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October 25, 2017  

Shorting Cryptocurrency "Next Logical Step'

Several digital-currency trading operations are rolling out short-selling services and derivative products to make it easier for cryptocurrency hedge funds to actually hedge.

Genesis Trading, a digital-currency market maker, has just introduced a currency-lending service that allows fund operators to short bitcoin the same way equity managers short stocks. Gemini, the cryptocurrency exchange run by Cameron and Tyler Winklevoss, is developing a bitcoin futures contract in partnership with CBOE Group that should be available before yearend. And earlier this week, derivatives-clearing startup Ledgerx began trading options and swaps referencing bitcoin.

“Allowing market participants to express both long and short viewpoints is critical to increasing price discovery,” Cameron Winklevoss said.

Until now, fund managers have had an extremely limited capability to hedge their long positions in digital currencies or generate profits via short bets — which explains why virtually all of the 100-plus cryptocurrency hedge funds that have launched so far are long-only vehicles. While some foreign exchanges trade cryptocurrency derivatives, most professional asset managers have steered clear of those venues over concerns about counterparty risk.

“There are very limited options that currently exist that give institutions the ability to go short bitcoin or other digital currencies on a large scale,” said Matthew Ballensweig, a business development and research associate at Genesis. “We definitely think there will be a large market.”

Indeed, within two years, Genesis foresees institutional short interest in bitcoin reaching $1 billion to $3 billion. And the amount could increase to the range of $10 billion to $15 billion within five years as more institutions begin investing in digital currencies. Since the start of the year, the total market value of all such currencies has grown nearly ten-fold, from $18 billion to $170 billion. A recent survey of 119 hedge fund managers by BarclayHedge found one out of four currently hold digital currencies or plan to in the near future.

Genesis is offering cash-collateral short trades on bitcoin with terms ranging from two weeks to one year, with position sizes up to $10 million. For now, the New York firm is drawing from its own inventory of bitcoin, but expects to begin tapping clients as demand grows. It also plans to expand its offering to include other types of digital currencies.

Gemini, which began working with the CBOE in August, initially will offer cash-settled bitcoin futures with near-term delivery dates. But it plans to introduce longer-dated contracts, and eventually may expand them to cover other types of digital currencies.

“A futures contract is the logical next step in the maturation of the bitcoin market,” Cameron Winklevoss said.

A short futures position can be used as a hedge by an investor who wishes to lock in a price or by a speculator betting purely on a price decline, a tactic that carries the potential for unlimited profit and unlimited risk. In a futures contract, the short position is taken by the investor who agrees to sell later at a set price.

Gemini's initiative is an outgrowth of a broader effort by the New York firm to offer investors exposure to digital currencies via exchange-traded funds. Gemini was the first to petition the SEC for a bitcoin ETF, but its application was rejected by the agency in March. Among other things, the SEC was concerned that too little was known about bitcoin trading globally to prevent market manipulation. The development of a bitcoin-futures market could help Gemini address the SEC’s concerns. Gemini is appealing the rejection of its application.

Ari Nazir, co-founder of cryptocurrency fund shop Neural Capital, said a number of startups are focused on developing more sophisticated products and services for the market, including new types of swaps and trading on margin.

“The market is early but it’s growing at a pace that’s attracting the types of people that are valuable to provide the mature financial instruments that work in traditional markets, and that’s good for the cryptocurrency space,” Nazir said. “What this space really needs to go from a $100 billion market cap to $1 trillion is institutional-type services.”

CORRECTION (10/25/17): This article has been corrected. The original version mistakenly referred to digital-currency exchange Gemini as Genesis Trading in two references. Gemini, not Genesis, is developing a bitcoin futures contract as part of a broader effort to offer inves-tors exposure to digital currencies via exchange-traded funds. And it was Gemini, not Genesis, that filed the first application for a bitcoin ETF with the SEC.