Juthica Chou, chief operating officer of LedgerX, talks about the company’s new license to offer its derivatives to retail investors and the resulting platform, Omni. She walks through what call and put options are, how they work and why people and companies purchase them as opposed to just buying or selling bitcoin directly. We discuss why LedgerX believes physically settled bitcoin options are superior to cash-settled ones, how LedgerX handles hard forks, and other contracts focused on the technicals of crypto networks it could offer such as its halving contract. Plus, she describes what it was like to be building a Bitcoin-centered company during the “blockchain not Bitcoin” era.
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Episode links:
LedgerX: https://www.ledgerx.
Juthica Chou: https://twitter.com/
LedgerX blog posts introducing Omni: https://blog.ledgerx.com/the-
CNBC interview with Ari Paul about why he bought $50,000 Bitcoin call option: https://www.cnbc.com/
Cheddar interview: more opportunity with the retail market:
https://cheddar.com/media/Bitcoin halving contract: https://blog.ledgerx.com/a-
Ledger on how to it would handle the Bitcoin Gold hard fork: https://www.ledgerx.com/
Call option for $100k Bitcoin by December 2020: https://www.bloomberg.com/
Unchained interview with Dan Morehead of Pantera Capital: https://
Cboe stops listing Bitcoin fuures:
https://www.coindesk.com/cboe-Why CME’s futures saw more volume than Cboe’s: https://www.coindesk.com/cme-
How Bitcoin futures will be taxed: https://blog.ledgerx.com/less-
Doomschain clock/attitude toward private blockchains: https://blog.ledgerx.com/
Oracle blog post: https://blog.ledgerx.com/how-
Transcript:
Laura Shin:
Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host Laura Shin. I’ve been doing a survey, and it’s come to my attention that not all of you know that I have another podcast. It’s shorter, newsier, and comes out Fridays, and it’s called Unconfirmed. If you haven’t taken a listen yet, go check it out. In particular, I’d recommend my recent interview with Peter Van Valkenburgh of Coin Center on Congress’ hearings about Libra.
Also, if you’re making vacation plans, consider the weekend retreat I’m teaching with Meltem Demirors of CoinShares and Jalak Jobanputra of Future Perfect Ventures. It’ll be at the beautiful Omega Institute in Rhinebeck, New York from September 20 to the 22. Be sure to check out the show notes for the link to sign up.
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Laura Shin:
My guest for today is Juthica Chou, Co-Founder and Chief Operating Officer and Chief Risk Officer for LedgerX. Welcome, Juthica.
Juthica Chou:
Thanks for having me, Laura.
Laura Shin:
LedgerX reached a major milestone recently, a first for the crypto space. Why don’t you tell the listeners what that is?
Juthica Chou:
Sure. So, LedgerX, we recently received a license that allows us to open up our institutional platform to retail investors, and then, more exciting, we recently actually launched it to retail investors. So retail investors can have access to the same derivatives, products, and options that the LedgerX institutional customer base has been trading for almost two years now.
Laura Shin:
And why don’t you elaborate on that? Like, what is it that LedgerX has been doing for the last few years?
Juthica Chou:
We are a US federally regulated, by the CFTC, exchange and clearinghouse, and what that really means is that we have a platform that allows people to come and trade a wide variety of products, from bitcoin, to bitcoin options, and other sorts of swaps, and then the clearinghouse is the part that guarantees the trade to give the customers the safety and security of knowing that the trades will settle in a regulated manner, and so we had launched that to institutional customers in October of 2017.
We were restricted in terms of our license to only allow that access to institutions, but we had worked with the regulators over the last maybe 6 to 9 months to get a new license and really be able to expand that offering so that any customer can have access to this, you know, highly regulated platform for getting into and out of bitcoin, and I think that’s really a key part of our products, is that we touch both fiat and bitcoin. So customers can buy a call option and receive actual bitcoin or buy a swap and receive bitcoin, and so that’s an important element that we usually call physically settled derivatives.
Laura Shin:
And for so long in this space, the rallying cry has been HODL or HODL. So why is it that someone would want to buy a derivative of bitcoin rather than bitcoin itself?
Juthica Chou:
So derivatives and options in particular allow a wide range of exposures and trades that people can do that can really enhance long positions that they have already. So let’s say somebody is long bitcoin and they do want to hold, but they’re not earning any, you know, yield or return on their bitcoin. They can use options to essentially earn some implied yield and generate some return. Similarly, if people want to get leveraged exposure on the long side, so they can buy call options instead of buying options themselves.
So I think what we see at LedgerX is a wide range of customers and customer base coming in to trade options for a whole bunch of different reasons. I mean, this is why I think options in particular are not zero sum, because, especially if you’re dealing with physical, they touch, you know, the world outside of just the single trade, and both sides can really benefit, depending on their specific considerations and constraints.
Laura Shin:
Why don’t we walk through some of those examples? Because I feel like just talking about it in the abstract can be kind of hard to wrap your mind around, but let’s just start with a call option. First just define what that is, and then walk me through why someone would choose to buy a bitcoin call option.
Juthica Chou:
So the standard academic definition of an option is that it is the right, but not the obligation, to purchase an underlying…we’ll call it bitcoin here at a certain price on a certain date in the future, and I think the way that I like to think about options as opposed to just spot or you know, bitcoin is really the last part of that definition, the two components that you do not get if you’re just buying or selling bitcoin, and that is a strike price and an expiration date.
So if we want to just buy or sell bitcoin right now, let’s say it’s around 10 thousand dollars. I can buy it at 10 thousand or I can sell it at 10 thousand, but if I want to trade a call option, well, now there’s a much wider range of trades that I can do. So, for example, I can take a call option that expires December of 2019, so December of this year, with a 25-thousand-dollar strike price, and this option on LedgerX is around 500 dollars right now.
