A bubble? We don’t even know how to value Bitcoin

From The Conversation.

Bitcoin is a “speculative mania” according to the governor of the Reserve Bank of Australia. But it’s not so easy to say that Bitcoin is a bubble – we don’t know how to value it.

Recent price rises (close to A$18,000 in the past three months) may be too great and can’t continue. But the Bitcoin market is only just maturing as an investment and as a currency, and so it may still have room to grow.

A bubble is when the price of an asset diverges from its “fundamentals” – the aspects of an asset that investors use to value it. These could be the income that can be earned from a stock over time, a company’s cash flow, the state of a country’s economy, or even the rent from property.

But Bitcoin does not pay out profits (like shares) or rent (like property), and is not attached a national economy (like fiat currencies). This is part of the reason why it is hard to tell what the underlying value of Bitcoin is or should be.

In the search for fundamentals some have suggested we should look at the supply of Bitcoins in the market (which is regulated by the technology itself), the number of Bitcoin transactions through the market, or even the energy consumed by Bitcoin miners (the computers that validate transactions and are rewarded with Bitcoins).

Diverging from fundamentals

If we take a close look, we can see how the price of Bitcoin may be diverging from these fundamentals. For instance, it is becoming less profitable to be a miner, especially as the energy required increases. At some stage the cost may exceed the price of Bitcoin, making the network less worthwhile to both mine and invest.

Bitcoin may be the best known cryptocurrency but it is also losing marketshare to other cryptocurrencies, such as Ethereum and Litecoin. Bitcoin currently accounts for 59.4% of the total global cryptocurrency market, but at the beginning of 2016 it was 91.3%. Many of these other cryptocurrencies have more functionality than Bitcoin (such as Ethereum’s ability to execute smart contracts), or are more efficient and use less energy (such as Litecoin).

Government policy, such as taxation or the establishment of national digital currencies, may also make it riskier or less worthwhile to mine, transact or hold the cryptocurrency. China’s ban on Initial Coin Offerings earlier this year reduced the value of Bitcoin by 20% in 24 hours.

Without these fundamentals the price of Bitcoin largely reflects speculation. And there is some evidence that people are simply buying and holding Bitcoin in the hope it will keep rising in value (also known as Greater Fool investing). Certainly, the cap on the total number (21 million) of Bitcoins that can exist, makes the currency inherently deflationary – the value of the currency relative to goods and services will keep increasing even without speculation and so there is a disincentive to spend it.

Bitcoin still has room to grow

Many big investors – including banks and hedge funds – have not yet entered into the market. The volatility and lack of regulation around Bitcoin are two reasons stopping these investors from jumping in.

There are new financial products being developed, such as futures contracts, that may reduce the risk of holding Bitcoin and allow these institutional investors to get in.

But Bitcoin futures contracts – where people can place bets on the future price of stocks or markets – may also work against the price of Bitcoin. Just like gamblers place bets on horse races rather than buying a horse, investors may simply buy and sell the futures contracts rather than Bitcoin itself (some contracts are even settled in cash, rather than Bitcoin). All of this could lead to less actual Bitcoin changing hands, leading to less demand.

Although the rush to invest is apparently encouraging some people to take out mortgages to buy Bitcoin, traditional banks won’t lend specifically for that purpose as the market is too volatile.

But it’s not just on the finance side that the Bitcoin market is set to expand. More infrastructure to support Bitcoin in the broader economy is rolling out, which should spur demand.

Bitcoin ATMs are being installed in many countries, including Australia. Bitcoin lending is emerging on peer-to-peer platforms, and new and more regulated marketplaces are being created.

Many companies are accepting Bitcoin as payment. That means that even if the speculation dies down, Bitcoin can still be traded for some goods and services.

And finally, although the fundamentals of Bitcoin are still up for debate, when it comes to transaction volume through the network there appears to be a lot of room for growth.

It’s good to remember that people have been calling Bitcoin a bubble for a long time, even when the price was just US$35 in 2013.

In the end, this is uncharted territory. We don’t know how to value Bitcoin, or what will happen. Historical examples may or may not apply.

