Regulated ETH Futures? Not So Fast

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Noelle Acheson is a veteran of company analysis and CoinDesk’s Director of Research.The opinions expressed in this article are the author’s own. The following article originally appeared in Institutional Crypto by CoinDesk, a weekly newsletter focused on institutional investment in crypto assets.Sign up for free here . Earlier this month, Heath Tarbert – the new…

imageNoelle Acheson is a veteran of company analysis and CoinDesk’s Director of Research.The opinions expressed in this article are the author’s own.
The following article originally appeared in Institutional Crypto by CoinDesk, a weekly newsletter focused on institutional investment in crypto assets.Sign up for free here .
Earlier this month, Heath Tarbert – the new chairman of the U.S.Commodity Futures Trading Commission (CFTC) – declared that ether, the token of the ethereum blockchain, was a commodity .
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This is significant, coming from the regulator of one of the largest derivatives markets in the world.Why? Because it opens the door to the possibility of regulated ether derivatives in the near future.The chairman was even more specific : “I’d say it is likely that you would see a futures contract in the next six months to a year.”
The market got excited because this would enhance the token’s appeal to institutional investors.

Derivatives enable hedging, which is a significant part of portfolio management and a solid support for long positions.A lively derivatives market, the reasoning goes, will encourage more investment, which will boost the price, which will encourage more investment, and so on.
Yet, with respect, I believe the chairman is mistaken.We will not see ether futures in significant volume on a regulated U.S.exchange any time soon.If ever.
Reputation risk Although it’s not just about the lack of demand, let’s look at that first.
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Ether futures currently trade on exchanges based outside the U.S., but volumes have been thin relative to the spot market.

On BitMEX, Huobi and Deribit, three of the largest crypto platforms that offer ether futures, the average 24-hour volume is less than 10% that of bitcoin, while the equivalent ratio in the spot market is almost 25%.
The difference could be due to ethereum’s relative youth, and the gap could close as the network matures.Or it could be that bitcoin will always be the institutional-grade asset of choice, rendering ether derivative demand too insignificant for major markets to profitably develop.
Either way, demand can be flexible.The real barriers to a successful launch of ether derivatives go much deeper.
Underlying risk Last week ethereum developers announced the target date for the next system-wide upgrade: December 4.This will be executed via a hard fork, in which the entire ecosystem needs to change – blocks processed on the old version will not be valid on the new.

There are several of these coming up.
This introduces an additional element of risk into the market.Earlier this year, an upgrade was delayed just 48 hours before it was due to launch, due to a “critical vulnerability.” And while it is extremely likely that bugs will be found and fixed in time, there is always the “what if?” that risk-takers have to focus on.
Even more worrying for ether derivative watchers is the upcoming consensus algorithm shift .Ethereum currently runs on a proof-of-work consensus algorithm similar to that of bitcoin.It has long been working on a migration to a different system, called proof-of-stake, in which the amount of ether you “stake” gives you the credentials to validate transactions and append new blocks on the blockchain.
This is like changing the motor of your car while it is speeding along the highway.

No matter how much testing is done and no matter how many parallel systems are in operation, it’s risky.
True, risk is precisely what derivatives were invented to mitigate – but the creators of derivative products like to have that risk reasonably quantifiable.While derivatives can help investors control risk, they don’t eliminate it; they redistribute it.The extra risk for exchanges will need to be compensated, and uncertainty of this magnitude could make ether derivatives prohibitively expensive..

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