So maybe I’m a long holder or maybe I am somebody new to bitcoin that wants to get upside exposure, but I might be a little bit worried about having as much capital at risk if I buy, you know, bitcoin at 10 thousand and I know that it can go down to, you know, 7 thousand, 6 thousand just because it is a volatile asset. I might instead decide to buy a call option for 500 dollars. The most I could lose is that 500 dollars, and if bitcoin does rally significantly, then I can essentially have that upside exposure and still make money with a big rally.
Laura Shin:
Yeah, I saw an interview that Ari Paul did with CNBC when he had purchased call options for 50K bitcoin by the end of 2018, and he had purchased them I guess in December of 2017, and the CNBC anchors were very confused. Like, why would you do this? And he was like, look, I view it as a way of…because he runs BlockTower Capital, one of the crypto funds. He was like, I view it as a way of being able to capture upside if bitcoin does, you know, go up.
And yet during this time when maybe there’s volatility and maybe the price could drop, like, 80 percent or whatever, that I would be able to hold fewer bitcoins on my balance sheet and keep the assets of my LPs from dropping that 80 percent or whatever it might be, and you know, he was just like, this is a way, yeah, to sort of limit the downside exposure, and I think he only paid 36 hundred for that, and so it’s a nominal amount for the size of his fund, and yet at that time when bitcoin was 20 thousand and he just was like, okay, is this a bubble? Is it not?
He didn’t know. He thought, okay, if it’s higher than 50K at the end of 2018, you know, then I’d like to make sure I have that in my fund. All right, so now let’s do the opposite…and also let’s clarify one other thing, which is I think that…and correct me if I’m wrong. I think that, normally, people use call options for those kinds of…that’s where they expect that…or not that they expect, but they want to ride any trends upwards, right? Call options are generally for prices that are higher than what it’s currently trading at. Is that correct?
Juthica Chou:
That’s correct. Yes. In terms of he contracts that people typically trade for call options, it’s with higher strike prices.
Laura Shin:
Okay, so now let’s talk about a put option. What is that? Again, you know, define it, and then walk me through why someone might prefer to buy a bitcoin put option over bitcoin.
Juthica Chou:
So a put option is, to use the academic definition, again, the right, but not the obligation, to sell bitcoin at a certain price on a certain date in the future, and so put options are very often used for people almost as insurance where they’re using them to protect their downside. So it could be maybe if it’s…you know, if we’re talking about a fund or even an individual that has bitcoin and they are a little bit worried maybe about some short-term decline or some of the headline risks that could cause bitcoin to fall significantly, they might buy maybe an 8-thousand-strike put option, and so what they’re doing is they’re buying insurance so that if something does happen and bitcoin goes to 6 thousand, well, now they have the right to sell bitcoin at 8 thousand, and so they kind of protected their position in a way, and the benefit of a put option’s similar to a call option, in that you’ll never lose more than you pay for the option.
Laura Shin:
So I give the example of Ari who’s running a crypto fund. What are some other examples of the kinds of people who buy these options and why?
Juthica Chou:
Well, I think, actually, the crypto fund I think is an interesting example that ties in puts and calls, because I think the Ari example is one that shows how unintuitively, you know, buying call options, which is ostensibly a bullish, very positive type of trade, can actually…when you tie in the world outside of it, can actually be slightly, you know, bearish in a way if the alternative is essentially sizing down a bitcoin position and then just having some levered upside calls in case, you know, you get benchmarked to bitcoin and you don’t want to miss out on the rally.
So I think funds use both puts and calls for a wide variety of trading around their positions. You know, I think in volatile environments, we tend to see more hedging, particularly if people…let’s say they’re selling options and can capture some of the volatility premium, and then in low volatility environments, like last year maybe July, August, we see both trading shops as well as companies even using options as a way to find more interesting trading opportunities when they don’t think there’s enough opportunity in just trading bitcoin itself.
But I think one of the really key pieces of the participant base for us are customers like miners and individuals who are long holders. You know, may have been in bitcoin for a while or maybe recently, and the reason that those are crucial is because they touch the physical. You know, miners obviously touch the physical. They deal in it every day, and so they’re the reason that we found it so important that we have to deal in the physical in order to provide them with these hedging instruments that actually make sense for them.
Laura Shin:
And elaborate on that, and this is actually something I was wondering, too. So, in contrast, the bitcoin futures contract that trades on CME is what’s called cash settled, meaning that, at the end of the trade, instead of getting bitcoin back, you get, like, the dollar equivalent of what the value was of that trade. So, for a miner, just describe why that’s a bad thing for them. Like, why they would prefer something physically settled.
Juthica Chou:
So miners have…you can almost think of them like similar to gold, for example. So bitcoin miners, they invest dollars in their infrastructure, and then they earn a fixed number of bitcoin, and so that bitcoin, it’s obviously same number of bitcoin that they earn in the mining reward, but the price of it, as denominated in dollars, fluctuates, and so they’re exposed to the price risk of US dollar versus bitcoin.
And so the cleanest hedge for a miner to hedge that is actually to be able to take the physical bitcoin that they have to pledge it as collateral, or if they’re just going to sell it, to sell it, and then to earn dollars back, as opposed to if they had to essentially take their bitcoin, convert it to dollars, and then use that dollar for a hedge, and then wait for that hedge to settle to cash.
So it suits both their price risk. It’s a much cleaner hedge because it’s exactly the price risk that they face, and then it suits their operations because they have bitcoin, and they’re very comfortable sending bitcoin as collateral, which, I really wouldn’t underappreciate that point. That when you deal in the physical and accepting bitcoin as a form of collateral is hugely powerful because, you know…and we see it at LedgerX. Anyone can send it 24/7, 365 outside of any banking windows.
