A new exchange is planning to launch in 2018 that would represent a sea change in the way futures are offered, traded, margined and cleared. EverMarkets Exchange (EMX), a project conceived by a team of young financial market professionals, combines key aspects of the emergence of financial technology (fintech) during the last decade. It promises to create a platform that offers trading and margining of cryptocurrencies, creating its own cryptocurrency in the process — a cryptocurrency index and a broad swath of traditional futures contracts.
The overriding thesis behind the project is to capture the efficiencies of the blockchain to provide cost savings to end users and to alter the entire derivatives exchange landscape.
“We intend to dramatically lower the cost of trading through the deployment of blockchain technologies,” noted an EverMarkets white paper. “By leveraging smart contracts and a shared ledger, our platform will transform the traditional roles of the broker, the clearinghouse and the exchange into a more streamlined process. Building a standardized and modern futures derivatives market should reduce the cost of managing risk and make the marking, clearing and settlement processes more efficient and auditable.”
There are many unique attributes EMX is planning, including a disintermediated platform that would allow traders to transact directly on the exchange with direct access to the clearinghouse. The clearinghouse and back office functions will fully use the Ethereum blockchain apparatus (see “Unique attributes,” below).
The exchange plans to launch sometime in 2018 for non-U.S. customers, with access to U.S. customers coming later once EMX obtains regulatory approval from the Commodity Futures Trading Commission (CFTC) as a Designated Contract Market (DCM) and Designated Clearing Organization (DCO). “We are going to be working with the regulatory authorities to receive a license to operate a regulated exchange and in the interim we will be operating an exchange that will be self-regulated,” says Jerald David, EverMarket’s chief operations officer.
Before EMX can launch as an exchange, it plans an initial coin offering (ICO) of the EMX cryptocurrency that is targeted for July 2018. This is a necessary step because the exchange will require the use of its cryptocurrency as margin.
The owners plan on listing its EMX token on numerous cryptocurrency exchanges prior to launching its exchange. Traders will be able to obtain the EMX token on these exchanges or through the use of “smart contracts” where they transfer their bitcoin, ethereum or other cryptocurrencies for the EMX coin to post as margin.
There are other third-party exchanges that specialize in trading these coins,” David says. “Our token will be traded on these other exchanges. [Traders will] receive them directly from us or they can access them through a margin syndicate that could lend these coins out.”
EverMarkets CEO Jim Bai says, “We are using smart contracts to handle all custody of collateral. That is what the blockchain was all about, using the transparent verifiable nature of the blockchain to facilitate transferring of funds without a middleman.”
A smart contract is a piece of code that is running on the Ethereum blockchain itself, explains Craig Austin, EMX chief technology officer. “Think of it as a global computer that lets you store data and code. It is that smart contract that we are writing to handle the clearing and settlement of futures trading on the EverMarket Exchange,” he says.
While EMX plans on offering direct access to its markets and clearinghouse to customers, it does see a potential role for futures commission merchants (FCM).
“We feel there is a role for the FCM, but it is a different role,” David says. “The role that we envision the FCM playing would be of margin syndicate. In the role of margin syndicate there would be a guarantee and the margin syndicate would have the ability to loan tokens to customers, which they would be able to charge for.”
The exchange itself plans to launch with futures on bitcoin and other cryptocurrencies, including its own: a cryptocurrency index that is yet to be fully designed and a host of the most liquid traditional futures contracts, such as WTI crude oil.
“We intend on listing a combination of both crypto futures as well as traditional commodities,” says David. “The initial contract slate that we have been discussing with customers [will include] our own contract, which is EMX (a futures on our own cryptocurrency) and some of the more heavily traded cryptocurrencies like bitcoin and ethereum,” he says. Also, EMX plans on having a crypto index, which will [include] some of the most heavily capitalized cryptos that are traded and will be rebalanced periodically. In addition to that, it will offer a select number of traditional commodities, some of the most heavily traded around the world. The intention will be to have these contracts at launch.”
The exchange will not include a traditional price and time match engine, but will operate an auction where traders will place orders into an open market during a five- to 15-minute period before an uncrossing session when orders will be matched. This will eliminate the time advantage of high-frequency traders and also eliminate the need for colocation.
Austin says it is similar to how the London Stock Exchange operates. “There is a call period and an uncrossing. [During] call periods people put in orders, cancel orders and move orders,” Austin says. “A short time after [the call period ends], we cross all the trades that are on the book and pick a price that crosses the most trades. We try and maximize the volume and all those traders get the same price. We [will likely] start with a five-minute timeframe.”
According to EMXs white paper, the design improves the price discovery process and minimizes market impact costs. “By using periodic pro-rata call auctions in lieu of continuous limit order trading, we de-emphasize the importance of speed and reassert competition based on price,” it notes. “The recent rise of alternative liquidity pools in equities has shown that there is significant demand for fresh ideas in execution and the sourcing of liquidity; we aim to translate many of these innovations to the derivatives arena.”
