley Duke predicts that, “as the space and investors become more sophisticated, you'll see an increased appetite among investors. You'll see a proliferation of ETPs that are single asset-based and represent an index. You'll see more yield-bearing products.  As more institutional investors participate, we may see more upside volatility and less of the downside.”

Looking at the derivatives space, Surbhi Singh expects that there will be more innovative products, particularly more crypto indices.  “Currently, the volume isn't there because of the absence of certain other products.  Right now, Ethereum bitcoin indices and options make up 60% of the market share.  Customers want to know what else is out there in addition to Bitcoin. With the ETF's launch, we expect larger participation.” Furthermore, customers want to get more educated about how to trade this asset class and must keep in mind that this educational process could require up to a year. Darren Jordan agrees, adding, "Much of the barrier lies in understanding how the underlying works. Much education is needed around the nuances of how the blockchain works."
 

Watch the webcast replay here.


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