Cryptocurrencies and other digital assets hold significant potential as a store of value and as a means of transacting. But like the early days of the internet, digital assets face many hurdles to broader adoption, including a lack of scalable infrastructure, a need for application layer development, inconsistent regulation, and cybersecurity vulnerabilities. Now, Bakkt and Intercontinental Exchange (NYSE: ICE) are working to strengthen these markets.
At launch, Bakkt realized its initial goal of offering physically delivered bitcoin futures, while leveraging existing institutional workflows in CFTC-regulated markets and minimizing risks. The launch of BakktTM Bitcoin Futures contracts on ICE Futures U.S are also the first futures in this new asset class with on-exchange price discovery. The Bakkt Warehouse enables physical delivery and has two important features. First, it is designed to eliminate the need for futures commission merchants to interact with bitcoin. And secondly, it is a qualified custodian as part of Bakkt Trust Company, which is essential in meeting institutional standards.
What is Bakkt
- Bakkt is a qualified custodian of digital assets, starting with bitcoin
- Consumer applications for digital assets, including payments
- Because it is neither an exchange nor a clearinghouse, Bakkt is working with ICE Futures U.S. and ICE Clear US to launch bitcoin futures with regulated price discovery
- Expanding access to the global economy by building trust in and unlocking the value of digital assets
- Kelly Loeffler, Chief Executive Officer
- Adam White, Chief Operating Officer
- Mike Blandina, Chief Product Officer
- Marc D'Annunzio, General Counsel
- Funding completed in December 2018 by Intercontinental Exchange, Boston Consulting Group, CMT Digital, Eagle Seven, Galaxy Digital, Goldfinch Partners, Alan Howard, Horizons Ventures, M12 (fka Microsoft Ventures), Pantera Capital, PayU (fintech arm of Naspers), Protocol Ventures
Seamless coordination between ICE Futures U.S., ICE Clear US and the Bakkt Warehouse is an important feature of Bakkt's Bitcoin Futures. Much like cotton and coffee futures contracts that can go to physical delivery, many of the same processes apply to the Bakkt Bitcoin Futures. The Bakkt Warehouse stands between the customer and the clearing member to securely manage bitcoin movements based on deep domain knowledge, along with significant investments in infrastructure and operations. This design allows clearing members to manage margin balances in USD or U.S. Treasuries, rather than bitcoin.
Another innovation in Bakkt's contract design is that the regulated price discovery and settlement prices do not rely on trade data from spot markets. It is widely reported that the vast majority of trading volume – greater than 90% – is impacted by manipulation, wash trades and other fraudulent activity. This means that for the first time, a benchmark futures price for bitcoin is being set without referencing the unregulated spot market.
Bakkt Bitcoin Contracts
The Bakkt Bitcoin Daily (BTC) and Monthly (BTM) Futures contracts are available for trading 22 hours per day, from 8:00 pm ET Sundays to 6:00 pm ET Fridays. Both contracts are leveraged futures and are margined in the same manner as all other futures on ICE Clear US. At launch, initial margin for the bitcoin contracts was initially set at 37% of the notional contract value, which must be met in USD or U.S. Treasuries, whereas variation margin must be paid in USD. There is no requirement to pre-fund, deposit or hold bitcoin to trade these futures contracts.
Connectivity is consistent with other contracts on ICE Futures U.S., including through direct connections, WebICE, and most of the major Independent Software Vendors (ISVs). Block trades and EFPs are available, and both futures contracts are supported by market making programs to promote liquidity. A fee holiday for trading and clearing Bakkt Bitcoin Futures will apply until the end of 2019. The use of the Bakkt Warehouse and any new data accesses for bitcoin futures are free to Bakkt customers through June 2020. Market data for Bakkt Bitcoin Futures is currently included in existing ICE Futures U.S. data packages at no additional cost.
Clearing and Risk Management
Margining is consistent with ICE Clear US's existing intraday variation margin call and the end-of-day margin process for initial and variation margin. All delivery accounts in the Bakkt Warehouse are held in the customer's name. Existing members of ICE Clear US who are clearing client business do not need to sign new documentation to clear bitcoin futures. The clearing members do not interact with bitcoin, nor are they required to have an account at the Bakkt Warehouse. However, clearing members may view bitcoin balances held by their clients at the Bakkt Warehouse by submitting a registration form. The
Bakkt Bitcoin Daily and Monthly Futures contracts will be supported by the existing ICE Clear US guaranty fund. In order to protect the guaranty fund contributions of non-defaulting clearing members, ICE Clear US has contributed an additional $35 million to the guaranty fund to be used only for losses related to bitcoin contracts. The risk waterfall is as follows:
- Margin and guaranty fund of defaulting clearing member
- A $35 million bitcoin-specific skin-in-the-game contribution from ICE Clear US that can only be used for losses related to bitcoin futures
- This amount is in addition to $68 million of existing skin-in-the-game contribution from ICE Clear US and ICE Futures U.S.