EMX’s leaders compare themselves to the IEX exchange on the derivatives side and say their structure will deliver similar perceived efficiencies and cost-savings to customers. “There is a common belief out there that exchanges are set up to benefit high-frequency traders and therefore the prices that some of the customers are executing at are below market value,” David says. “If we are able to do our job correctly, we can bring a [fairer] price and a price that is more representative at the time for the trader. It is a hard thing to quantify but there are going to be cost savings for customers.”
Austin says this will draw traders to the exchange. “If they are not receiving fair executions because of other market participants in some current exchanges and they believe in the auction model as we do, we think there is some value there,” he says.
Clearing & Structure
While the cost to traders associated with HFT is a debatable argument, especially on the futures side where there is no national market system, EMX expects to create more measurable efficiencies through its use of the blockchain. “There is significant complexity in the back-office processes that facilitate derivatives transactions. Payments, clearing and settlement processes are currently intermediated by a whole host of systems, depositories and counterparties that differ across borders and across products,” notes the exchange. “A standardization of global trade reporting and governance could be a noteworthy driver of cost savings in simplifying these workflows and increasing overall productivity.”
Austin adds, “The way we describe our clearinghouse is that it is built on top of the blockchain. In this case the Ethereum blockchain is allowing us to settle trades [and] to store customer margin accounts. Ethereum is the second most popular cryptocurrency right now behind bitcoin; it is a global decentralized network, there is no owner of it. It is programmable, so each company, team or individual can write code that runs on top of it and allows people to transfer value and store value safely. We are using the technology to build a decentralized clearinghouse.”
The lack of intermediaries also should provide price efficiencies. “Our intent is to create a fee that is less than current marketplaces and is transparent,” Bai says. “Our goal is to be more than competitive; it is to come to market with an offering that is less expensive.”
While so-called efficiencies are great on paper, the greatest cost to traders usually involves the bid/ask spread, and without a robust liquid market that spread tends to be wide. To address this, EMX is putting together its own internal liquidity provision team that it plans to split off as a separate subsidiary once the exchange goes live.
“We will have our own internal liquidity provision team,” David says. “Mark Pimentel (EMX president and head of trading), one of our founders who traded at Knight and Citadel, has been working with us on what the market infrastructure would look like.”
Their plan is to create a market-making group that would have no informational or fee advantage over regular market participants, but will add liquidity by participating in all of the auctions.
“The intention will not be to post P&L, the intention will be to help balance the books and increase participation in the actual markets as they are being settled,” David says.
Bai says the goal with the market-making team is not to generate profits but to facilitate trading, to settle auction imbalances and inject liquidity into the exchange so that it benefits everyone.
Key to this, is EMX’s plan to split the team into a separate subsidiary prior to launch and to compensate them as a vendor. “We want to ensure that there is no miscommunication of what the role of the entity is,” Bai says. “The entities’ sole role is to provide liquidity in the marketplace and we can’t think of a better way to ensure confidence than operating behind a wall and having that entire operation separate from the parent company. It is going to be separated before we open up our markets.”
Who Will Trade?
EMX’s initial target audience will be active cryptocurrency traders but EMX expects more traditional market participants to join. The goal is to build an exchange for cryptocurrency traders in the near term and institutional traders in the long term.
“We expect traditional market participants who have amassed tremendous amounts of wealth in cryptocurrencies who are looking for alternative means to deploy that,” Austin says. “We also anticipate that current crypto trades will have interest in traditional commodities.”
David adds, “We believe that the majority of our traders will be individual traders or companies that are currently long these currencies,” and he adds that the ultimate goal of the exchange is to offer global trading 24/7 for all the commodities — both crypto and traditional — that a customer would want.
“There is a corollary to that, if we do our job correctly, we will be offering enhancements to how futures markets are currently operated,” David says. “Whether it would be through the efficiencies of the blockchain [or] through innovation of our contract offerings, the impact we will have on the futures markets will be great.”
The folks at EMX have put in place a plan for a fintech firm that promises to be truly revolutionary. “The goal is to build a new derivatives exchange using cryptocurrencies as collateral and using smart contracts to handle the margin, settlement and clearing aspects of futures trading,” Bai says. “We see a huge need in the crypto space right now for an institutional-level exchange, a derivatives exchange, and we can see the benefits of using new technology, specifically blockchain, smart contracts and cryptocurrencies to facilitate the trading of derivatives.”
During the last few years, we have been hearing, from many quarters, how blockchain technology would revolutionize the financial world; that it would be the ultimate fintech disruptor. EverMarkets could be the first test case of this concept. Its success or failure will not be the final word on the value of blockchain as a revolutionary disruptor of markets, but it may provide the first practical test case for what we have been hearing is the future during the past few years. For that reason alone, it will be worth watching.