Laura Shin:
Let’s talk a little bit more about this physically settled aspect. So how does it work exactly? When I decide to buy or sell a bitcoin call or put options, you can pick whichever example it is, do I literally send you my bitcoin to do that, and then, at that point, what do you do with it?
Juthica Chou:
So the options that we have are dollar denominated. So you can either send us dollars and use those dollars to purchase an option, a call option, let’s say, or you can send us bitcoin and then sell the bitcoin on the platform and then use those dollars to purchase the option, and in either case, we custody both the fiat and the bitcoin as the centralized custodian.
Laura Shin:
And then once the trade settles, people are returned what, the fiat that they sent if they sent fiat and then the bitcoin they sent if they sent bitcoin?
Juthica Chou:
Yeah, so the mechanics are that let’s say you purchase a call option, let’s say that 25-thousand-strike call option. So you purchase it for 500 dollars. So you pay 500 dollars today, and then when it expires in December, if it’s in the money…so let’s say bitcoin is at 30 thousand, then you’ll purchase bitcoin for 25 thousand dollars. So you’ll pay 25 thousand dollars, and you’ll receive one bitcoin.
Laura Shin:
And then for the person on the other end of that trade, like, how do you ensure that you’ll have the bitcoin that you can deliver?
Juthica Chou:
Yeah, so that’s exactly what we…that’s really what we do as a central clearinghouse. So at the time that the seller takes the other side of the trade, they collect 500 dollars today, and they’re posting one bitcoin with LedgerX, and LedgerX holds that bitcoin until the maturity so that we can guarantee that if you decide to exercise your call option, that we have the bitcoin.
Laura Shin:
And how do you store all those bitcoins? Do you put them in some kind of cold storage that only you control? That, you know, at the time the contract ends, you are the one who decides where the bitcoin goes, or is it like some kind of multi-stake where the parties have to sign off, or how does that part work?
Juthica Chou:
We have to have ultimate control over it. That’s the only way that we can accept it as a form of collateral.
Laura Shin:
Okay, and I’m assuming it’s…is it in cold storage?
Juthica Chou:
We don’t go into too much detail publicly about how exactly we do it.
Laura Shin:
Okay. Okay. Yeah, well, that makes sense. So why is it that LedgerX decided to focus on derivatives?
Juthica Chou:
So it’s kind of two-fold. One is that, you know, I come from an options background, and I really do believe that options are a very important piece of the development of a market that has elements of being a financial instrument, and we saw companies that were in the space that were producing real businesses, consumer-facing, merchant-facing using bitcoin, remittances, things like that.
And in the course of their business, what they were doing is they were warehousing bitcoin on their balance sheet in order to insulate their end customer from the price volatility risk, and so, you know, we kind of thought one example is that if they had better tools to be able to hedge the risk on their balance sheet, similar to how large oil producers do, then they could scale their businesses and provide more of these user cases for bitcoin to other people.
So we thought that would be good for the ecosystem that these could be used in a wide variety of ways, but there’s another element, which is that we knew…it was a very deliberate approach from a regulatory point of view because we didn’t want to go down the path of the state-by-state licenses. We knew that the federal path was going to be harder, but we wanted just one federal regulator that was a regulator that, you know, most people would be familiar with and that would have preemption over the states.
Laura Shin:
And when you say that you wanted to avoid having to go state by state, that’s basically the process that companies like Coinbase, like some of the regular spot exchanges, have had to go through. Is that the kind of company that has to do that?
Juthica Chou:
Exactly. Yes.
Laura Shin:
And so amongst some of the other exchanges working in crypto derivatives, like Bakkt and ErisX, they’re focused on futures. Why is your focus a little bit more on options?
Juthica Chou:
Well, you know, I think, ultimately, a lot of other people will eventually get to options, as well. You know, for us, it’s…and what we see in particular, is because bitcoin is so volatile, options present opportunity that you can’t really get from a linear instrument, and so some of these cases, when we talk about earning yield off of bitcoin by selling call options, that’s unique because of bitcoin’s volatility, and options are really I think the only way to both capture the volatility as well as to help dampen the volatility over time.
Laura Shin:
Yeah, and just to explain that a little bit more for listeners, when she talks about yield, I think…or Juthica, when you’re talking about yield, I think what you’re referring to is that example of a miner can kind of put up a…they can I think it’s purchase a call option, I guess it would be, and then they earn the price that the buyer is paying for that call option. So let’s say they earn, like, 500 dollars for putting up that bitcoin, and then later on, if the contract has purchased, at least they’ve sold the bitcoin for higher than what it was at the time that the call option was made.
So let’s say bitcoin is 10 thousand dollars now and they do that and then they earn the 500 dollars, but then later, if, you know, the price does go above whatever the strike price is, then at least they haven’t had to sell the bitcoin for 10 thousand. You know, they sold it for, like, 15 thousand or whatever in the future. Is that what you mean? There was something about this where, when I learned about it, it reminded me a little bit of MakerDAO and how people put up ETH as collateral and get DAI, which is pegged to US dollars in the meantime.
Juthica Chou:
I’m not super familiar with MakerDAO, but in the case of what you were saying for the call options, that’s correct. So a miner would sell a call option. They would collect 500 dollars today for that 25-thousand-dollar strike, and then if when, at expiration, bitcoin is above 25 thousand, then they’ll sell bitcoin for 25 thousand, which they might prefer to, if they had to sell some of their bitcoin today at 10 thousand, and then if bitcoin’s below 25 thousand, then they just get their bitcoin back, and they can, you know, do that trade again, and so they can essentially earn 500 dollars over a, like, five-month period.
