Unchained - LedgerX on the Reasons to Trade Bitcoin Options - Ep.130

Starting point is 00:00:02 Hi everyone. Welcome to Unchained, your no-hype resource for all things crypto. I'm your host, Laura Shinn. 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 Valkenberg of Coinburg of Coin Center on Congress's hearings about Libra. Also, if you're making vacation plans, Consider the weekend retreat I'm teaching with Melton Mirrors of Coin shares and Jalik Jobun Pruchra of Future Perfect Ventures. It'll be at the beautiful Omega Institute in Rimbach, New York, from September 20th to the 22nd. Be sure to check out the show notes for the link to sign up. Grow your crypto and earn up to 8% per year with Crypto.com. It's the place to buy over 40 coins at true cost with no fees and no markups. Download the crypto.com app today. Cracken is the best exchange in the world for buying and selling digital assets.

Starting point is 00:01:06 It has the tightest security, deep liquidity, and a great fee structure with no minimum or hidden fees. Whether you're looking for a simple fiat on-ramp or leveraged options trading, Cracken is the place for you. Cipher trace cutting-edge cryptocurrency intelligence powers anti-money laundering, blockchain analytics, and threat intel. leading exchanges, virtual currency businesses, banks, and regulators themselves use cipher trace to comply with regulation and to monitor compliance. My guest for today is Juthica Chow, co-founder and chief operating officer and chief risk officer for Ledger X. Welcome, Jutthaca. Thanks for having me, Laura. Ledger X reached a major milestone recently, a first for the crypto space. Why don't you tell the listeners what that is? Sure. So Ledger X, we recently, uh,

Starting point is 00:01:58 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 Ledger X institutional customer base has been trading for almost two years now. And why don't you elaborate on that? What is it that Ledger X has been doing for the last few years? We are a U.S. 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.

Starting point is 00:02:44 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 to access to institutions. But we had worked with the regulators over the last maybe six to nine 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.

Starting point is 00:03:36 And so that's an important element that we usually call physically settled derivatives. And for so long in the space, the rallying cry has been hoddle or hoddle. So why is it that someone would want to buy a derivative of Bitcoin rather than Bitcoin itself? 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 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 levered exposure on the long side so they can buy call options instead of buying options themselves.

Starting point is 00:04:27 And so I think what we see at LedgerX is a wide range of customers and customer base coming into 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 deal in the physical, they touch, you know, the world outside of just a single trade. and both sides can really benefit depending on their specific considerations and constraints. Why don't we walk through some of those examples because they 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, you know, would choose

Starting point is 00:05:11 to buy a Bitcoin call option. So the standard academic definition of an option is, 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 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 $10,000, I can buy it at $10,000 or I can sell it at $10,000. 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

Starting point is 00:06:06 call option that expires December of 2019, so December of this year, with a $25,000 strike price. and this option on LedgerX is around $500 right now. So if I am a, maybe I'm a longholder 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 Bitcoin at $10,000. And I know that it can go down to $7,000, $6,000 just because it is a volatile asset. I might instead decide to buy a call option for $500. The most I could lose is that $500.

Starting point is 00:06:51 And if Bitcoin does rally significantly, then I can make, you know, essentially have that upside exposure and still make money with a big rally. 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. This was, and he had purchased them, I guess, in December 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, you know, because he runs Block Tower

Starting point is 00:07:31 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 go up. And yet during this time when maybe there is volatility and maybe the price could drop, you know, like 80% or whatever, that I would be able to hold fewer bitcoins on my balance sheet and keep the assets of my LPs from, you know, from dropping that 80% or whatever it might be. And, you know, he was just like, this is a way to, yeah, to, sort of like limit the downside exposure. I think he only paid $3,600 for that. And so, you know, it's a nominal amount for the size of his fund. And yet, you know, at that time when Bitcoin was

Starting point is 00:08:24 $20,000 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, I have that in my fund. Okay. 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 bets where they expect that, or not that they expect, but they want to ride any trends upwards, right? Like call options are generally for prices that are higher than what it's currently trading at. Is that correct?

