Professor Profile: José Corrêa Guedes

For the special edition about cryptocurrencies we are glad to present a special professor profile with Professor José Corrêa Guedes.

Professor José Corrêa Guedes is a Full Professor of Finance at CLSBE holding a Ph.D. in Finance from Ohio State University, USA and a degree in Economics from CATÓLICA-LISBON.

We want to thank the Professor for his participation, time, and availability. This interview is a unique opportunity for us and our “readers” to learn more about cryptocurrencies.

We should start with the obvious question, do you believe that cryptocurrencies are a good investment for the future or is it a bubble?

That’s a tough question... What I can tell you is that I will not put my money into it. It’s very speculative, very risky, very unpredictable. This is something that has no intrinsic values, so you can never say whether it’s cheap or expensive. There’s no benchmark against which to measure its value. So, I have no answer to that, but no way I would recommend an investment in that. But we know people have made a lot of money, and some people have already lost a lot of money.

Can cryptocurrencies compete or are a threat to normal currencies?

Well, I think it’s a threat. I think central bankers don’t look at it in a very positive light because it can undermine monetary policy. On the other hand, one of the objectives of these cryptocurrencies is to provide a way for economic agents to emancipate themselves from central banks, so the money supply is no longer controlled by the central bankers. That is being one of the properties or characteristic of the cryptocurrencies that has been sold as one of the big advantages of it. It’s not controlled by the central banks, so they cannot inflate the currency. But the reverse of this is that central bankers don’t like it because they lose control over monetary policy.

So, do you think more central banks will follow South Korea and heavily regulate cryptocurrencies? And should they?

The more successful these cryptocurrencies become, probably more intrusion you’ll have from the central bankers, limiting the scope of usability, because I think they feel threatened by the emergency of these cryptocurrencies. th So, I don’t know if you’re aware, but the 12 February a number of important authorities in Europe, like the EBA (European Banking Authority), the ESMA, have jointly issued a warning against the dangers of using these cryptocurrencies particularly advising banks and financial institutions to be very prudent in the way they deal with these. So, they are concerned and they feel threatened.

In the United States, around the middle of December, there was a time there were going to be options on cryptocurrencies, but I think in the end most of the investment banks pulled out of it. Do you think there is going to be an option market on cryptocurrencies, and if so should it be, or could it be, compared to a normal one?

I think that’s a very interesting question, it connects more with the things I work on. I think you know, there is a future now on bitcoin. The major operators of these future markets like the main participants in the future exchange were significantly reluctant to participate. Their concerns were basically resulting from the following, exchanges when they announce a new contract, or a new derivative contract, on the underlying they have to decide about margins: what are the margins that the participants who purchase futures, and participants who sell futures, what are the margins they are required to deposit to be able to trade the contracts. And, the margins are typically calculated on the basis of the volatility of the underlying assets. So, you see assets which are very volatile with bigger margins than assets which are much more stable. That’s the way that the future exchanges have to protect themselves against credit risk.

One issue was that the margins would have to be so high for bitcoin to bring the credit risk down to a reasonable level that that would kill the market. So, they ended up deciding with big margins but on the view of many participants not sufficiently high to cover the credit risk. And, if that was the case, and put yourself in the position of a broker. You broker a contract for a client, you demand from the client the margin required by the exchange but then you had a price variation during the day that exceed the margin. Who is on the hook for that? In principal the client, the client was the trader who lost the money so the client that put up the money, but if the client did not have the money then it would be the broker himself that would be on the hook. That’s why many brokers refuse to participate and that creates some difficulty to the take-off of futures.

Another issue is that typically you think there’s symmetry between short and long positions. You can bet that the underlying is going up or you can bet the value of the underlying is going down. So, you purchase futures if you believe the prices going up and you make money if the prices go up, and you sell futures if you believe the prices going down and you make money if the prices go down. There’s a symmetry between these two types of position and typically the margins are the same for short and long positions. Now for an underlying such as volatile as bitcoin,

there’s no limit to the losses you can have when you short because, remember, if you short, if you sell futures, you’re going to lose money if the prices go up. Since there’s no limit on how much the prices can go up, there’s no limit to the losses of short positions. So, these markets became asymmetric in the sense that it was easy to trade long positions and it was hard to trade short positions. So future markets did not contribute as supposed to do to the discovery of the fair price for bitcoin, because there was a fundamental asymmetry between the way to express a bullish view and the bearish view on the bitcoin. It was easy to express a bullish view and it was difficult to express a bearish view and that might have contributed to the big spike in the value of bitcoin during a certain period.

This was a long detour to answer your question, but the point is when the underlyings are very volatile coming up with a derivative contract on these volatiles can be tricky and raise a number of problems, which you typically do not see in more stable types of underlyings.

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