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The Derivative Market Is Aimed At Retail And Institutional Investors, Who Want Indirect Exposure To Cryptos

2021 opened the doors for many retail and institutional investors to participate in the crypto games, but the majority still prefer to use traditional methods of investments like options or futures contracts.

The derivatives market is best suited for institutional clients, mutual funds, market makers, and professional traders, since they may not be allowed to directly interact with the crypto market, and using a regulated futures contract, such as the CME Bitcoin futures, provides them with access to the market.

For instance, Renaissance Technologies, a $130 billion hedge fund, received approval to invest in Bitcoin futures markets on the Chicago Mercantile Exchange (CME), while retail investors still opt for arbitrage and non-directional risk exposure.

Meanwhile, the first reason crypto derivatives may be changing the crypto-economic landscape is the increase in short-term correlation between crypto leaders like Bitcoin and Ethereum to traditional markets. For instance, Bitcoin showed a close correlation with the United States 10-year Treasury Bill. When traditional investors seek larger returns on their fixed income instruments, it usually also affects crypto demand in general.

6de99bd05d668f4f7d63f4a22e9ef7d4Source: TradingView

The second reason for derivative adoption is miners, utilizing long-term contracts as a hedge since they do not need to sell their holdings in order to gain advantage and income. For instance, miners can use three-month futures contracts to act as insurance vessels in the event of a massive price fluctuation. Miners can also use options contracts to hedge against volatility.

The crypto leader, Bitcoin, may also turn out to be a perfect tool for collateralizing cash loans that can be used in traditional finance. Fidelity Digital Assets and crypto borrowing and exchange platform Nexo agreed to work together in bringing crypto lending services for institutional investors. Such a move vastly increases their exposure limits for this asset class and would take the burden off of companies like Tesla and Block (ex-Square).

Meanwhile, traders are also expanding into semi “fixed income” strategies like covered calls, iron condors, bull call spread, and others, with the use of crypto options. For now, the Deribit derivatives exchange holds an 80% market share of the Bitcoin and Ethereum options markets, but U.S. regulated options markets like the CME and FTX US Derivatives (formerly known as LedgerX) are gaining traction.

The last reason derivatives are set to explode in 2022 is the expectation of reduced volatility in the crypto sector, despite the fact that options impose further volatility pressure in an event of a swing.

However, with the increase of institutional investors, the bid and ask size for derivatives would also go up, eliminating or diminishing the effect of retail investor liquidations. When more professional financial institutions and traders join the crypto race, the lesser the impact of extreme price fluctuations and avoid issues such as the March 2020 crash when BitMEX servers “went down” for 15 minutes.

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