ErisX’s Spot Market: More Institutional Participation and Regulatory Oversight Coming to Crypto?

United States-based cryptocurrency exchange ErisX recently announced the public launch of its spot market trading, a move that takes the company a step closer to its goal of being a one-stop shop for the trading of spot and futures contracts in a regulated environment.

Per the information on its product page, ErisX will support dollar trading pair with bitcoin, bitcoin cash, ether and litecoin — in addition to bitcoin trading pairs with the other three cryptocurrencies.

What’s ErisX’s plan in the crypto space?

Since 2017, ErisX has been building a trusted market infrastructure to support the institutional adoption of cryptocurrency.

The Chicago-based company wants to make it possible for players in the capital market to have access to digital assets in the same way — and perhaps at the same venue — that they access traditional financial products like securities. Just before the end of April, there were reports that TD Ameritrade, which has some 11 million retail clients, has been testing ErisX’s crypto exchange and could soon offer crypto trading on its platform, where clients already trade traditional financial products.

Beyond crypto spot market, which is what most existing crypto exchanges offer and is also what ErisX’s spot trading is about, ErisX plans to launch a derivatives exchange once the U.S. Commodity Futures Trading Commission (CFTC) approves its application to operate both a derivatives exchange and a clearing house.

As a quick refresher, a spot market is a trading venue — digital or otherwise — where financial instruments such as securities, commodities and currencies are traded for on-the-spot delivery. Delivery means the exchange of cash for the financial instrument in question. Therefore, a crypto spot market would be any venue, such as exchanges, where you can instantly trade cryptocurrencies.

How will the ErisX platform work?

Trading on the ErisX spot market will work pretty much like existing exchanges like Coinbase. Users will need to go through Know Your Customer (KYC), Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) compliance checks before they’re able to use ErisX’s platform. Traditional brokerage firms already do this when onboarding users that trade through brokerage platforms and may not have to repeat the process.

Like other U.S.-based crypto exchanges, ErisX has licenses that make it possible for it to support the trading of a USD/crypto pair.

Why is ErisX attracting institutional investors?

Following the closing of the third round of Series B funding, which the company announced alongside the launch of its spot market exchange, ErisX has now raised a total of $47.5 million from 22 investors, according to business information platform Crunchbase.

These investors — which include TD Ameritrade, DRW Holdings, CBOE, TradeStation and Nasdaq, just to name a few — are interested in ErisX for a few reasons, all of which sum up to the fact that they see promise in how the crypto exchange is building a robust, transparent, integrated and regulatory-compliant market infrastructure in the crypto space.

TradeStation, an American online securities and futures brokerage company, invested in ErisX because it believes ErisX is bridging the gap between the traditional and crypto market. John Bartleman, president of TradeStation Group, in a press release, said:

“TradeStation is actively working to help bridge the gap between traditional markets and crypto markets. Our investment in ErisX supports further advances in the crypto market structure and will help bring more established players into the space. Supporting firms like ErisX, that understand regulation and markets, benefits the crypto ecosystem.”

TD Ameritrade, on the other hand, has seen increasing demand for the trading of crypto products from its retail customers. So, the American brokerage firm invested in ErisX because it sees the crypto exchange operator as a viable avenue to offer its customers access to the crypto market in a transparent way. Tim Hockey, CEO of TD Ameritrade said:

“As investors in ErisX, as well as a strategic contributor in the initiative, we are looking forward to advancing our innovation goals by working with an established, CFTC-regulated exchange that will include digital asset futures and spot contracts on a single platform.”

Steve Quirk, executive vice president of Trading & Education at TD Ameritrade, added that:

“Our retail clients are seeking to access and trade digital currency products in the same way they do with traditional capital markets — through a legitimate, regulated and transparent exchange. That’s precisely why we chose to invest in ErisX — to make digital currency products more accessible to retail clients.”

While U.S.-regulated exchanges including Coinbase and Gemini already offer institutional trading products in some ways, their services don’t cover the extensive needs of institutional investors. Institutional investors typically use leverage tactics to hedge or optimize their portfolio returns through derivatives. Some popular derivatives include futures, options, swaps, warrants, and contracts for difference.

U.S.-based derivatives market operators CBOE Global Markets and CME Group were the first to offer cash-settled crypto futures. While CBOE discontinued its bitcoin futures offering in March, industry market intelligence provider Diar pointed at volume data to suggest that CBOE was struggling to compete adequately with CME. CME continues to offer bitcoin futures, with volumes reportedly growing on a monthly basis.

However, investors and traders want a futures market for physical bitcoin settlement.

In this context, physical bitcoin is the same thing as the bitcoin in your wallet. “Physical” is only a relative term to indicate that actual bitcoin is being traded for cash, as opposed to trades where only cash is changing hands based on the price of bitcoin.

During a meeting with the CFTC on Feb. 14, 2018, Richard Gorelick, the head of market structure at the trading firm DRW, said:

“We continue to have concerns that the way these futures contracts are pegged to these cash markets, which are less transparent, could result in dislocations in the future. We've expressed our view that we would like to see physically settled cryptoasset contracts to help deal with some of these concerns.”

Cointelegraph had reported in June 2018 about possible manipulation of bitcoin prices for gains in the bitcoin futures market. In addition to the risk of manipulation, contracts are inefficient for professional traders who also actively trade cryptocurrency.

Garrett See of crypto trading firm DV Chain told the Business Insider:

"If they are physical delivery futures, then I know exactly what my P&L [profit and loss] will be if I hold it to expiration. If they're cash settled, I have to make another trade to unwind the spot position at expiration and I have to hope that I can unwind my position at the expiration price (including fees) even though I may not have the ability to trade on the exchanges that are being used to determine settlement price."

The futures products for physical settlement being developed by ErisX — as well as by its competitor, Bakkt — will meet the needs of institutional investors.

Bakkt is a crypto exchange platform being developed by Intercontinental Exchange, the parent company of the New York Stock Exchange. Similar to ErisX, Bakkt is developing both crypto spot and futures market. Beyond creating a market infrastructure that attracts institutional players, Bakkt wants to build and develop crypto use cases, according to Bakkt’s chief operating officer Adam White.

Following Bakkt’s announcement of a futures market for physical bitcoin settlement last year, See told Business Insider:

“If bitcoin is trading at a discount in the spot market relative to the futures market, a trader can go long bitcoin and short the future for a profit. This is hard when a future settles in cash because it requires a trader to make another trade.”

A more transparent crypto spot market

The CFTC last year reportedly requested trading data from top exchanges, following reports that the spot market might have been manipulated for gains in the futures market.

The introduction of even more advanced futures products, like the ones ErisX and Bakkt are working on, could result in more regulatory oversight of the spot exchange operators. The increased attention could, in turn, drive the exchanges toward maintaining the best and most transparent exchange practices.