Laura Shin:
One other way that I wanted to ask about, so earlier with the futures, you know, I seemed to…just with my question, it sort of felt like, to me, that it would be preferable to me to have a physically settled contract where I am receiving bitcoin back, simply because it’s so volatile. It would be like, oh, maybe if I did a trade, but then later I might realize that, like, a day later, I would’ve gotten a lot more money for it or something, like, if it were settling in dollars as opposed to bitcoin, but then another thing was that just from the purchaser’s perspective, they also have the flexibility of whether or not to actually buy on the expiration date, right? As far as I understand. Maybe I’m wrong.
Juthica Chou:
Yeah, that’s correct.
Laura Shin:
Yeah, so that also gives the purchaser more flexibility. So it just feels like physically settled derivatives will always be superior to cash settled. Is that correct?
Juthica Chou:
Yeah, I think so. I think that’s absolutely correct.
Laura Shin:
Oh, okay. All right. Well, that’s why we’re…
Juthica Chou:
Yeah, and I think the reason that I think some people go down the route of cash settled is because it’s much easier to get to launch because it’s easier from a regulatory point of view, you know, because the regulators are already comfortable with holding cash and to some degree, settling to cash. So, arguably, settling to cash in this market, as you alluded to, is not very prudent, but yeah, I think especially in a market like bitcoin where the physical is so easy to move, you know, physical commodities in general are very important markets, and that’s coming from markets where it’s actually difficult to store and move the physical commodity, but bitcoin has that in spades.
Laura Shin:
Right. I think I was reading one of your blog posts or something and you talked about how it’s not like you have to deliver a barrel of crude at the end of the trade.
Juthica Chou:
Right.
Laura Shin:
All right, so let’s dive a little bit more into Omni then. So, you know, this is the platform where both retail and institutional customers can actually interact in the same marketplace. Before launching Omni, I think customers on your platform needed to have a minimum of 10 million dollars in assets, and now there’s actually no net worth requirement. Correct me if I’m wrong about any of this. So just one thing that made me wonder is, is it desirable from a retail perspective to have the entity that you’re trading with be an institution? Like, is there some way that they could be at a disadvantage because they don’t have the same tools, or does that really not apply here?
Juthica Chou:
I think general…you know, and I’ll abstract from this even a little bit because I come from the high frequency trading background, which, you know, obviously, gets a lot of these types of questions, and I think in general, having institutions is much better for retail liquidity. You know, institutions, they’re out there on multiple platforms hedging very efficiently, and so that just provides better and better pricing for retail.
Laura Shin:
What price or index are you guys using to determine whether or not the price actually hits the strike price for any specific contract? Because, as we’ve seen, the crypto space has a lot of fake trading, and there are flash crashes, and we even saw…apparently, I saw on Twitter at least…I did not look into this myself, but it’s from a fairly credible source that it looks like there might’ve been people who were manipulating prices on Bitstamp in order to profit on BitMEX. So how can you guys determine whether or not a price is legitimate and isn’t being manipulated for profits on LedgerX?
Juthica Chou:
Yeah, I mean, it’s a huge issue with spot markets and with overseas exchanges, and you know, outside of surveilling our own markets, the beauty of our products is if we go back to that example of you bought a call option for 500 dollars with a 25-thousand-dollar strike price, when expiration comes, you get to decide if you want to exercise that option and pay 25 thousand dollars to buy bitcoin.
So all LedgerX does is we just do the delivery of the trade, but we don’t make any determination as to whether that option is, you know, in the money or essentially whether bitcoin is above 25 thousand or below. We leave that up to whoever the long holder is, and so that way, they can factor in different exchanges, different things they see and make the determination that they think is appropriate.Laura Shin:
Oh, okay. Wow, that’s pretty genius and probably a load off your back, and LedgerX is saying that it will never charge any fees for trades. So, if that’s the case, how do you make money?
Juthica Chou:
So I think Paul went into this a little bit on one of his blog posts. So, for Omni, there are no fees, and then for the institutions, we charge on their side for essentially a maker fee. So Omni has no fees in taking, and so, you know, we make the money off the institutions, and as Paul alluded to, the institutions, you know, like the professional traders, they price it in anyway, and so it’s kind of part of our way to just keep the fee schedules transparent. You know, the price that you pay is what you’re getting for it and not having…and then on the institutional side, they know exactly what they’re paying and they price it in. So we make it on that side.
Laura Shin:
And you have a wait list of about 3 thousand people I believe. So why is there a wait list at all?
Juthica Chou:
Well, I mean, so, for us, as we work through adding users, there’s a whole host of operational and regulatory, you know, additional items that we just want to make sure we get completely right. I think one of the things that we get really good feedback on for the LedgerX institutional platform is that people have had just a really good experience, and so we want to make sure that as Omni customers come on, all of our stakeholders, from the customer all the way down to the regulators and the banks, also continue to be very happy with the LedgerX experience.
Laura Shin:
And you launched with 15 institutions in 2017. How many institutions do you have on your platform now?
Juthica Chou:
It’s about 250 now.
Laura Shin:
And I saw that Paul said recently in an interview on Cheddar that the institutional market has been slower to materialize and that LedgerX thinks the opportunity is in the retail market. Why do you guys think that, and what does the size of that opportunity look like?
Juthica Chou:
So, you know, I think for us from…first, to kind of put institutional into context, as you mentioned, our requirements are around 10 million dollars or more in assets, and so we definitely see significant interest in maybe the smaller size institutions, but for what people traditionally refer to as financial institutions, getting to the very, very large hedge funds and investment banks, I think bitcoin’s market cap is still not large enough for the opportunity to be meaningful to them. You know, even at 200 billion, that’s just the size of the stock, really.
