On May 11, 2020, ErisX announced it was listing physically-settled futures contracts on Ethereum (ETH). This makes ETH the second most exchange-traded digital asset after Bitcoin (BTC). The contract specifications are fairly straight-forward. The notional size is 1 ETH coin and there are several different expirations, from daily, weekly, monthly and quarterly. The contracts are required to be fully-funded, so the purchase price of the ETH must be posted by a purchaser and the physical ETH must be deposited with the clearing house before a participant can trade. In other words, no margin will be permitted to trade these products. To date, not much volume has transacted in these contracts. Trading in BTC futures and options and ETH futures has yet to catch on here. In fact, newer offshore unregulated exchanges like Binance and BitMEX continue to dominate with respect to trading volumes in cryptocurrency derivatives. Of course, US traders are not able to trade those products.
So why is this such a big deal? Maybe the ETH futures are too early or maybe trading will never catch on here in the US. Fascinating to consider, however, is that ETH began its existence as both a commodity and a security. Listing a security regulated by SEC rules on a futures exchange regulated by CFTC rules sounds odd, right?
ETH was first sold to purchasers through a crowdsale, with the proceeds being used to fund development of the blockchain. This occurred in 2014. The marketing and sale of ETH would probably have qualified the crowdsale of ETH as a covered offering under the Howey test: it is an investment of money; there is an expectation of profits from the investment; the investment of money is in a common enterprise; and any profit comes from the efforts of a promoter or third party. Yet, as of 2018, in comments made by William Hinman, Director, SEC Division of Corporate Finance at the Yahoo Finance All Markets Summit he stated that ETH no longer represented a security offering. What happened?
In Hinman’s opinion, ETH had become sufficiently “decentralized.” Since the value of ETH is no longer determined by the managerial efforts of the promoter, it had lost all auspices of a security. As Hinman stated, the “material information asymmetries recede. As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite [material information] disclosures becomes difficult, and less meaningful.” Mr. Hinman goes on to say that: “And putting aside the fundraising that accompanied the creation of Ether, based on my understanding of the present state of Ether, the Ethereum network and its decentralized structure, current offers and sales of Ether are not securities transactions. And, as with Bitcoin, applying the disclosure regime of the federal securities laws to current transactions in Ether would seem to add little value.”
Although ETH is no longer considered a security, it remains a commodity. As such, it makes sense that a futures contract on an ETH underlying trades on a regulated futures exchange outside of SEC jurisdiction.
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