“That’s Our Two Satoshis” — How The Crypto Derivatives Explosion Affects Markets

Despite a slower week, volatility did not wane as Bitcoin alone moved between $9800 and $12,000 last week, with over 90% annualized volatility.  Prices ended largely unchanged week-over-week, as these large price swings were mostly quick and sharp, typically moving hundreds of dollars in minutes.  Volume was light, with virtually no significant news driving prices and a general lack of conviction. Away from the exchanges, OTC dealers reiterated that flow was nearly non-existent.  Notably, the higher quality “defensive” tokens that typically have high up-capture and low down-capture were generally better for sale last week -- which may be indicative of funds and traders still raising cash to meet margin calls after so many levered shorts and longs were liquidated at the end of June.   This price action is similar to when BB-rated, high quality HY bonds get sold aggressively when funds need to raise cash to meet redemptions. 

“The most compelling theory has been that Bitcoin is increasing in response to geopolitical tensions and has been adopting the characteristics of “digital gold”. Positive daily correlation between gold futures and bitcoin have held an average value of 0.8 for the past nine days, reaching a YTD high of 0.89 on Tuesday. While cycles of positive correlation with gold futures is not notable in and of it itself, the duration and magnitude of this most recent cycle is unique. Numerous macro developments have spurred similar price patterns in both gold and bitcoin this week, further bolstering this thesis. For example, as trade tensions between the US and China eased following the G20 summit’s conclusion this weekend, gold dipped below $1,400 as BTC also began to have a more significant correction. We are hesitant to say that Bitcoin has fully adopted the characteristics of “digital gold” just yet, but we continue to track its responsiveness to broad macro disruptions and will continue to observe its longer term correlation.”

• US Crypto-exchange, Kraken, acquired a Futures trading startup earlier this year. 
• ErisX received the green light from the CFTC to offer physically settled Bitcoin Futures. 
• Bakkt, which has raised almost $200mm in funding, will begin testing its own physically settled futures platform this month. 
• The CME looks likely to offer ETH futures in the not too distant future, and its Bitcoin futures volume is exploding (The Block offers a detailed look into CME’s growth of Bitcoin Futures and its investor demographics).
• The world’s most active crypto exchange, Binance, announced it plans to roll out perpetual swaps for Bitcoin and other digital assets. 
• Total open interest at Amsterdam-based crypto options exchange, Deribit, is up 10x this year. 
• Bitmex, the leading unregulated crypto futures exchange hit $1 trillion of annual trading volume. 
• … and we’re about to be introduced to 3x levered tokens via FTX.

The growth in derivatives is universally viewed as a long-term positive, and for good reason.  In traditional markets, derivatives lead to more efficient pricing via spot/futures arbitrage, better cash/inventory controls, tighter risk management, hedging of forward production, higher ROI, and more efficient ways to express investment theses around specific catalysts.  However, in the still immature crypto world, we’re seeing how the rise of derivatives can lead to increased volatility and poor risk management, especially when the majority of participants are looking to derivatives simply to increase leverage, many of whom don’t always understand how margin works.  And perhaps most importantly, many of the non-Bitcoin “alt” coins that have been popular for the past few years were really just levered bets on crypto’s success -- so as the regulated Bitcoin futures and options market grows, real investors no longer have to look beyond Bitcoin and a few other select digital assets investments to get levered upside. 

Source: CME