Watching Developing Financial Markets

I avidly watch developing financial markets.  Not markets in the developing world.  I’ll let the analysts on Wall Street watch them. Nope, financial product markets.  Sometimes they hit, and sometimes they miss.

When I was on the floor at CME, often some of the best ideas for new contracts came from market participants.  Sometimes they’d work and most often they wouldn’t.  It is very hard to develop a new market.

I bought a Helium miner in November of 2019.  Watching that network develop has been interesting.  Lately, the token has been on a bit of a run but it might be cooling.  When I surf online, I see a lot of chatter about it.  People are buying miners and they are back-ordered.  There are questions about antennae and placement.

One contract that has really intrigued me has started to get some traction.  Ameribor was developed by Richard Sandor.  We call him Doc Sandor.  He developed the interest rate contracts at the CBOT back in the day, started the Climate Exchange and knows what he’s doing.  I interviewed him on the TopStep Trader podcast a year or so ago.

Ameribor reminds me a little bit of when my friend Roger Carlsson started the Euribor at the LIFFE way back in the day!  What’s interesting about it is during the financial crisis, the existing benchmark rate, LIBOR, turned into a circus.  Banks gamed the market and artificially moved the benchmark interest rate around.  They got a hand slap from regulators.  LIBOR is still around but the market knows it needs to be replaced.

The largest futures contract in the world is the Eurodollar at CME, and it is the hedging vehicle for LIBOR.  But, LIBOR is set to be replaced by the end of 2021.  No one has settled on what to replace it with yet.  Ameribor has to be one of the top contenders.  Mid-tier and small banks love it because it reflects their true borrowing costs as opposed to LIBOR which is handmade for the big banks.

Another interesting market is lumber.  Lumber prices have skyrocketed over the past year.  I have watched the MaterialsXchange steadily grow volume.  The lumber market is highly fragmented and local, unlike the grain markets.   They have been onboarding new customers as the lumber industry begins to embrace digital. It can be very hard to get stodgy industries to change.  Many industries relied on phone markets until Covid.  Even when a good tech solution can replace the call around market, the call around market has enough network effect and volume to remain.

Of course, there is crypto and the big Coinbase IPO.  The crypto market to me is interesting for a lot of reasons.  I wonder what the big institutional players will do now that they have entered.  They are used to having a place to hedge.  CME and FTX offer cash-settled futures, but recently I read somewhere that JPMorgan recently released an analysis of the steep contango in USD cash-settled bitcoin futures markets which effectively renders the futures more expensive than spot. Existing marketplaces are not a single observation of spot prices but an average of the price across major spot exchanges. The resulting tracking error is more than 10% over the past year. This makes the contracts unsuitable for hedging and also highlights deeper structural issues which prevent the 10% gap from being arbitraged away.

Of course, when you read the fine print in the contract documents on construction, they will tell you that the futures price is really sort of an index, not the actual price.  This is not unheard of and it is not deceitful.  Many products in the futures industry are structured this way.

That makes the futures price an imperfect hedge for the big institutions.  For day traders, it doesn’t matter.  For long term holders of the asset, it might.

The other interesting thing to watch is what happens to companies that based their business model on using Ethereum’s Ether gas. Gas in the context of Ethereum is a unit and a measurement for the computing power that is needed to execute certain operations in the EVM. This computing power is provided by the miners in the system, and since they use energy to produce it, they are rewarded with gas. Of course, the more energy is required for the execution of an operation (for example, a transaction or a smart contract), the more gas is needed.

One of the clearest things to me about crypto is it is not even close to ready for prime time to process large amounts of transactions quickly.  Competing with credit card networks will come, but it won’t be this year.  The same can be said for clearing operations like DTCC and OCC.  Trying to push transactions through them sometimes is like pushing a bowling ball through a garden hose.   Certainly DeFi might be an answer someday, but it’s not ready for prime time yet either.

With the run-up in the price of ethereum, ether gas got expensive.  It will be interesting to see how it affects businesses that are using gas.  Will they switch to something else?  Will they go under because it’s too expensive to operate?

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