Starting point is 00:09:05 That's correct, yes. In terms of the contracts that people typically trade for call options, it's with higher strike prices. 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? 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 we're talking about a fund or even an individual that has Bitcoin and they are a little bit

Starting point is 00:09:55 worried maybe about some short-term decline or some of the headline risk that could cause Bitcoin to fall significantly, they might buy a, you know, maybe a, you know, maybe a, you know, an 8,000 strike put option. And so what they're doing is they're buying insurance so that if something does happen and Bitcoin goes to 6,000, well, now they have the right to sell Bitcoin at 8,000. And so they kind of protected their position in a way. And the benefit of a put option, similar to a call option, is that you'll never lose more than you pay for the option. And now, 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, you know, why?

Starting point is 00:10:49 Well, I think the, actually, the crypto fund, I think, is an interesting example that ties in, puts and calls because I think the, the Ari example is one that shows how unintuitively, you know, buying call options, which is ostensibly a bullish, very powerful. 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 benchmarks 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. I think we've seen 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

Starting point is 00:12:03 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 longholders, 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, minors 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 on the physical in order to provide them with these hedging instruments that actually makes sense for them. And elaborate on that.

Starting point is 00:12:44 Like why? And this is actually something I was wondering too. So in contrast, the Bitcoin futures contracts 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, you know, why that's a bad thing for them, like, like why they would prefer something physically settled. So miners have, you can almost think of them like, like, similar to gold, for example. But so Bitcoin miners, they invest, you know, dollars in their

Starting point is 00:13:28 infrastructure. And then they earn a fixed number of Bitcoin. And so, So that Bitcoin is, you know, 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 U.S. 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

Starting point is 00:14:14 hedge to settle for cash. So it suits, you know, 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 is, And 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, we see that Ledger X, anyone can send it 24-7, 365 outside of any banking windows. Let's talk a little bit more about this, you know, physically settled aspect. So how does it work exactly? I, when I decide to buy or sell a Bitcoin call or put option, you can pick whichever example it is.

Starting point is 00:15:03 Do I literally send you my Bitcoin to do that? And then at that point, what do you do with it? 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 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 a centralized custodian. And then once the trade settles, people are returned to what? The Fiat that they sent if they sent Fiat or and then the Bitcoin they sent if they sent Bitcoin or?

Starting point is 00:15:46 So yeah, so the mechanics are that if you purchase, let's say you purchase a call option. let's say the 25,000 strike call option. So you purchase it for $500. So you pay $500 today. And then when it expires in December, if it's in the money, so let's say Bitcoin is at $30,000, then you'll purchase Bitcoin for $25,000. So you'll pay $25,000 and you'll receive one Bitcoin. 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? Yep. So that's exactly what we, that's really what we do as a, as a central clearinghouse. So at the time that the seller does, takes the other side of the trade, they collect $500 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, your call option, that we have the Bitcoin. And how do you store all those bitcoins? Do you put them in,

Starting point is 00:16:50 some kind of cold storage that only you control that, you know, at the time the contract ends, you're the one who decides where the Bitcoin goes, or is it like some kind of multi-sig where like the parties have to sign off or how does that part work? We have to have ultimate control over it. That's the only way that we can accept it as a form of collateral. Okay. And I'm assuming it's, is it in cold storage? We don't go into too much detail publicly about how exactly we do it.

Starting point is 00:17:21 Okay. Okay. Yeah, well, that makes sense. So why is it that that Ledger X decided to focus on derivatives? So it's kind of twofold. 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, you know, that is a, has elements. of being a financial instrument. And we saw, you know, companies that were in the space that were doing, you know, 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.

Starting point is 00:18:15 And so, you know, we kind of thought one example is that if they had better tools to 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 use cases for Bitcoin to other people. And so we thought that would be good for the ecosystem, and 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 most people would be familiar with and that would have preemption

Starting point is 00:19:08 over the states. 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 exchange, the regular spot exchanges have had to go through is that the kind of company that has to do that? Exactly, yes. And so amongst some of the other exchanges working in crypto derivatives like Backed and Erasex, they're focused on futures. Why is your focus a little bit more in options? Well, you know, I think the, I think ultimately a lot of other people will,

Starting point is 00:19:45 eventually get to options as well. You know, for us, it's, and what we see in particular, is the, 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. Yeah. And just to explain that a little bit more for listeners, when she talks about yield, I think, 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 big, like they can, I think

Starting point is 00:20:38 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 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 like, so let's say Bitcoin is $10,000 now and they do that. And then they earn the $500. but then later if the price does go above whatever the strike prices, then at least they haven't had to sell the Bitcoin for $10,000. You know, they sold it for like $15,000 or whatever in the future. Is that what you mean?