So it’s not really feasible for them to devote a whole bunch of resources for a trading desk for something like this when it is still pretty small an opportunity and when they can kind of wait and then throw more resources at it later when it’s larger. So we see the opportunity on the other end of the spectrum, but that said, you know, 200 billion in market cap is still a lot…that’s really big to a small company like LedgerX and to some of our customers, and you know, we had a record second quarter. We’re seeing a ton of demand that is really meaningful to us.
Laura Shin:
And when you say record second quarter, what was the volume?
Juthica Chou:
It was about 200 million worth of derivatives traded and cleared in the second quarter.
Laura Shin:
Great. So we’re going to discuss some of the more unique contracts on the platform as well as regulation in a moment, but first a quick word from the sponsors who make this show possible.
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Laura Shin:
Back to my conversation with Juthica Chou of LedgerX. So something I was curious about was what would happen if a bitcoin hard fork happened during the period of a contract? Like, let’s say that you had had these physically settled contracts trading on August 1, 2017. Who would’ve kept the bitcoin cash that resulted from the bitcoins that were in your possession at that time or for any airdrops or anything like that? How do you guys handle that?
Juthica Chou:
Yeah, it’s a great question. So we had posted, especially around the time when there were a lot of hard forks, a general approach to our hard fork policy. The short answer is that there is no clear answer because it really does depend on each fork. It depends on our ability to…it depends on the forked coin. It depends on if that’s traded in exchange. It depends if that has regulatory implications, as well.
Like, if somebody forks bitcoin into something that resembles a security, it depends on the security of the forked coin itself. So, you know, it is, in general, as a centralized custodian, the value should accrue to our participants, but in each case…I mean, I believe there was a specific fork that we actually gave our specific guidance on. It should be somewhere on our website, but we really have to take it case by case at this point.
Laura Shin:
So let’s talk about something else that’s kind of unique to this space, which is that you guys have a bitcoin halving contract in which people can trade contracts that I guess are sort of basically bets on the one…I can’t even speak today. On when the next halving will be, and for people who aren’t aware of what halving is, it’s when the block rewards, which is the number of new bitcoins that are minted by the software every 10 minutes, that’s when those rewards will be cut in half. So, right now, it’s 12.5 bitcoins that are released every 10 minutes, and at some point next year, like in the spring / early summer, it’s going to be 6.25. So describe for listeners how this bitcoin halving contract works.
Juthica Chou:
Yeah, so, as you mentioned, it’s a pretty straightforward contract on when the halvening will occur. So if the halvening occurs before a certain date, the contract pays off, and then if it doesn’t, it ends up in zero. So it’s a binary contract in that way.
Laura Shin:
And who is trading that contract, and why would they want to bet on that? How does that help them?
Juthica Chou:
Well, so, you know, we can always come back to the case of miners, for example, who have obvious exposure to the halvening, and then other participants…I mean, I think some people sort of look at the halvening as possibly a catalyst for bitcoin price depreciation based on what’s happened at previous halvenings, as well as just, you know, if there’s a view that as the mining reward goes down, transaction fees go up. A lot of both businesses and individuals and companies have exposure to the halvening, and so being able to hedge that exposure in a pretty direct way, hedging when it’ll happen, is important to customers.
Laura Shin:
And so just so I understand, from the mindset of a miner, it’s a little bit like, okay, if the block reward gets cut earlier than I expected and my revenue goes down earlier than I expected, then, essentially, I can make a little bit of money off this contract. Is that sort of why they’re purchasing it?
Juthica Chou:
Yeah. Exactly, and so it would be exactly that. So let’s say it happens, like, a month or two earlier, then the contract pays out, which would hopefully offset some of the loss from the reward going down sooner than expected.
Laura Shin:
And so this halving contract is based on the technicals of the network. What are some other examples of types of contracts you could imagine that are also unique to crypto assets? You know, because this contract, you couldn’t have this in traditional financial services, right? Like, this is something unique to the crypto asset space. So are there other examples of kind of contracts you guys could imagine offering that are related to technicals of networks?
Juthica Chou:
Well, I think something that settles to the difficulty is a very intriguing contract from my point of view, and we’ve kind of actually already designed the specifications, and what’s great is, I mean, we talked a little bit about the susceptibility to manipulation when it comes to spot exchanges and cash settled contracts, and I think physically settled are obviously a lot better because, as you mentioned, you just get the bitcoin. You don’t have that exposure, but I mean, you take a contract that settles to the difficulty of a particular block, and that’s nearly impossible to manipulate. So it’s a super clean settlement, and I think it’s something that people would both, again, have exposure to, like if you’re a miner, but also be interested in speculating on. So I think difficulty contracts, and then I think in the future, transaction fee contracts, as well.
Laura Shin:
Oh, it sounds so interesting. I kind of love this. I think this is fascinating, and I don’t know, at a certain point, it gets kind of creative and fun I think. So I look forward to seeing what you guys do. So another contract that you guys recently introduced was one for a 100-thousand-dollar bitcoin by December 2020, and I saw in the article on this that…it was in Bloomberg. That there was a demand for such a contract from institutional customers with assets between 10 million and 1 billion. So is that how you decide on which contracts to introduce? Like, people sort of make requests and you see kind of what there’s demand for, or how do you decide?
Juthica Chou:
Yeah, we list the contract. I mean, we usually do it in conjunction with where we see both direct customer requests and demand as well as where customers trade. So, you know, for example, one of the things that surprised me a little bit when we launched LedgerX and as we started scaling it with the institutions was that people had much longer dated demand than I initially thought. I thought it was going to be more that people would want to trade 1, 2, 3-month contracts because bitcoin was so volatile, that nobody really knew where it was going to be a lot further out, but we’re actually seeing the opposite. I think most of…not most, but a large, large portion of our open interest is in December 2020, June 2020, and so we kind of look at some of those patterns, and that helps inform listing contracts that people request.