What we do know is that the technology behind most cryptocurrencies is enabling new models of value transfer through secure global consensus networks, and that is causing excitement and nervousness. Investors should beware.

Authors: Alicia (Lucy) Cameron, Senior Research Consultant, CSIRO;
Kelly Trinh, Data Scientist, CSIRO

FED Lifts Rate As Expected

The FED has lifted the federal funds rate to 1.5% after their two day meeting – the third hike this year. The move was expected and had been well signalled.  This despite inflation still running below target, though they expect it will move to 2% later.  More rate rises are expected  in 2018.  This will tend to propagate through to other markets later.

Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Hurricane-related disruptions and rebuilding have affected economic activity, employment, and inflation in recent months but have not materially altered the outlook for the national economy. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‑month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/4 to 1‑1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

Voting for the FOMC monetary policy action were Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Patrick Harker; Robert S. Kaplan; Jerome H. Powell; and Randal K. Quarles. Voting against the action were Charles L. Evans and Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.

ASX ‘Monopoly’ Tipped to Continue Thanks to Blockchain

From Investor Daily.

According to Morningstar analysts, the ASX’s decision to move its cash equities clearing and settlement system (CHESS) to distributed ledger, or blockchain, technology would further strengthen the exchange’s “strong competitive position”.

“Although DLT has enormous potential, few real-world examples of DLT use have emerged which makes ASX somewhat of a leader in the space, being the first stock exchange to commit to DLT in a meaningful way,” the report said.

The new system would have a number of benefits for stakeholders and stockbroking firms in the form of administrative savings as well as “richer, more timely and more accurate data”.

“ASX currently generates around AUD 100 million or 13 per cent of group revenue from clearing and settlement of cash equities which we expect to benefit from the new system via the monetisation of new functionality and services.”

The adoption of blockchain technology would further cement the ASX’s protection against competition, identified as “regulation and network effects”, the report said.

“The federal government and regulators have sought to increase competition for nearly a decade, but the process of regulatory reform is slow and still has many obstacles to overcome.

“A government report found that even if competition were allowed in cash equities clearing, competitors are unlikely to emerge, as the regulatory requirement to maintain operations and regulatory capital in Australia reduce potential synergies for overseas clearinghouses.”

And even if the regulatory barriers were removed, a ‘network effect’ would still provide the ASX protection against competition, the report indicated.

“Competitors can easily create the technology required for a rival exchange, but investors are unlikely to switch to a less liquid market.”

The report pointed to the attempt of the “sole viable alternative exchange to the ASX”, Chi-X, to launch a rival equities exchange in 2011, which only attracted market share of 10 per cent and “appear[ed] to plateau due to a lack of market depth”.

Furthermore, the technical aspect of integrating local market participants such as stockbrokers would then create “switching costs”, which would also dissuade them from moving to another securities exchange.

However, the report also signalled that lack of competition had served to somewhat “undermine” the ASX as it led to “a culture that lacks innovation and efficiency”, and that blockchain could serve to pose a “material threat”.

Nonetheless, the ASX’s willingness to explore the implications of new technologies, capital-light business model, high dividend payout ratios, lack of appetite for acquisitions, debt-free balance sheet and strong cash conversion all meant it had secured a “monopoly in the Australian primary listed equity market”.

ASX Selects Distributed Ledger Technology to Replace CHESS

The ASX has announced its intention to replace CHESS using distributed ledger technology (DLT) developed by its technology partner Digital Asset (DA).

This is an excellent example to highlight that distributed ledger is so much more than just the Bitcoin bubble.

Distributed Ledger technology combines a number of different core elements that support the transfer process and recordkeeping:

  • Peer-to-peer networking and distributed data storage provide multiple copies of a single ledger across participants in the system so that all participants have a shared history of all transactions in the system.
  • Cryptography, in the form of hashes and digital signatures, provides a secure way to initiate a transaction that helps verify ownership and the availability of the asset for transfer.
  • Consensus algorithms provide a process for transactions to be confirmed and added to the single ledger.