Starting point is 00:21:27 There was something about this where like when I learned about it reminded me a little bit of like MakerDAO and how people put up ETH as collateral and get die, which is pegged to U.S. dollars in the meantime. I'm not super familiar with Make or Dau, but in the case of what you were saying for the call options, that's correct. So a minor would sell a call option. They would collect $500 today for that $25,000 strike. And then if when at expiration, Bitcoin is at above $25,000, then they'll sell Bitcoin for $25,000, which they might prefer to if they had to sell some of their Bitcoin today at $10,000. And then if Bitcoin's below $25,000, then they just get their Bitcoin back and they can, you know, do that trade again. And so they can essentially earn, that's, you know, $500 over a like five month period. One other way that I wanted to ask about, so earlier with the futures, you know, I seem to just with my question, it sort of felt like it was to me, that it would be preferable to me to receive, you know, to have a physically settled contract where I am receiving Bitcoin back simply because it's so volatile, it would

Starting point is 00:22:44 be like, oh, maybe if I did a trade, but then later I might realize that like a day later, I would have gotten a lot more money for it or something. Do you not like if it were settling in dollars as opposed to Bitcoin. But then another thing was that just from the purchasers perspective, they also have the flexibility of like whether or not to to actually buy on the expiration day, right? Like as far as I understand, maybe I'm wrong. Yep, that's correct. Yeah. So that also gives the purchaser more flexibility. So why, so it just feels like cash settled derivatives are always going to be superior. Sorry, opposite. Physically settled derivatives will always be superior to cash settled. Is that correct?

Starting point is 00:23:34 Yeah, I think so. I think that's absolutely correct. Oh, okay. All right. Well, I mean, I think we're, yeah, and I think the, you know, the reason that, I think some people go down the route of cash settled is because it is easier, it's much easier to get to launch because it's easier from a regulatory point of you, 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, but yeah, I think especially, especially in a market like Bitcoin, where the physical is so easy to move, you know, physical commodities in general are very, very important markets. And that's coming from markets where it's actually difficult to store and move the

Starting point is 00:24:19 physical commodity. But Bitcoin has, you know, has that in spades. 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. All right. So let's type 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 your platform needed to have a minimum of $10 million 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 training with be an

Starting point is 00:25:08 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? I think in general, you know, And I'll extract from this even a little bit because I come from the high frequency trading background, which is, 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 are, they're out there on multiple platforms hedging very efficiently. And so that just provides better and better pricing for retail. What price or index are you guys using to determine whether or not the price

Starting point is 00:25:49 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 have 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 is it? and being manipulated for profits on Ledger X? Yeah, I mean, it's a huge issue with spot markets and with overseas exchanges. And outside of surveilling our own markets, the beauty of our products is if we go back to

Starting point is 00:26:34 that example of you bought a call option for $500 with a $25,000 strike price, when expiration comes, you get to decide if you want to exercise that option and pay $25,000 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 $25,000 or below, we leave that up to whoever the longholder is. And so that way they can factor in different, you know, exchanges, different things they see and make the determination that they think is appropriate. Oh, okay. Wow. That's, that's, that's, um, that's. pretty genius and probably a load off your back. And Ledger X is saying that it will never charge any fees for trades. So if that's the case, how do you make money? 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

Starting point is 00:27:37 on their side for essentially a maker fee. So the Omni has no fees in taking. And so we make the money off the institutions. And as Paul alluded to, the institutions, you know, the professional traders, they price it in anyway. And so it's kind of part of our way to just keep the fee schedules very transparent. You know, the price that you pay is what you're getting for it and not having, and then, you know, on the institutional side, they know exactly what they're paying and they price it in. So we make it on that side. And you have a wait list of about 3,000 people, I believe. So why, Why is there a wait list at all? Well, I mean, so for us, as we work through adding, you know, users,

Starting point is 00:28:24 there's a whole host of operational and regulatory, you know, additional items that we just want to make sure we get completely right. You know, I think one of the things that we get really good feedback on for the Ledger X 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, on everyone, all of our stakeholders from the customer all the way down to the regulators and the banks are also continue to be very happy with the Ledger X experience. And you launch with 15 institutions in 2017.

