March 24 (Bloomberg) -- Tera Group Inc. created a framework for buying and selling swaps linked to Bitcoin that would let investors hedge risk from trading the digital currency.
The firm announced today that it drafted a bilateral agreement that provides a legal template for trading Bitcoin swaps. Tera Group, based in Summit, New Jersey, is seeking clearance from the U.S. Commodity Futures Trading Commission so it can begin trading Bitcoin contracts on its swap-execution facility. Tera Group also said it’s handling a multimillion-dollar swap between two American institutions.
“We as a company are trying to bring some structure and some protocol to help the Bitcoin community,” Leonard Nuara, the president of Tera, said during a phone interview today. “It provides a tool for a natural hedge to get relief from the price changes in Bitcoin.”
Bitcoin’s closing price has swung between $534.71 and $951.39 this year after ending 2013 at $757.50, with volatility spurred by the collapse of the Tokyo-based Mt. Gox exchange, according to the CoinDesk Bitcoin Price Index. The price was $578.55 at 5:58 p.m. New York time today.
Legal agreements like the one Tera Group created can spur derivatives trading by offering investors a template for structuring deals. The overall swaps market was spurred in the 1980s by another framework: the International Swaps & Derivatives Association’s master legal document, which is still in use today for customized trades that can’t be backed by clearinghouses.
Swaps let investors, companies and institutions exchange one kind of payment for another. Some use swaps to exchange principal and interest in one currency for the same in another currency. They can also be used to speculate on prices or to replicate the return on specific investments.
The regulation of Bitcoin and related derivatives is an unresolved question in many parts of the world. Even as regulators and investors struggle to grasp Bitcoin’s many uses - - including investment vehicle, payment-processing system and money-laundering tool -- they are now confronted with the additional complexities of an emerging derivatives market.
Tera Group is joining others in trying to create Bitcoin derivatives.
George Samman, a former Wall Street investment adviser who in May helped start a platform for betting on Bitcoin’s price swings, saw trading on his BTC.sx website grow to more than $35 million by Jan. 21. After the shutdown of Mt. Gox, BTC.sx suspended trading because it had to find another exchange partner for its customers.
At the CFTC, the top U.S. derivatives regulator, lawyers are considering if and how to oversee derivatives linked to Bitcoin and other digital currencies, two people briefed on its work said in February. The agency has been preparing an internal memo that examines the CFTC’s authority over digital currencies and how it might exercise those powers to regulate the markets, the people said.
Tera Group has provided information about its Bitcoin agreement to the CFTC and is in discussions with the regulatory agency, Nuara said in the phone interview. Tera hasn’t asked the CFTC to decide on approval by a certain date, he said.
“The infrastructure and regulatory protocols already exist in the conventional OTC swaps markets to support these hedging instruments,” Nuara said in a statement today. “Regulatory approval is crucial to the long-term growth of the market utilizing Bitcoin.”
The CFTC is looking into whether Bitcoin and other virtual currencies meet the definition of a commodity under CFTC rules against manipulation, Mark Wetjen, acting CFTC chairman, said March 11 at a news conference in Boca Raton, Florida, after a speech at a Futures Industry Association meeting.
“The analysis hasn’t concluded, but I think people believe there is a pretty good argument that it would fit that definition, or there are at least arguments that it would,” he said. The agency is also looking at platforms that are seeking to offer derivatives tied to virtual currencies, he said.
Steve Adamske, a CFTC spokesman, declined to comment on Tera Group.