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The Systemic Risk of Financial Bitcoin Products

The world of Distributed Ledger Technology (DLT) and its possible implementations is currently being explored from many different angles. There are numerous interest groups in this field as both incentives and risks draw an increasing level of attention to new projects with high potential impact. No perspective is easily generalisable because, at such an early stage of progress of this technology and its projects, most use cases are novel and therefore full of idiosyncrasies. This means that there is a sensitive need for accurate information about all aspects of those companies and organisations with the intention to use this technology in any form.

The blockchain concept is the most prominent version of Distributed Ledger Technology. However, it is not yet clear whether it will maintain its position or whether other DLT concepts such as block directed acyclic graphs (blockDAG) or transaction-based directed acyclic graphs (TDAG) will supersede block chains as peer-to-peer networks that validate data transfers. Consequently, the position of the most popular cryptocurrencies like Bitcoin, Ethereum, Ripple, etc. is not as stable and clear as it may seem now. The companies and the projects listed on, a platform tracking the history of the capitalization of thousands of different cryptocurrencies, deployed these DLT concepts and will have to proof their real-life impact which will determine their correct value with time.

Functionality and coherence – the systemic correctness – of a project is being tested while already being funded by early-stage or angel investors and venture capitalists. These investors promise themselves large returns on their investments by trying to identify potentially fast-growing but still undervalued start-ups. This process contains several interconnected risk-dependencies which implies that there is a high level of (risk-)complexity for all stakeholders. These include regulatory uncertainty on the legal side since this field just emerged and therefore needs a framework. This, as well as psychological risk, for instance the lack of market experience of said firms that could be used to design an investment outlook. What produces the complexity is the fact, that another risk factor, namely financial risk, is strongly affected by this legal and political risk, due in no small part to social and academic developments which again feed back into this conglomerate of risks.

All these aspects, one might argue, are part of the every-day life of people invested in the markets, as well as regulators, such as politicians and bureaucrats. There are, unfortunately, two problems regarding this assessment. The first being the lack of knowledge concerning the implications of this potentially disruptive technology, the second being that many of the afore-said regulators do not have skin in the game, meaning they are not directly exposed to the negative consequences of their own actions. The former implies that, at such an early stage, decisions regulators make do not properly take the described complexity into account. This phenomenon can be classified as a structural deficiency since it focuses on the regulatory environment that will heavily influence how market participants and future legislators will perceive the upcoming status-quo. The latter point describes the well-understood phenomenon that humans tend to be particularly risk-averse regarding future events when they are affected by possible negative consequences that might come with the events or as consequences thereof.

The U.S. Commodity Futures Trading Commission (CFTC) aims “[…] to foster open, transparent, competitive, and financially sound markets”. […] The Commission historically has been charged by the CEA with regulatory authority over the commodity futures markets. These markets have existed since the 1860s, beginning with agricultural commodities such as wheat, corn, and cotton. Over time, these commodity futures markets, known as designated contract markets (DCMs) regulated by the Commission, have grown to include those for energy and metals commodities such as crude oil, heating oil, gasoline, copper, gold, and silver. The agency now also oversees DCMs for financial products such as interest rates, stock indexes, and foreign currency [italicised by author].”

Additionally overseeing the more than $400 trillion swaps market, questions surrounding the actual capacity to deliver high-quality policies emerge. As reported last week, New York City-based LedgerX was granted permission to sell their newest speculative financial product, physically settled Bitcoin futures, not only to institutional but also to retail investors by the CFTC. The conservative perspective on this is that it is too early and too risky to allow such financial products, exactly when, as the CFTC states that “Bitcoin, a virtual currency, is a commodity unlike any the Commission has dealt with in the past,” according to CFTC Chairman J. Christopher Giancarlo.

Having a more risk-averse approach to products with a socio-economic influence as significant as that of Distributed Ledger Technology-based projects might be a more stable approach to avoid systemic risk. In the worst case, inappropriate decision making will increase the exact risk the CFTC attempts to prevent. A matter that the Future Citizen Institute will investigate is whether the classification of cryptocurrencies as commodities is suitable.

Author: Patrick Lehner

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