Starting point is 00:29:00 How many institutions do you have on your platform now? It's about 250 now. And I saw that Paul said recently in an interview on Cheddar that the institutional market has been slower to materialize and that Ledger X thinks the opportunity is in the retail market, why do you guys think that and what does the size of that opportunity look like? So, you know, I think for us from, first to kind of put institutional into context, you know, as you mentioned, our requirements are around $10 million or more in assets. And so we definitely see significant interest in maybe the smaller size institutions, but for what people traditionally

Starting point is 00:29:41 refer to as, you know, financial institutions, getting to the very, very large, you know, hedge funds and investment banks, I think Bitcoin's market cap is still not large enough for the opportunity to be meaningful to them. Even at $200 billion, that's just the size of a stock, really. And 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.

Starting point is 00:30:22 That's really big to a small company like Ledger X and to some of our customers. And so we're seeing, you know, we had a record second quarter. We're seeing a ton of demand that is really meaningful to us. And when you say record second quarter, what was the volume? It was about $200 million worth of derivatives traded and cleared in the second quarter. 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 words from the sponsors who make this show possible. Will the world follow France and advocate banning privacy coins? Will government-backed stable

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Starting point is 00:33:44 air drops or anything like that. How do you guys handle that? Yeah, it's a great question. So we have a, you know, we had posted, especially around the time when there are a lot of hard forks, are 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, um, It depends on the forked coin. It depends on if that's traded on an 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 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 fork, a specific fork that we actually. gave our specific guidance on it should be somewhere on our website. But we really have to take a case by case at this point. 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

Starting point is 00:34:56 I guess are like sort of basically bets on what on the one, I can't even speak today on when the next having will be. And for people who aren't aware of what having 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 Bitcoin's 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 having contract works. Yeah. So it's a pretty, as you kind of mentioned, it's a pretty straightforward contract. on when the having will occur. So it pays off. If the havinging occurs before a certain date,

Starting point is 00:35:45 the contract pays off. And then if it doesn't, it ends up in zero. So it's a binary contract in that way. And who is trading that contract? And why would they, like, why would they want to bet on that? How does that help them? Well, so, you know, we can always come back to the case of minors, for example, who have obvious exposure to the having. And then, you know, other participants, I mean, I think some people sort of look at the happening as possibly a catalyst for Bitcoin price appreciation based on what's happened at previous happenings, 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 happening. And so being able to hedge that exposure, you know, in a pretty direct way, you know, hedging when it'll happen. is important to customers. And so just so I understand it, from the mindset of a minor, 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

Starting point is 00:36:52 expected, then essentially I can make a little bit of money that, you know, off this, off this contract. Is that sort of why they're purchasing it? Yeah, exactly. And so we, it would be exactly that. So if the, you know, let's say it happens like a month or two earlier, then the contract pays out, which, you know, would hopefully offset some of the loss from the reward going down sooner than expected. And so this having 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 that, you know, because like this contract, you couldn't have this in a normal

Starting point is 00:37:36 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? 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 we talked a little bit about the susceptibility to manipulation when

Starting point is 00:38:06 it comes to spot exchanges and cash settle 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 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 minor, but also be interested in speculating on. So I think difficulty contracts and then I think in the future transaction fee contracts as well. Oh, that 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 $100,000 Bitcoin by December 2020. And I saw in the article on this, it was in Blooming. that there was a demand for such a contract from institutional customers with assets between

Starting point is 00:39:08 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? Yeah, we list the contracts and 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 one, two, three-month contracts because Bitcoin was so volatile that nobody really knew where it's going to be a lot

Starting point is 00:39:56 further out. But we're actually seeing, you know, 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, you know, that people request. That's interesting. I wonder if it's sort of like, you know, the fact that, no, that would make, I guess because you just open a 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 it's not entirely true. One other thing, though, that I did want to mention, not that this is investment advice, but when I read that, I couldn't help but think about how in a recent episode, Dan Moorhead of

Starting point is 00:40:47 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, I think it was 2020, yeah, that Bitcoin would hit $122,000. So when I saw that contract, it just reminded me of that contract or 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 CBO 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.

