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Kleinberg Kaplan Lawyers Weigh In On Bitcoin

As hedge funds and all sorts of investors become more active in trading bitcoin and other cryptocurrencies, hedge fund lawyers Stephen Bielecki and Eric Wagner of Kleinberg, Kaplan, Wolff & Cohen have been analyzing the rise of digital assets throughout the year, as a number of Kleinberg Kaplan clients were already involved in or have entered the space, including some launching their own cryptocurrency-focused funds.
“Many anticipate that the launch of the futures platforms will pave way for the SEC to approve a bitcoin ETF,” Bielecki notes, as the futures market will likely help to create a more regulated and steady underlying market.
“It was already possible to trade bitcoin derivatives on LedgerX, but that platform does not have the same scale as CBOE and CME, so the market impact of the contracts created by these major exchanges may greatly outsize the effects that LedgerX has had to date,” he says. The market price may start to settle with these new mainstream futures offerings and even further once Nasdaq launches its bitcoin futures platform later in 2018.
In the near term, more buyers (of bitcoin and bitcoin futures contracts) could continue driving the market higher, Bielecki and Wagner add. “Many anticipate that futures trading will make it more attractive for institutional investors to gain exposure to bitcoin, both through futures and by actually acquiring the underlying bitcoin now that they are able to hedge those direct bitcoin investments, which could drive the price further.” But they caution, “It’s possible that aggressive bets against bitcoin via futures contracts could have a negative impact on trading prices of bitcoin itself.”
Bielecki and Wagner point out a potential market price stabilizer from the new futures exchange trading – more price sourcing. “CBOE and CME are planning to use relatively narrow price sourcing, but Nasdaq has said it expects its pricing to be based on dozens of global sources,” they say. “That broader-based sourcing may have a steadying effect on pricing by accounting for myriad bitcoin markets that, currently, sometimes have significant price dislocations.”
In the event of wild price gyrations, “CBOE will at least have the ability to halt trading if there are significant swings in short periods,” Bielecki explains.
And the fact that futures contracts allow investors to gain market exposure to bitcoin without having to hold the actual underlying digital assets, which can require significant technological and security infrastructure, may well help greatly expand interest in digital assets, Bielecki notes. “The futures exchanges may encourage more institutional investors to join the market.”
Still, the Kleinberg Kaplan lawyers flag a short list of several of the meaningful risks inherent to bitcoin and other cryptocurrencies that will continue to give pause to many investors, including some hedge funds. They note some of these:

  • Quickly evolving but uncertain and internationally inconsistent regulatory and legal environment surrounding cryptocurrency
  • Potential to lose a private key needed to transfer a virtual currency, potentially resulting in a permanent loss of investment
  • Ongoing risk of hack and malfunction, both of exchanges and personal digital wallets, and theft or loss of cryptocurrency
  • Higher margin requirements for bitcoin futures relative to non-bitcoin futures – for instance, the CME is requiring initial up-front cash postings for bitcoin that are far higher than those for crude, gold and other assets
  • Digital currency transactions, be they legitimate, or a result of theft or mistake, are generally not reversible
  • Evolving security threats, especially as smaller retail and novice holders become appealing targets due to inferior or easily breached security measures and larger institutional investors become appealing targets due to potentially increasing value of their holdings
  • Universal adoption of any particular cryptocurrency, and cryptocurrency in general, is highly uncertain
  • Lack of qualified service providers to support those holding cryptocurrencies
  • Intellectual property claims that may call into question a given cryptocurrency
  • Rapid changes to cryptocurrency systems – software modifications affecting transaction speed, memory size, etc.
  • Prohibitive costs of insuring digital assets and lack of viable insurers
  • Ongoing infiltration of bad actors, as cryptocurrencies are still often used for illicit purposes in dark corners of the web

Even with the technical, reputational and economic perils of investing, Bielecki and Wagner expect the market to continue building out, particularly for sophisticated investors. “That extreme volatility is itself a draw for many hedge fund players who have developed their own strategies for digital currencies, be they, for example, buy-and-hold, cross-exchange arbitrage or direct investment in companies participating in the broader cryptocurrency ecosystem,” they say.
“Certain fund investors are not looking for exposure to just a one- or two-percent day-to-day price swing, and now they can look to futures markets to make longer-term bets, in either direction, on potentially much wider price differences,” Bielecki notes. “Volatility presents great opportunity (as well as potential down-side) for traders, while futures present a chance to steady the market, since, no matter how bullish some are on bitcoin, bears can now take the other sides of their trades.”