Current State of the Crypto Derivatives Market
While spot trading in cryptocurrencies has been consistently increasing over the past few years, with daily traded volume exceeding $10 billion dollars, the derivatives market for cryptocurrencies is still fairly nascent. Most of the existing derivatives exchanges for cryptocurrencies are unregulated and operate out of jurisdictions where the regulations for crypto exchanges are in the gray zone.
As we see from data on ratio of derivatives-to-spot volumes in various markets, crypto derivatives still has some distance to grow.
In the US, besides CME’s bitcoin futures contracts, a majority of the derivatives trading happens over the market with boutique crypto derivatives trading firms offering structured derivatives products such as reverse convertibles and variance swaps to entities that manage money for wealthy individuals and families. Relative to spot trading, in which retail investors account for a significant chunk of the trading volume, the highly specialized and complex nature of derivatives precludes retail investors from participating in the crypto derivatives market.
Regulatory Landscape for Crypto derivatives
As cryptocurrencies still lack legal recognition in many jurisdictions, crypto derivatives market largely remains unregulated. However, due to the highly volatile nature of the crypto asset class, and the damaging consequences of leverage trading and several risks that derivatives expose investors to, regulators in some countries such as the UK are mulling over a ban of crypto derivatives trading.
Types of Crypto derivative offerings available
Unlike traditional derivatives markets, where the multitude of derivatives products range from simple options and futures to highly complex CDS and CDOs, crypto derivatives market, in its current state, offers simple derivatives products such as futures and perpetuals with margin trading. The market for plain vanilla call/put options for cryptocurrencies is still growing. There is a huge demand for sophisticated financial market products, but the most common product available on exchanges are the basic perpetual swap - which is a rolling product that offers leverage, often up to a 100x, for market participants that want to take a long or short view on the price of the major cryptocurrencies, such as BTC, ETH, and XRP.
Leading Players in the Crypto derivatives Space
In addition to CME, which has seen a record trading volumes for its bitcoin futures product last month, BitMEX, Deribit, OkEx and BitFlyer are some of the leading providers of crypto derivative products (mostly futures). However, derivatives-focused crypto exchanges have been springing up in 2019 with both ErisX and LedgerX having received licenses to offer crypto derivative products to investors. Unsurprisingly, Binance has also entered the game ( they are the Facebook + Amazon + Google of Crypto currently but one sometimes gets the feeling that they are Icarus flying a tad too close to the sun).
BitMEX is by far the leader. BitMEX launched early on, and was for the longest time the only game in derivatives town. Bitmex daily volumes for the BTC perpetual contracts described above touched 16 bn per day on some days this past week. To put things in perspective, Coinbase does around $250 m a day in daily volume and Binance does around $900 m a day.
The future for crypto derivative platforms
Like with spot exchanges, there is the problem of fake volumes on derivatives exchanges as well.
Volumes at OkEx, Bitflyer etc are most likely predominantly ‘simulated’, and BitMEX volumes have sometimes been questioned. Additionally, most of these, especially BitMEX, have a reputation for being unregulated casinos, with no KYC/AML stipulations, and fairly opaque settlement practises.
Impending FATF rules adopted by the G-20 on information disclosures required of exchanges to prevent money laundering and other nefarious use cases will go a long way towards cleaning up the exchange business. As the crypto industry matures, it is important that new venues prop up in a regulated manner, and cutting edge technology that is widely prevalent in traditional markets are also adopted. Lack of regulation is an especially galling structural impediment to institutional adoption. Derivatives are a key tool for risk management and is critical for crypto to grow into the mainstream as a traditional asset class. Regulation will allow large volumes of institutional capital to come in, and HFTs, algorithmic trading and dark pools to emerge. This will then provide a feedback loop, leading to a secular growth and eventual maturity in the overall crypto asset class.