CHESS (Clearing House Electronic Subregister System) is the system used by ASX to record shareholdings and manage the clearing and settlement of equity transactions in Australia. It was world-leading when introduced in the 1990s, providing name-on-register functionality, electronic communications and removing paper share certificates. It continues to be a robust and reliable system. ASX is now taking the opportunity to replace CHESS with a next generation post-trade platform using contemporary technology.

Today’s decision follows the successful build of enterprise-grade DLT software for core equity clearing and settlement functions, and the completion of extensive suitability testing by ASX and DA over the past two years. The testing confirms ASX’s confidence in the functional, capacity, security and resilience capabilities of DA’s application of DLT to meet the needs of Australia’s financial marketplace and maintain the highest regulatory and operational standards. The testing included two independent third party security reviews of DA’s technology.

The testing was conducted in parallel with a stakeholder consultation program, which included briefing of regulators, to enable ASX to develop a comprehensive understanding of what the market wants in replacing CHESS.

ASX will now work with stakeholders on finalising the scope of Day 1 functionality for the new system, drawing on its extensive consultation that will continue in 2018. Day 1 functionality and the proposed timing for transition are expected to be released for market feedback at the end of March 2018.

The new system will be operated by ASX on a secure private network where participants are known, ‘permissioned’ to have access, and must comply with ongoing and enforceable obligations.

The system will be designed without access barriers to non-affiliated market operators and clearing and settlement facilities. It will also give ASX’s customers choice as to how they use ASX’s post-trade services. Customers will be able to connect in a similar way they do today, with the addition of using contemporary global ISO 20022 messaging, or they may interact directly with the distributed ledger. The transition period to the new system will be determined in consultation with stakeholders.

Dominic Stevens, ASX Managing Director and CEO, said: “ASX has been carefully examining distributed ledger technology for almost two-and-a-half years, including the last two years with Digital Asset, in order to understand its potential application. Having completed this work, we believe that using DLT to replace CHESS will enable our customers to develop new services and reduce their costs, and it will put Australia at the forefront of innovation in financial markets. While we have a lot more work still to do, today’s announcement is a major milestone on that journey.”

Peter Hiom, ASX Deputy CEO, said: “ASX has consulted extensively on the needs and priorities for replacing CHESS, including with customers, share registries, software vendors, other exchanges and industry associations. I am very grateful for their input and support. We’ve given over 80 DLT system demonstrations to more than 500 attendees, and conducted over 60 CHESS replacement workshops for more than 100 organisations from the global financial services industry.
“ASX has also formed a strong partnership with Digital Asset over the past two years, and we’re confident we have chosen the right partner. Together, we look forward to continuing to work with the industry as we finalise the requirements and the roadmap for implementation of the new system.”

Blythe Masters, Digital Asset CEO, said: “After so much hype surrounding distributed ledger technology, today’s announcement delivers the first meaningful proof that the technology can live up to its potential. Together, DA and our client ASX have shown that the technology not only works, but can meet the requirements of mission critical financial infrastructure.”

Coinciding with today’s decision, ASX will exercise its pro-rata right to participate in DA’s recent Series B fundraising and subscribe for US$3.5 million convertible notes. ASX and DA have agreed to work exclusively on DLT in Australia and New Zealand. This agreement applies while the Day 1 functionality of the new system is being finalised, and will continue subject to agreement of the full contractual arrangements for the development and support of the new system. These decisions underscore ASX’s strong commitment to working with DA to unlock the benefits of DLT.

Banks Pay More Than Half Of All Dividends In Australia

Data from the latest Janus Henderson Global Dividend Index  reveals that Australia’s banks pay $6 out of every $11 of the country’s dividends each year but dividends are growing slowly given already high payout ratios.

Leading is Commonwealth Bank which raised its per share payout 3.7 per cent on the back of steady profit growth, but National Australia, Westpac and ANZ all held their dividends flat.

CBA and Westpac were identified in the report as the world’s fourth and sixth biggest dividend payers respectively, with Chinese and Taiwanese technology and manufacturing companies taking the top three place.

Overall, Australian dividends typically peaked in the third quarter and this year was no different. Payouts jumped to a record $22.8 billion, up 17.0 per cent on a headline basis, boosted by a stronger Australian dollar. But resources apart, dividend growth in Australia was  sluggish.