Laura Shin:
That’s interesting. I wonder if it’s sort of like…you know, the fact that…no, I guess because you just opened to retail investors…I was going to say that maybe this sort of is one way in which kind of this retail market differs from the institutional, but that’s not entirely true. One other thing, though, that I did want to mention, and not that this is investment advice.
But when I read that, I couldn’t help but think about how, in a recent episode, Dan Morehead of Pantera mentioned that I guess his firm had mapped out bitcoin’s price logarithmically over time and then projected out that by the end of…think it was 2020. Yeah, that bitcoin would hit 122 thousand. So when I saw that contract, it just reminded me of his statement, and I thought, okay, well, I guess we’ll see.
All right, so one other thing that I wanted to ask about this was Cboe stopped listing bitcoin futures contracts in March, and I noticed that they had pretty small volume compared to CME. In December, their volume was about a quarter million or a little bit less, but it had actually once been as high as about 2 billion at the beginning of 2018. So are there any lessons that you guys are trying to draw or can draw from how unpopular this contract eventually became?
Juthica Chou:
Not really. I mean, to be honest, I didn’t follow it too, too closely, but I think it, you know, perhaps validated some of the positions that we took in the past about the focus on physical settlement, but no, we’ve just been really focused on LedgerX and our participants and just making sure that we have a great product that our participants like using.
Laura Shin:
So I noticed that LedgerX has said before that you guys have intentionally decided not to offer products or services that would require regulation by the FCC. Why not?
Juthica Chou:
Well, being regulated is no joke. You know, I think we’re such an interesting company because we’re a startup, but the licenses that we have, we are held to the exact same standards as, you know, 40-billion-dollar companies, and so I think the regulation is necessary for what we want to do and for providing a safe platform to our customers, but I don’t think we can conceivably run a small business like this having to deal with another set of federal regulations.
Laura Shin:
Oh, but was there a reason why you preferred the CFTC over the FCC?
Juthica Chou:
It was more that we went down the path because we were really focused on bitcoin. I think some of the FCC stuff is more I think for people who are doing, I suppose, tokens, but I think more ETFs in particular, but in the early days, we just took a bet that bitcoin would be a commodity and fall into the CFTC’s jurisdiction.
Laura Shin:
So I know that you guys needed to get two licenses from the CFTC. Can you describe what those two were and what those enable you to do?
Juthica Chou:
Yeah, so we have three licenses now.
Laura Shin:
Oh, okay.
Juthica Chou:
Yeah. So a brief bit of history. So we had two. In July 2017, we got our first two. So we have the Swap Execution Facility, which is the institutional exchange license, and then we got the Derivatives Clearing Organization, which is the clearinghouse, and so that’s the one that allows us to custody dollars, to custody bitcoin. That’s how we kind of guarantee all the trades and hold the collateral to settlement.
But the Swap Execution Facility is what limited us from not being able to touch retail. So the third license that we applied for and got was the Designated Contract Market, which allows us to do futures and retail, and so, at this point, we’re only really operating the Designated Contract Market and the Derivatives Clearing Organization because everybody can trade on both of those, but we still have the third license because we haven’t gotten rid of it yet.
Laura Shin:
I saw that a few years ago, you guys submitted a public comment to the New York State Department of Financial Services requesting that it exclude companies subject to the Commodities Exchange Act from the BitLicense, but they did not create that exemption you requested. So do you guys need to apply for a BitLicense, and if so, do you plan to do so?
Juthica Chou:
No. So this is a conversation we’ve actually had with the CFTC and with DFS. So this is where having the federal license really does come in handy, because the federal regulators are of the view that they have preemption over state licenses.
Laura Shin:
And I also noticed that you’re open to Singapore customers in addition to US customers. So why is Singapore the other jurisdiction that LedgerX is available in?
Juthica Chou:
Well, you know, as we started looking at other areas to expand to, we really started with the regulators that had good relationships with, you know, the US regulators, particularly the CFTC, and so we were able to get some introductions there, and just the partnership that they had made it easier for us to do what we wanted to do, as compared to some of the other countries in Asia where I think we would’ve needed very significant even changes in law from their side in order to offer our products.
Laura Shin:
And I also saw that you commented that, from a banking point of view in addition to the regulatory point of view, it was easier to start with institutional customers. So I was curious to hear more about this banking issue. I mean, I don’t know how well known it is to listeners. Maybe I should do a podcast on it, but crypto companies typically have a very, very difficult time getting banked. They often get cut off from their banks. People who’ve been following the Bitfinex and Tether sagas probably have some inkling of this, but so was that common…meant to imply that, essentially, if you have institutional customers, that then that kind of makes the banking easier or at least makes it less likely you’ll have your banking cut off?
Juthica Chou:
I mean, I think now the environment is a lot better. You know, even in the US, I think there’s some banks that are public about their involvement in the space, but we started LedgerX in 2014, and no joke, I think Paul and I spent the first nine months of the company just solely focused on getting a bank account and not even a custody account. All we wanted was just an operating account that we could hold our VC money in, and so the banking…and that lasted for a couple of years.
So, during that period, as we really, really struggled to get banking relationships and find banks that were comfortable, you know, with the crypto space, the fact that we were focused on institutions was definitely something that we found made them a lot more comfortable, but now LedgerX, we’re proven. I think people are more familiar with us and our regulator, the CFTC, and then there’s banks that are much more comfortable with crypto, and so now I think it’s not as big a deal, provided that you just have the right regulatory oversight.
Laura Shin:
All right, well, let’s hope for a lot of these startups out there that I think some of them at least are still struggling with this. One thing also that I was curious about just from a regulatory perspective is how will the trades of bitcoin futures be taxed? Do you have any clarity on that?
