An inspection of the BTC spot trade volumes against the combined BTC futures trade volumes (BitMex + CME + CBOE) will reveal that the derivatives market for Bitcoin is now neck to neck with the actual coins being traded. When SEC was still mulling over what decision to take with respect to a Bitcoin ETF, the market saw prices rally from ~$6000 to ~$8500, before coming back down. Clearly the introduction of financial instruments for cryptocurrencies, now looked upon as a new asset class, is around the corner and Wall Street will in all probability treat this as its go-to signal to dive into cryptos. While ETFs may take time, crypto derivatives, beyond BTC futures, in the meantime can be harbingers of good tidings for the bear market of digital assets.
It is significant to note that Wall Street is late to the crypto party; retail investors took to cryptocurrencies, especially Bitcoin, back in 2017 and the crypto world has never looked back since. Now the corporate dollars of Goldman Sachs and JP Morgan clients’ want in, but institutional investors will not pour their billions into Bitcoin and the likes if they have to tread unfamiliar territory. This is where the role of derivatives becomes crucial: they can provide the much-needed indirect exposure to traditional investors.
For those unfamiliar, a financial derivative can be defined as a contract between two or more parties (buyers and sellers) whose value is based on an underlying asset agreed upon by the parties involved. Consider cryptocurrency coins or tokens and you can have derivatives that use them as the underlying asset. Those who are trading these contracts now have exposure to the crypto markets, without actually having to own any cryptocurrencies. In the case of traders who have spent the last 30 years or so making trades on CME or ICE in the derivatives market, trading BTC or ETH derivatives will be no different. Familiarity will be one of many factors to attract a new grade of crypto investors and traders, the grade who has up until now, shied away from the digital asset markets.
Introduction of a wider set of derivatives, like calendar spreads & butterfly, options, swaps, and indices, not just for a couple of top coins but for a good mix of coins and tokens, greatly stands to boost the cryptocurrency landscape. To begin with, derivatives are a good way to hedge a portfolio; the current crypto trader will benefit greatly from this. Moreover, a diverse market, with different types of derivatives instruments traded by traders with varying amounts of appetite for risk will aid in better price discovery. Not just that, a vibrant crypto derivatives market will see increased participation and as a consequence, improved liquidity. This will help many coins and tokens that have smaller markets today and poor liquidity; an increase in both the variety and the number of trading choices via derivatives products will benefit the alt-coins market.
The introduction of derivatives in traditional markets transformed the space and fuelled the evolution of global financial markets into the form we see today. The crypto markets, still far from maturity can capitalise on the merits of the legacy markets and embrace derivatives to improve liquidity as well as the freedom they proffer to their participants.
About the author
Awanish Rajan is a crypto trader. An alumnus of the prestigious IIT-Madras, he has been an active researcher of the blockchain technology, cryptocurrencies, and distributed systems. Currently, the CEO of a fintech startup, he and his team have built the first complete crypto derivatives exchange named idap.io. A prototype for the Desktop Application is already out, with a recent announcement of the web-version being released shortly. idap.io recently closed a successful pre-sale of its token, IDAP.