More broadly, the headline growth of global dividends in Q3 2017 jumped by 14.5 per cent to US$328.1 billion and underlying growth was 8.4%, the fastest in nearly 2 years. Data is to 30th Sept 2017.

The Asia-Pacific region led with dividends up 36.2% to $69.6illion, equivalent to an underlying increase of 121%.  China Mobile accounted for almost half of the region’s headline increase and three-quarters of Hong Kong’s with a huge $8.4 billion special, the largest single payment in the world in Q3, helping Hong Kong’s total dividends reach a record $25.2 billion.

While every region saw global dividends increase, payment records were broken in Australia, Hong Kong and Taiwan.

They say that after record second and third quarters, the world’s listed companies are comfortably on course to deliver the highest ever annual total this year. They expect 2017 dividends of $1.249 trillion, an increase of 7.4%, which is $91 billion higher than their previous estimate.

Note all figures are in US$.

ASIC accepts enforceable undertakings from ANZ and NAB to address conduct relating to BBSW

ASIC says Australia and New Zealand Banking Group (ANZ) and National Australia Bank (NAB) have today entered into enforceable undertakings (EUs) with ASIC in relation to each bank’s bank bill trading business and their participation in the setting of the Bank Bill Swap Rate (BBSW), a key Australian benchmark and reference interest rate.

On 10 November 2017, the Federal Court made declarations that each of ANZ and NAB had attempted to engage in unconscionable conduct in connection with the supply of financial services in attempting to seek to change where BBSW set on certain dates (in respect of ANZ, on 10 occasions in the period 9 March 2010 to 25 May 2012, and in respect of NAB, on 12 occasions in the period 8 June 2010 to 24 December 2012). The Court also declared that each bank failed to do all things necessary to ensure that they provided financial services honestly and fairly.

The Federal Court imposed pecuniary penalties of $10 million each on ANZ and NAB for the attempts to engage in unconscionable conduct in respect of the setting of BBSW. The Court also noted that each of ANZ and NAB will give EUs to ASIC which provides for them to take certain steps and to pay $20 million to be applied to the benefit of the community, and that each will pay $20 million towards ASIC’s investigation and other costs.


ASIC commenced legal proceedings in the Federal Court against ANZ on 4 March 2016 (refer: 16-060MR) and against NAB on 7 June 2016 (refer: 16-183MR). The EUs form part of an agreed resolution to those proceedings.

On 16 November 2017 Jagot J of the Federal Court published her decision in both the ANZ and NAB proceedings ([2017] FCA 1338).

On 5 April 2016, ASIC commenced legal proceedings in the Federal Court against the Westpac Banking Corporation (Westpac) (refer: 16-110MR). These proceedings are ongoing.

ASIC has previously accepted enforceable undertakings relating to BBSW from UBS-AG, BNP Paribas and the Royal Bank of Scotland (refer: 13-366MR, 14-014MR, 14-169MR). The institutions also made voluntary contributions totaling $3.6 million to fund independent financial literacy projects in Australia.

In July 2015, ASIC published Report 440, which addresses the potential manipulation of financial benchmarks and related conduct issues.

The Government has recently introduced legislation to implement financial benchmark regulatory reform and ASIC has consulted on proposed financial benchmark rules.

Is The Global Banking Network Really De-globalising?

An IMF working paper “The Global Banking Network in the Aftermath of the Crisis: Is There Evidence of De-globalization?” released today, shows that contrary to popular belief, the Global Banking Network has not shrunk since the GFC in the simple way often thought. Using complex and innovative modelling, they conclude that the banking world in some ways is connected more deeply, and with greater complexity than before. This means that players in one location could be impacted more severely by events in other geographies. They conclude that the hidden dynamics of the global banking network after the crisis suggest that the assertion that cross-border lending has shrunk globally seems to miss out significant details. They refrain from assessing the risk impact of this observation.

However, we conclude, like our digital world, global banking is more financially networked than ever, suggesting that risks could be propagated widely and in unexpected directions.