Juthica Chou:
Yeah, so futures do get the…well, so this is not tax advice, but just from what I’ve kind of seen and read, futures do get 1256 tax treatment, and it’s this strange thing…
Laura Shin:
I don’t know what that means.
Juthica Chou:
So they get 1256 tax treatment. I’m not sure exactly what that is offhand, but it is beneficial and preferable to how bitcoin spot gets taxed.
Laura Shin:
Oh, okay. Well, that’s good, because I feel like that is still a major, major issue that needs to be resolved in the crypto space. So something else that I got curious about was, you know, when you talked about how you guys decided to focus on bitcoin, and that sort of led you to the CFTC. As we’ve seen, ether it looks like will be considered a commodity, or at least it’s been hinted in various ways that at least it’s not a security. So if that becomes official then, could you see LedgerX offering derivatives in ether?
Juthica Chou:
Yeah. Absolutely, and we actually…I believe it was last summer when there was a comment from the FCC, maybe from one of their commissioners, about it not being a security. We actually circulated draft filing with the CFTC for us to offer Ethereum, and then kind of shortly after that is when it became a much more drawn-out process as they decided to open up for public comment. So, at this point, you know, I think we’re just going to kind of wait and see, and if the CFTC gives the guidance that it’s a commodity, then we’ll move on it, but otherwise, we’ll just stay focused on bitcoin.
Laura Shin:
And I’m assuming that would also apply to things like bitcoin cash, Zcash, or like, any of these other digital assets that are somewhat similar to bitcoin?
Juthica Chou:
Correct. Yeah.
Laura Shin:
So we’ve made it very, very far into the episode without getting into your background, and you’ve mentioned this mysterious Paul. So why don’t you now kind of…and also, you know, you guys were so early. So I just want to hear the story of how you came to found LedgerX.
Juthica Chou:
Yeah, so we’d been in bitcoin for maybe a couple of years before we started LedgerX, and by in bitcoin, I don’t mean we were super active, but we followed it and traded it here and there and just paid attention to it.
Laura Shin:
And before that…or not before that, but during this period, explain where you were working and how…
Juthica Chou:
Yeah, so I was working…so, sorry, it was 2011. So I was working at Goldman at the time. Paul was at Y Combinator on the west coast.
Laura Shin:
And this is Paul Chou, the CEO.
Juthica Chou:
Paul Chou, yeah.
Laura Shin:
Who’s also your husband.
Juthica Chou:
Correct. Yeah, and so he got exposed to it first, and so this was summer of 2011 when there was that price spike up to 30 and then back down, and so we went through the process of buying our first bitcoin on Mt. Gox at the time, which was a very, very cumbersome process between getting our funds from Goldman to…I think we used Dwolla to Gox, but once we had bitcoin, we could just send it back and forth, you know, cross coast easily, seamlessly 24/7.
And so we played around with it. We ultimately ended up not really doing much with it both personally and definitely professionally, partly because we both had full-time jobs, and we didn’t really feel comfortable with just, you know, holding keys on our laptops, but we still found it really interesting, and I think a couple years later, there were a couple things that happened. One was that the market cap had appreciated significantly.
So, you know, it was now…I mean, it was obviously a lot lower than it is here, but it was now approaching a scale where Coinbase was around and companies were moving reasonable amounts of bitcoin that could actually start to support a derivatives market, and then, two, was there were these tenet hearings in November of 2013, which our takeaway was fairly positive on bitcoin and that we thought the regulators were going to take a constructive approach towards regulating bitcoin.
So with those, we had thought about doing derivatives for a while, and I think after those hearings, we just went all in on LedgerX. We were early. We were naïve. I was actually watching an interview this morning, and a guy said that one of his biggest advantages was his innocence, and I think you can say that for us, too. That we didn’t really know how long a process it was going to be, but we got through it, and you know, we’re here 5, 6 years later.
Laura Shin:
And I have heard you also talk about navigating this blockchain, not bitcoin era. In fact, actually, I want to quote a little bit your husband talking about that period. He said in a blog post quote, I cannot stand the years of my life wasted in board meetings with morons lecturing me about how private blockchains are going to revolutionize back office technology and suck the air out of the ecosystem for things like bitcoin.
They were right about one thing. They did suck the air out of the ecosystem for a few years, drawing away valuable investment capital that could’ve been used for legitimate projects in public blockchains, and then toward the end of the post, he says, quote, Wall Street back office technology isn’t historically inefficient because they didn’t have access to magical blockchains.
Wall Street technology sucks because they marginalize technologists, the, and he puts this in quotes, business guys rule. Traders, bankers, these are the…again, quotes, front office guys. Everyone else doing the work of recordkeeping and coding are called, again, quotes, back office, and I imagine these are all air quotes, and they are treated and paid horribly.
I’ve worked on trading floors where traders will throw footballs at the heads of nerdy programmers who are cluelessly being made fun of. So I was curious to know, like, you know, how this period felt for you guys where you were making this bet on bitcoin, and all around you…you know, you’re based in New York. You guys have these backgrounds from Goldman. It felt like everybody else was focused elsewhere. How did you navigate that period?
Juthica Chou:
It was rough. It was a hard period. You know, as his post mentioned, it would suck the oxygen out a lot, and I think part of what made it really hard is not just that everybody was focused on blockchain, which we didn’t really believe was a thing without bitcoin, but you saw a lot of companies pivoting towards that because that’s where the opportunity was, and we were pretty stubborn on sticking to building a product that we believed in, and so it was definitely a test of our will and resilience, but I guess I’m glad it sort of has died down, and I think, ultimately, one of the things that really…there were a couple of reasons why we were so set on it.