Starting point is 00:41:36 So are there any lessons that you guys are trying to draw or can draw from how popular this or how unpopular this contract eventually became? 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, you know, on physical settlement. But no, we've just been really focused on Ledger X and our participants and just making sure that we have a great product that our participants like using. So I noticed that Ledger X has said before that you guys

Starting point is 00:42:15 have intentionally decided not to offer products or services that would require. regulation by the SEC, why not? Well, being regulated is no joke. It's, you know, I think we are, we're such an interesting company because we're a startup, but we are the licenses that we have, we are held to the exact same standards as, you know, $40 billion companies. And so I think the regulation is necessary for what we want to do and for providing a safe platform to our customers.

Starting point is 00:42:49 but I don't think we can conceivably run a small business like this having to deal with another set of federal regulations. Oh, but was there a reason why you preferred the CFTC over the SEC? It was more that we went down the path because we were really focused on Bitcoin. I think some of the SEC 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 CFC's jurisdiction.

Starting point is 00:43:28 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? Yeah, so we actually, so we have three licenses now. So we, so a brief bit of history. So we had to, 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 clearing house. And so that's the that's the one that allows us to custody dollars, to custody Bitcoin. That's where, that's how we

Starting point is 00:44:05 kind of guarantee all the trades and hold the collateral to settlement. And then, 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 a designated contract market, which allows us to do futures and retail. And so we, 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. I saw that a few years ago, you guys submitted a public comment to the New York State Department

Starting point is 00:44:47 of Financial Services. requesting that exclude companies subject to the Commodities Exchange Act from the Bit License, but they did not create that exemption you requested. So do you guys need to apply for a Bit license? And if so, do you plan to do so? No. So this is a conversation we've actually had with the CTC 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. And I also noticed that you're open to Singapore customers in addition to U.S. customers. So why is Singapore the other jurisdiction that Ledger X is available in?

Starting point is 00:45:31 Well, we had, 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 U.S. regulators, particularly the CFTC. 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 without, as compared to some of the other countries in Asia where I think we would have needed very significant even changes in law from their side in order to offer our products. 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 institutions. customers. So I was curious to hear more about this banking issue. I mean, this is, 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 Biffinux and Tether Saga's probably have some inkling of this. But so was that common

Starting point is 00:46:42 meant to imply that essentially if you have institutional customers, then that kind of makes the banking easier or at least makes it less likely you'll have your banking cut off? I think, I mean, I think now the environment is a lot better. There's, you know, even in the U.S., I think there's some banks that are, you know, public about their involvement in the space. But, you know, 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 it was the banking, and that lasted for a couple of years. So during that period, as we really, really struggled to get banking relationships

Starting point is 00:47:31 and find banks that were comfortable with, you know, with the crypto space, the fact that we were focus on institutions was definitely something that we found made them a lot more comfortable. But now LedgerX is both, you know, 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. 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

Starting point is 00:48:15 trades of Bitcoin futures be taxed? Do you have any clarity on that? Yeah. So futures do get the, well, so this is not tax advice, but my, just from what I've kind of seen in red, futures do get 1256 tax treatment. And it's this strange thing. I don't know what that means. So they get 1256 tax treatment. I'm not sure exactly. what that is offhand. But it is beneficial and preferable to how Bitcoin's spot gets taxed. 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.

Starting point is 00:49:05 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 Ledger X offering derivatives in Ether? Yeah, absolutely. And we actually, when I believe it was last summer when there was a comment from the SEC, maybe from one of the commissioners about it not being a security, we actually, circulated draft filing with the CFTC for us to offer Ethereum. And then, 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, we're, 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

Starting point is 00:49:58 it. But otherwise, we'll just stay focused on Bitcoin. 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? Correct. Yeah. 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 kind of just want to hear the story of how you came to found Ledger X. Yeah, so we had been in Bitcoin for, you know, maybe a couple of years before we started Ledger X.

Starting point is 00:50:43 And by in Bitcoin, I don't mean we were like super active. But we had followed it and traded it here and there and just paid attention to it. And before that or not before that, but during this period, explain like where you were working and how. Yeah. Yeah. So I was, I was working. So it was actually, sorry, it was 2011.