The global financial crisis in 2008-09 underscores the unique role of financial interconnectedness in transmitting and propagating adverse shocks. Previous literature stresses the significance of network structure in generating contagion,  lays out detailed mechanisms of contagion through balance-sheet effects, is followed by a large body of theoretical and empirical research on interbank markets, mostly within a single country or region, that focuses on modeling banks’ behavior in response to shocks in the financial system. Cross-border implications of the banking network, however, are mostly ignored due to scarcity of data and rich country-level heterogeneity that may lower the explanatory power of a unified framework.

The sharp fall in global cross-border banking claims after the crisis has been persistent, either measured in Bank for International Settlements (BIS) Locational Banking Statistics (LBS) or BIS Consolidated Banking Statistics (CBS). This persistent aggregate decline in cross-border banking claims has been considered evidence of financial deglobalization. In this paper, we consider the validity of the financial de-globalization argument by studying the evolution of the global banking network before, during and after the crisis, with a particular focus on the aftermath of the crisis. Instead of trying to establish the role of the network in propagating the crisis at a global level, we take the role of the global banking network as given and seek to investigate the impact of the crisis on the network. In this context, our key contributions to the literature are twofold: (i) we measure and map the global banking network using a model-free and data driven approach; and (ii) we analyze the evolution of the network using network analysis tools, including some novel applications, that are relevant given the  characteristics of the global banking network and the available data.

The foremost challenge in constructing the global banking network is to map and identify an accurate and comprehensive network structure using the available data on cross-border banking flows. Researchers face a tradeoff between data coverage and frequency. High frequency data, such as banks’ daily transactions, often contain a limited number of banks within a country, while datasets with a good coverage of global lending mainly report country-level aggregate statistics, and are updated infrequently. This challenge is further complicated by the difficulty in identifying the composition, sources and destinations of bank flows, primarily due to the use of offshore financial centers as important financial intermediaries. Not only are global banks able to conduct cross-border lending via entities in their headquarters and offshore financial centers, but also they can lend domestically through subsidiaries and/or branches within the border of the borrower countries. BIS International Banking Statistics (IBS), through its two datasets (LBS and CBS), offer the best available data to map the international bank lending activity across countries. This is especially the case of the CBS dataset, which consolidates gross claims of each international banking group on borrowers in a particular country, aggregating those claims following the nationality of the parent banks. This nationality-based nature of CBS is an advantage over LBS, which follows a residency-based principle, and thus obscures the linkages between the borrower country and the parent bank institution, when lending originates in affiliates located in third countries (e.g., off-shores financial centers). A disadvantage of using CBS is that it registers the full claims of the affiliates, independent of how those assets were funded (e.g., a claim of a foreign affiliate that is fully funded with local domestic depositors is still counted as a claim from the country of the parent bank on the borrower country where the affiliate is located). In order to avoid this overstatement of financial linkages, which are large in the case of emerging countries as shown in the next section, we combine BIS CBS data with bank level data, taking into account the claims of foreign affiliates and the local deposit funding used by subsidiaries and branches.

We use the improved measure of cross-border banking linkages to  onstruct a sequence of global banking networks, and apply tools from network theory to analyze the evolution of economic and structural properties of the network. We take a step further to incorporate this important discussion into our choice of metrics to identify important players and trace the structural evolution of the global banking network. We provide an in-depth discussion of network measure choice based on the structural context of a core-periphery, asymmetric and unbalanced network structure and in the economic context of characterizing banking flows at the country level.

We introduce measures of node importance that capture  distinct aspects of global banking linkages. In particular, we use recursively defined Katz-Bonacich centrality and authority/hub measure to characterize country importance based on its connection to and dependence on other important countries, as well as a novel application of modularity in order to capture the regional fragmentation of the network. The flexibility of our network configuration allows us to use a small number of network metrics to reveal distinct aspects of network structure and node importance.

We find that the overall shrinkage of cross-border bank lending after the crisis, which has been the key argument behind the claims on financial de-globalization, is also reflected in the average number of links and their strength in the global banking network.

However, rich details on the evolution of the network suggest that this argument is overly simplified.

