The first financial instrument tied to bitcoin has launched following approval from the US government.

TeraExchange, a swap execution facility based in Summit, New Jersey, is marketing the bitcoin derivative to large institutions looking for a way to reduce the volatility and risk associated with traditional types of bitcoin exposure.

CoinDesk spoke with president and co-founder Leonard Nuara, who said that the new product can help bridge the gap between the existing bitcoin trading ecosystem and a broad landscape of investors that are genuinely interested in digital currency.

Nuara told CoinDesk:

“This is a major step forward for the broader bitcoin community by building out a first institutional mechanism for hedging in the bitcoin space in a regulated marketplace. This is a step toward, potentially, reducing volatility and increasing liquidity in the marketplace because people will have more safety and soundness in their trading.”

TeraExchange began working on the product earlier this year, and only just received approval from the US Commodities Futures Trading Commission (CFTC), the government agency that regulates futures and options markets.

Limiting exposure to market forces

The bitcoin swap, like other financial products of its kind, enables parties holding the instrument to hedge against fluctuations in the digital currency’s value.

No actual bitcoins are exchanged during the process. Rather, the swaps are denominated in US dollars and actual transactions between counterparties use that currency as well.

The swaps give counterparties – ranging from large merchants to miners – the ability to insulate themselves from long-term changes in the price of bitcoin that may impair their ability to operate. Further, the fact that the exchange is regulated by the CFTC gives institutions governed by strict rules regarding platform usage the ability to gain exposure to bitcoin markets.

Other efforts, such as the planned bitcoin ETF created by Cameron and Tyler Winklevoss currently being considered by the Securities and Exchange Commission (SEC), are still undergoing review.

Swap tied to dynamic price ticker

To determine the price at which the swaps will trade, TeraExchange has developed an index that draws information from a series of major exchanges worldwide.

Nuara explained that in order to make the system work, the company needed to provide real-time data that was compliant with the standards put in place by US regulators. This meant constructing price indicators that would meet CFTC approval.

He told CoinDesk:

“What we had to build, and then prove through the documentation that we provided to the CFTC, was that our index was robust enough and diverse enough and able to act to filter out anomalous beahvior enough, that the index is not susceptible to manipulation, or the marketplace.”

TeraExchange has built information-sharing relationships with the high-volume bitcoin exchanges in the world, each of which will provide real-time data to the company’s price index.

Regulator response positive

During the interview, Nuara commented that the perception of US regulators as a group that harbors a desire to impair bitcoin is wrong.

Instead, he said agencies like the CFTC have a genuine desire to make sure they get these regulations right:

“[The CFTC] are just extremely cautious with regards to what they do, so they want make sure they get it right. They were quite receptive to regulating [the bitcoin swaps], provided that all the requirements were met.”

The development of a bitcoin derivative pushes the broader market into uncharted waters, opening the door to move involvement from institutions that, in many cases, are prohibited by their own policies to invest in digital currency.

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