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We have all heard that the liquidation of billions of dollars in futures contracts caused the intraday price of Bitcoin to plummet by 25% (Bitcoin) And ether (Ethereum) But the fact is that since BitMEX launched its perpetual contract in May 2016, the industry has been troubled by 100x leverage tools.
The derivatives industry goes far beyond these retail-driven tools because institutional clients, mutual funds, market makers, and professional traders can benefit from the hedging capabilities of the tool.
In April 2020, the US$130 billion hedge fund Renaissance Technologies was approved Invest in the Bitcoin futures market Use tools listed on CME. These trading mammoths are completely different from retail cryptocurrency traders, but instead focus on arbitrage and non-directional risk exposure.
Short-term correlation with traditional markets may rise
As an asset class, cryptocurrency is becoming a representative of global macroeconomic risks, regardless of whether crypto investors like it or not. This is not unique to Bitcoin, as most commodity tools will be affected by this correlation in 2021. Even if the price of Bitcoin is decoupled on a monthly basis, this short-term risk-taking and risk aversion strategy will seriously affect the price of Bitcoin.
Note how the price of Bitcoin is related to the stability of the 10-year U.S. Treasury bill. Whenever investors demand higher returns from holding these fixed-income instruments, additional requirements are placed on cryptocurrency exposure.
In this case, derivatives are essential because most mutual funds cannot invest directly in cryptocurrencies, so the use of regulated futures contracts, such as CME Bitcoin futures, provides them with an opportunity to enter the market.
Miners will use long-term contracts as a hedge
From a miner’s perspective, cryptocurrency traders do not realize that short-term price fluctuations have no meaning for their investments. As miners become more professional, their need to continue to sell these tokens is significantly reduced. This is exactly why derivatives were created in the first place.
For example, miners can sell quarterly futures contracts that expire in three months, effectively locking in the price during that period. Then, no matter how the price changes, from this moment on, the miners know their returns in advance.
Similar results can be achieved by trading Bitcoin option contracts. For example, a miner can sell a call option for March 2022 for US$40,000. If the BTC price drops to US$43,000, or 16% lower than the current US$51,100, this will be sufficient to compensate. In exchange, the profit of miners above the $43,000 threshold was reduced by 42%, so the option tool played an insurance role.
Bitcoin’s use as traditional financial collateral will expand
Fidelity digital assets and crypto lending and trading platform Nexo recently announced a partnership to provide Provide crypto lending services for institutional investorsThe joint venture will allow cash loans backed by Bitcoin that cannot be used in traditional financial markets.
This movement may ease the pressure on companies such as Tesla and Block (formerly Square) to continue adding Bitcoin to their balance sheets. Using it as collateral for day-to-day operations has greatly increased their exposure to this asset class.
At the same time, compared with traditional fixed income, even companies that do not seek targeted investment in Bitcoin and other cryptocurrencies may benefit from the industry’s higher yields. For institutional clients who are not willing to be directly exposed to the volatility of Bitcoin but at the same time hope to obtain a higher return on assets, lending is a perfect use case.
Investors will use the options market to generate “fixed income”
Deribit Derivatives Exchange currently holds 80% of the Bitcoin and Ether options market. However, U.S.-regulated options markets like CME and FTX US Derivatives (previously known as LedgerX) will eventually receive attention.
Institutional traders tap into these tools because they provide the possibility of creating semi-“fixed income” strategies, such as Underwriting phone, Iron Vulture, Bull market spread And others. In addition, by combining call (buy) and put (sell) options, traders can set up option transactions with a predefined maximum loss without the risk of being liquidated.
Central banks around the world are likely to keep interest rates close to zero and below inflation. This means that investors are forced to seek markets that offer higher returns, even if it means taking some risks.
This is exactly why institutional investors will enter the crypto derivatives market in 2022 and change the industry as we currently know it.
Volatility reduction is coming
As mentioned earlier, it is now well known that crypto derivatives can increase volatility in the event of unexpected price fluctuations. These forced liquidation orders reflect futures instruments used to obtain excessive leverage, which is usually caused by retail investors.
However, institutional investors will gain wider representation in the bitcoin and ether derivatives market, and therefore will increase the scale of buying and selling of these instruments. Therefore, the US$1 billion settlement of retail traders will have less impact on prices.
In short, more and more professional players participating in crypto derivatives will reduce the impact of extreme price fluctuations by absorbing the order flow.Over time, this effect will be reflected in the reduction in volatility, or at least avoidance such as Crash in March 2020 When the BitMEX server is “down” for 15 minutes.
The views and opinions expressed here only represent author It does not necessarily reflect the views of Cointelegraph. Every investment and transaction involves risks. When making a decision, you should conduct your own research.
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