- Guaranty fund contributions of non-defaulting clearing members
To protect the clearing house and its members from concentrated or large directional positions in bitcoin contracts, ICE Clear US will run a conservative bitcoin stress test on each clearing member's portfolio every day and will require incremental initial margin to cover any observed shortfall.
Open positions that are not offset or closed at expiry will expire into physical delivery. Each clearing member's outstanding positions are migrated to the ICE Clear US Midas system as delivery positions. In Midas, clearing members choose from a list of client delivery accounts in the Bakkt Warehouse that will make or take delivery of bitcoin. Midas then matches buyers and sellers for delivery. The resulting delivery intentions are then communicated to the Bakkt Warehouse.
After receiving delivery intentions, the Bakkt Warehouse automatically allocates bitcoin in each designated seller's delivery account, with reserved bitcoin ineligible for transfer out of the seller's delivery account. If the specified delivery account does not have sufficient bitcoin to satisfy all of its delivery obligations, the customer will be required to move additional bitcoin into their delivery account. If it is determined that the customer does not have sufficient bitcoin to satisfy delivery, clearing members will have a limited window in which to arrange for an Alternate Delivery Process (ADP).
As part of its existing end-of-day process, ICE Clear US collects USD delivery funds from the buying clearing members. These funds are collected on the morning of the designated delivery date. Once receipt of the delivery funds is confirmed, the Bakkt Warehouse executes delivery and moves previously reserved bitcoin from the seller's to the buyer's delivery account. ICE Clear US then releases USD delivery proceeds from the buyer's to the seller's clearing member.
The Bakkt Warehouse is a digital asset custody solution built by ICE from the ground up over the course of two years. It leverages the same institutional-grade hardware, operational controls and cybersecurity systems that are relied on to manage ICE's regulated exchanges globally.
The Bakkt Warehouse is a qualified custodian operated by Bakkt Trust Company and regulated by the New York State Department of Financial Services. The warehouse is designed to securely safeguard and manage bitcoin and an internal ledger records deposits, transfers, deliveries and withdrawals. The only interaction with the Bitcoin blockchain occurs when customers deposit and withdraw bitcoin at the Bakkt Warehouse.
Other Secure Aspects of the Bakkt Warehouse Include:
- A bank-grade compliance program for anti-money laundering and knowyour- customer requirements, including on-chain surveillance techniques to verify digital asset provenance. This includes the same technologies and surveillance mechanisms relied upon by federal law enforcement agencies.
- Whitelisting of addresses to ensure that all deposit and withdrawal addresses are verified to confirm that bitcoin is not being sent to, or received from, suspicious or inaccurate addresses.
- Extensive operational, physical and cybersecurity protections to safeguard private keys (a private key is the secret alphanumeric password required to transfer bitcoin ownership from one Bitcoin address to another).
- Insurance coverage of $125 million in insurance policies.
The Bakkt Warehouse uses both warm (online) and cold (offline) wallets to secure customer funds, with the majority of assets stored offline in air-gapped cold wallets. All cold wallet cryptographic keys are encrypted, sharded and geographically distributed in an m-of-n architecture, and warm wallet keys are secured using hardware security modules (HSM). Private keys are never transferred across any open or unencrypted communication channel, and access is protected by firewalls and other network-layer security controls.
Customer funds are protected by layers of automated controls including multi-factor authentication, destination address whitelisting and multisignature controls. All cryptographic systems are secured in bank-grade vaults and datacenters that are protected with 24/7 physical security. Role-based permissions strictly limit employee access and strict operating procedures direct the safekeeping and storage of customer funds.
ICE created Bakkt to address the lack of regulated, trusted infrastructure in digital assets. Bitcoin markets are global and fast-growing both in scale and sophistication. However, that growth has generally occurred outside of regulated markets, which is true for most nascent asset classes. Recent examples include the U.S. natural gas and power markets in the late '90s, and the credit default swaps markets prior to the 2008 financial crisis. Both of these markets are now largely regulated and transparent.
As new markets grow in size and potential, they tend to require more infrastructure, including the capability to observe, transact and regulate the market. This is where ICE's experience in technology, market access and regulatory compliance is being applied to bring the same benefits to this growing asset class.