While connections within traditional major global lenders (banks in France, Germany, Japan, UK, and US) became sparser, many non-reporting countries located at the periphery of the network are more connected, mainly due to the rise of non-major global lenders out of Europe. Measured in metrics of node importance, these lenders have been steadily climbing up the rank, resulting in a corresponding decline of European lenders in status and borrowers’ decreasing dependence on traditional lending countries. Moreover, we find substantial evidence indicating increasing level of regionalization of the global banking network. Even though post-crisis retrenchment of major global and non-major European banks’ operation in the aggregate was just partially offset by the rest of the BIS reporting countries’ regional expansion, their targeted expansions have increased regional interlinkages through both direct cross-border and affiliates’ lending. More formally, using network modularity as a novel application to assess the quality of network cluster structure based on region divisions, we find that this measure increases after the crisis, thus indicating, from the perspective of network theory, that some form of regionalization characterizes the post-crisis dynamics of the global banking network. Finally, we also confirm this regionalization process through a regression analysis of the evolution of cross-border lending. After controlling by geographical distance and trade relationships as well as lender and borrower characteristics, we find a statistically significant increase in cross-border lending when both borrower and lender belong to the same region, especially in the case of peripheral lenders during the post-crisis period.

We show that without proper adjustment, country-level banking statistics suffer from multiple data issues that distort the actual role of each country in cross-border lending, and increase the difficulty of accurately detecting key players in the network. We find evidence confirming the overall shrinkage in the scale of cross-border bank lending using a variety of network analysis tools. Moreover, these methods capture rich dynamics that occur inside the global banking network and are not captured by traditional aggregate indicators.

Using a set of centrality measures with meaningful economic interpretations, we delve substantially deeper to capture the interconnectedness faced by each country. While the structural stability of the highly concentrated global banking network is mainly due to the stability of major global lenders, we observe decline in importance for non-major global European lenders and a corresponding rise in the ranks for lenders from other region, comprised of mostly emerging market lenders. The hidden dynamics of the global banking network after the crisis suggest that the assertion that cross-border lending has shrunk globally seems to miss out significant details.

NOTE: IMF Working Papers describe research in progress by the authors and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

With a new futures market, Bitcoin is going mainstream

From The Conversation.

The Chicago Mercantile Exchange will soon begin trading Bitcoin derivatives (futures contracts), signalling the cryptocurrency is now a mainstream asset class. Bitcoin has had limited use in the mainstream economy in part because the volatility of its price. The value of the currency might go up or down significantly between the time a deal is struck and delivery.

The introduction of Bitcoin futures contracts will allow investors to manage this risk, and make it safer to hold and trade in Bitcoin. This will make the cryptocurrency more accessible to individuals and businesses, and encourage developers to build more products and services on top of the technology.

Futures and other derivatives are contracts between two parties to fix the price of an underlying asset (currencies, shares, commodities etc.) over a period of time or for a future transaction. The buyer of these contracts commits to purchase the underlying asset at a set price and at a certain date, and the seller commits to sell.

There are two main uses for these contracts. First, to reduce price risk by freezing future prices. The second use is speculation. For instance, a speculator would commit to buy a commodity/share/currency at a certain time, hoping that the market price at the time of delivery is higher than the price set in the contract.

Airlines commonly buy long term oil future contracts to hedge against the potential increase in fuel price, or to take advantage of what they believe to be a low price.

Similarly, future contracts will enable traders to lock in the value of Bitcoin for a defined period of time. This effectively removes the risk associated with fluctuation in value. In addition, since these contracts will be traded on the Chicago Mercantile Exchange, the exchange effectively guarantees that both buyers and sellers will abide by the agreement.

In 2010, one Bitcoin was worth less than one hundredth of an Australian cent. As of Monday the 6th of November, the price is near A$10,000.

The market capitalisation of Bitcoin is now well over A$160 billion, which is larger than the GDP of most small countries. As the price of Bitcoin has grown, so too have transaction volumes, showing an increasing use of the cryptocurrency.

As a result, Bitcoin is starting to look like a credible investment in any respectable financial portfolio.

Although, this is not the first futures contract for cryptocurrency. Futures contracts already exist for both Ethereum and Monero.