One is we were pretty sure that we were right just from a first principles technical point of view, but two is I’m a markets driven person, and if bitcoin was really nothing, then the market would’ve reflected it, but you know, even while all of this was going on, the price still stayed at some…it might’ve only been, like, 5, 10 billion dollars, but that’s still a lot of market cap that was still sustained even while everyone was talking about how bitcoin was worthless and it was all about blockchain.
Laura Shin:
All right. So I also want to ask about a few other offerings you have or plan to roll out. I saw in a blog post you mention that you’ll be offering a subscription-based data service that you described as Bloomberg meets Wolfram|Alpha. Tell us more about that and how that fits into your overall strategy.
Juthica Chou:
Yeah, I mean, data is always…it’s generally an important part of markets, and what we want to do with that is not just make the data available, but we want to make it approachable, you know, particularly options data. I mean, I can say that, oh, the December 25-thousand strike call expiring in, let’s say, 2020 is 2 thousand dollars bid at 3 thousand dollars, but that doesn’t mean much to you, and so what we’re trying to do is how can we take this data that we have that’s incredibly rich and make it approachable and meaningful to folks?
And so we’ve launched on our website a very, very early, crude version of this called the LedgerX Oracle, which is kind of something that you can just talk to. You know, you can just ask it questions, ask it what’s the chance that bitcoin will be above 10 thousand a month from now, and it takes these probabilities, and it pulls them from the options data that we have, and so we want to really expand that over time and make it something that people can talk to, but that they can get real live options pricing driving behind it.
Laura Shin:
And another product you have is called the LXVX. What does that indicate, and how do you construct that?
Juthica Chou:
It’s a volatility index. It’s roughly a 30-day volatility index. So we construct it from usually one or two months of options that are listed, and that’s designed to give people a sense of what bitcoin-implied volatility is. So realize volatility is looking historically at how much bitcoin has moved. What the LXVX tells us is what is the market pricing for where they think volatility will be over the next 30 days, and so that’s an important metric even to people who may not trade options, per se. Maybe they are only trading bitcoin, or maybe they just run a business in the bitcoin space and they want to know how much uncertainty is being priced in, and so that index is designed to give the market a sense of what traders are estimating or forecasting for future volatility.
Laura Shin:
And the last thing I wanted to ask about in terms of the products was the LedgerX PIT. What is that, and what happens in the PIT?
Juthica Chou:
Yeah, the PIT, this is another one that I think I found very interesting. So if you humor me, I’ll just tell a really quick story. So, when I was at Goldman, I started in high frequency trading, and so it was electronic. It was highly efficient, algorithmic, and I worked there for five years from 2006 to 2011, and I remember towards the end of my time there, I just remember wondering why markets hadn’t fully gone electronic, because it was so much more efficient.
So I didn’t really understand that, and so then I moved to the Goldman franchise desk, which is the desk that’s client facing, and I got a completely different perspective of trading, which is that it’s not necessarily just about the efficiency and cutting latencies and getting, you know, a fraction of a penny better here and there. A lot of it is social, and a lot of the experience that people have is better when they know who they’re dealing with.
You know, when it’s anonymous trading, I think people tend to assume the worst intentions, not give people the benefit of the doubt, not treat people as well, but when it’s non-anonymous, it’s a much richer experience, and we noticed that, through LedgerX…because we have a block trading mechanism which is done directly between participants, and then we clear it, and we noticed that this was becoming a much richer experience. That people were using this mechanism even if they could get the same kind of pricing on the screens, but just because of the experience.
And so the PIT is designed to be a virtual PIT, really. It’s similar to the Chicago trading pits and the way that people interact there and the way that they play the long game. You know, it’s not so much let me just do this one trade and try to screw over the other side. It’s, you know, you have a lasting relationship. You’re going to have to deal with these people going forward, so kind of playing the long game there. So that’s what the PIT is designed to do for our institutional customer base.
Laura Shin:
I love that. That’s a great lesson from your Goldman days, and one other thing that I was curious about was I believe that you worked at Goldman during the financial crisis. Is that correct?
Juthica Chou:
That’s correct. Yeah.
Laura Shin:
So do you think that that kind of affected your interest in bitcoin, and if so…or regardless of whether or not it did, how do you take that experience in this venture? Like, how does it affect how you plan to manage LedgerX?
Juthica Chou:
I think the biggest thing that I got out of that experience was just realizing how bad things can get very quickly, and so, you know, I think in my current role running a mission-critical operation, it’s kind of good to have that healthy amount of paranoia and just realizing what can go wrong and how badly things can go wrong really quickly, as we saw with the economy in 2008. I don’t know that it…you know, maybe years later as I…you know, in 2011 I think when I got introduced to bitcoin, I think I had more of an appreciation for it because of having gone through 2008, but obviously, at the time, I didn’t really…even though that’s around when the white paper came out, I wasn’t really aware of it until a little bit later.
Laura Shin:
All right. Well, where can people learn more about you and LedgerX?
Juthica Chou:
So LedgerX, on our website, and I am recently on Twitter. So my Twitter handle is just my first name, Juthica.
Laura Shin:
Okay. Great. Well, thanks for coming on Unchained.
Juthica Chou:
Thank you for having me.
Laura Shin:
Thanks so much for joining us today. To learn more about Juthica and LedgerX, check out the show notes inside your podcast player. If you’re not yet subscribed to my other podcast Unconfirmed, which is shorter and bit newsier, be sure to check that out. Also find out what I think are the top crypto stories each week by signing up for my weekly newsletter at UnchainedPodcast.com. You can sign up right on the homepage. Unchained is produced by me, Laura Shin, with help from Fractal Recording, Anthony Yoon, Daniel Nuss, and Rich Stroffolino. Thanks for listening.