Starting point is 00:51:00 So I was working at Goldman at the time. Paul was at Y Combinator on the West Coast. And so this is Paul Chow, the CEO who's also your husband. Correct. Yeah. And so he got exposed to it first. And so this was summer 2011 when there's that price spike up to 30 and then back down. And so we went through the process of buying our first Bitcoin on Mount Cox at the time, which was a very, very, very, cumbersome process between getting our funds from Goldman to, I think we used to Walla to Gox. But once we had Bitcoin, we could just send it back and forth, you know, cross coasts, easily, seamlessly, 24-7. And so we played around with it. We ultimately ended up not really doing much with it, both, you know, 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 laptop. So

Starting point is 00:52:00 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, you know, 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 the Senate hearings in November of 2013, which were, 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, you know, we had thought about doing DRODIS for a while.

Starting point is 00:52:49 And I think after those hearings, we just went all in on ledger acts. we were early, we were naive. I think 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 we're here five, six years later. And I have heard you also talk about navigating this like 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

Starting point is 00:53:37 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 have 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 marginalized technologists. And he puts this in quotes, business guys, rule. Traders, bankers, these are the,

Starting point is 00:54:16 again, quotes, front office guys. Everyone else doing the work of record keeping 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 uh 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 um it felt like everybody else was focused elsewhere. How did you navigate that period? It was rough. It was a hard period. You know, as his post mentioned, you know, it sucked the oxygen out a lot. And I think it was a part of what made it really

Starting point is 00:55:05 hard is not just that everybody was focused on on blockchain, which we didn't really believe was a thing without Bitcoin. But, you know, you saw a lot of companies like pivoting towards that because that's where the opportunity was. And we were pretty, um, 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, you know, it sort of has died down. And I think, you know, I think ultimately one of the things that really, there were a couple reasons why we were so set on it. One is we were pretty sure that we're right just from a first principles technical point of view. But two, is I'm a market's driven person. And if Bitcoin was really,

Starting point is 00:55:51 nothing, then the market would have reflected it. But the, you know, even while all this was going on, the price still stayed at some, you know, it might have only been like five, 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, you know, worthless and it was all about blockchain. All right. So I also want to ask about a few other offerings you have or plan to rollout. I saw in a blog post you mentioned 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. Yeah, I mean, data is always, it's generally been, it's generally an

Starting point is 00:56:35 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, if we, I can, you know, say that, oh, the December 24th, 5,000 strike call expiring in, let's say, 2020 is $2,000 bid at $3,000, but that doesn't really 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

Starting point is 00:57:18 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 10,000 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. And another product you have is called the LXVX. What is that? indicate and how do you construct that? It's a volatility index. It's about, it's roughly a 30-day volatility index. So we construct it from the usually front, you know, 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,

Starting point is 00:58:20 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's, that index is designed to give the market a sense of what traders are estimating or forecasting for future volatility. And the last thing I wanted to ask about in terms of the products in your say it was the Ledger X pit. What is that and what happens in the pit? Yeah, the pit is, 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

Starting point is 00:59:09 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. And so I didn't really understand it. 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

Starting point is 01:00:10 we notice that through Ledger X 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

Starting point is 01:00:38 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. And so that's what the pit is designed to do for our institutional customer base.

Starting point is 01:01:02 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? That's correct, yeah. So do you think that that kind of affected your interest in Bitcoin and if so, like, or, or, you know, regardless of whether or not it did, like, how do you take that experience, you know, in this venture? Like, how does it affect how you plan to manage Ledger X? I think the biggest thing that I got out of that experience was just realizing how bad things can get very quickly.

Starting point is 01:01:44 And so it just, you know, I think in my current role, you know, running a mission critical operation, it's kind of good to have that healthy amount of paranoia and just realizing, you know, what can go wrong and how badly things can go wrong really quickly as we saw at 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, you know, 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. All right. Well, where can people learn more about you and Ledger X? So Ledger X on our website. And I am recently on Twitter. So my Twitter handles just my first name, Juthica.

Starting point is 01:02:36 Okay, great. Well, thanks for coming on Unchained. Thank you for having me. Thanks so much for joining us today. To learn more about Truthica and Ledger Acts, check out the show notes inside your podcast player. If you're not yet subscribed to my other podcast, Unconfirmed, which is shorter and a 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 Factor Recording, Anthony Noon, Daniel Nuss, and Rich Stroffolito.

Starting point is 01:03:07 Thanks for listening.

Unchained - LedgerX on the Reasons to Trade Bitcoin Options - Ep.130

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