But the Chicago Mercantile Exchange’s futures contract is significant as the CME group manages not only the Chicago Mercantile Exchange, but also the Chicago Board of Trade and New York Mercantile Exchange and Commodity Exchange. Combined, these exchanges represent the largest derivative market in the world.

The decision to issue futures contracts on Bitcoin rather than another derivative is also significant. So far Bitcoin derivatives have mainly been swap agreements. A swap is a commonly used financial tool where two parties agree to swap financial instruments, such as interest or currencies. The key point is that the two parties, the buyer and seller, make a deal directly with each other.

As a swap agreement is not done through an exchange, the risk of a party not delivering on the agreement can be quite high. If one party decides to opt out, the agreement has to be terminated. This leaves the other party exposed.

Futures contracts eliminate this “counterparty” risk, as the exchange clears the transaction and guarantees delivery. And unlike swaps, futures contracts are standardised (in term of size, how much is going to be traded, and maturity date etc.). This means futures contracts can be traded at any time until maturity, making them very liquid and accessible.

The lack of a futures market in Bitcoin was a significant barrier to it becoming a mainstream asset class. You can buy and sell forward contracts on the Fijian dollar, for instance, meaning that institutional funds anywhere in the world can hold Fijian dollars in their portfolio and manage the risks of that asset.

But they cannot yet do that with Bitcoin. Until now, there has been no way to offload the risks associated with fluctuating prices. An investor could always hold the cryptocurrency, but they would do so fully exposed to price volatility.

The introduction of Bitcoin futures contracts will allow traders to hedge against this volatility and eliminate the currency risk. This will make Bitcoin more attractive for both individuals and corporations.

As crypto-assets become a mainstream investment class, other products emerge around them (such as exchange traded funds). It will also have a similar effect to that of mainstreaming share ownership – enabling a much larger fraction of the population to diversify their asset portfolios and income streams.

This will unlock some of the value currently being built on cryptocurrencies and blockchain technology – new products and services – that are currently only accessible to a relatively small number of the early enthusiasts and those helping build the technology.

The increased flow of investment funds into Bitcoin will likely push prices up further, but it will also incentivise more work to build products and services on the technology. Bitcoin just went mainstream.

Authors: Jason Potts, Professor of Economics, RMIT University; Marie-Anne Cam, Senior Lecturer in Finance, RMIT University

NAB settles BBSW court case for $50m

From InvestorDaily.

In an announcement made late on Friday, NAB admitted that on 12 occasions between 2010 and 2011 its employees “attempted to engage in unconscionable conduct in breach of the ASIC Act”.

The settlement will see NAB fork out a $10 million penalty, cover ASIC’s costs of $20 million and donate $20 million to an ASIC-nominated financial consumer protection fund – all of which will be reflected in its 2017 financial year results.

NAB is the second of three major banks to settle with ASIC following claims of rigging the bank bill swap rate (BBSW). ANZ has already settled, leaving Westpac as the last bank remaining defending the court case.

Commenting on the settlement, NAB group chief executive Andrew Thorburn said the way BBSW was calculated “had changed since that time”.

“We accept we did not meet the high standards of professional conduct that ASIC, the community and NAB expects of itself, in that market during that period,” Mr Thorburn said.

“The ASX is now responsible for the administration of BBSW and NAB fully supports the reforms that are being introduced by the ASX to enhance trust and transparency in the BBSW market.

The Best Indicator Yet Rates Are On Their Way Up

The US 10-Year Bond Rates climbed above 2.4% yesterday and provides a strong signal that interest rates in the USA are on their way up as the FED reduces QE and moves benchmarks higher. After the Trump effect took hold late last year, we reached a peak in March, before falling away but the current rates are level with those in May.

There will be a knock on effect on the global capital markets of course, and as Australian Banks are net borrowers of these funds, will feel the effect of more expensive capital, and this is likely to flow through to their product pricing. As Treasury Head John Fraser said today:

“…though global monetary conditions can also impact upon the wholesale funding costs of Australian banks”.

We suspect the markets are underestimating the potential for rates rises, and soon.