Many in the crypto and digital assets markets have been claiming that institutions are moving into this space and are now banging down the digital door to get access to this asset class. They may finally be onto something. By many measures, the market for digital assets is growing at a pace that appears primed for broader adoption by more sophisticated players in the markets like private capital, pensions funds, endowments, traditional hedge funds, and banks. The crypto derivatives market is a leading example of this. It has been growing faster than the spot market over the past three years and is now estimated to be 40% of the top global exchange volume according to CryptoCompare in their July Exchange Review Report.
“In the last two years we have seen traditional pension funds like Fairfax County’s Virginia’s Police Officers Retirement System, traditional banks like JP Morgan, Signature Bank, and multiple billion dollar family offices across the country holding and investing in Bitcoin and other crypto currencies,” says Kavita Gupta, visiting scholar at Stanford University.
The US Commodities Futures Trading Commission (CFTC) is considered one of the planet’s toughest regulators, and they have approved several crypto futures contracts for trading like CME’s Bitcoin Options, NYSE’s Bakkt, and LedgerX. This approval comes despite their refusal to approve a Bitcoin ETF as they judge the spot market as unreliable and manipulated to a much higher degree than most people realize. Institutions often cite regulatory uncertainty as one of the main reasons for not allocating to crypto and digital assets, and they have a point. Most tokens and coins fall under a legal grey area that has yet to be clarified by most major securities authorities. Derivatives are a different breed.
The widespread availability of these derivatives has led to private capital and institutions allocating to them, seemingly setting or matching new records with each passing month. Open interest in Bitcoin contracts hit an all time high of $2.1 billion on July 31st and then nearly matched that mark with the August expiry that passed just last week. In the U.S. alone, anyone with a TD Ameritrade or Robinhood account can invest in crypto options just as easily as buying a share of Apple AAPL -8% or Tesla TSLA -9%, and this has likely contributed to the explosive growth seen in options trading volumes this year. The rumour in the professional COVID-19 work at home community in the global financial services sector is that the vast numbers of new homeworkers has contributed to the retail volume of derivative trading.
It helps to have traditional heavyweights like the CME and NYSE behind these contracts, and while growth started slowly and intermittently, it is now moving at a steady pace. According to a recent research report by Tokeninsight, derivatives trading volume is rising steeply, up 100 percent from the same period one year ago as spot volumes have seen a drop, down 18% in Q2 but still have yet to pass spot trading volumes. There are also venues like Huobi, Bitmex, and Deribit, and investors are flocking to them not only because they are seen as safer by some, but also because of the flexibility and creativity found in derivatives markets.
Denis Vinokourov, head of research for digital assets prime broker Bequant, recently commented in CoinTelegraph, “Options are a very efficient way to hedge exposure to the underlying product, be that Bitcoin or Ethereum spot or even futures/perpetuals. In addition, it is easier to structure products that would offer ‘yield,’ and it is this that has been particularly appealing to market participants, especially in the wake of sideways market price action.”
Does a rising tide lift all ships?
Crypto assets are growing and the markets are maturing at a remarkably fast pace given their relative infancy. Bitcoin is increasingly gaining mainstream awareness as public companies and central bankers discuss it with stablecoins, central bank digital currencies (CBDCs), and the Digital Yuan, increasingly as a prolonged economic downturn caused by the COVID-19 pandemic looks increasingly likely. Last month a publicly traded company MicroStrategy MSTR -3.8% became one of the single biggest individual holders of Bitcoin when it bought about $250 million worth of BTC because it is a ‘reasonable hedge against inflation that is superior to cash’.
This led to a short-lived rally, but this was less important than the initial indications that larger firms are now starting to seek out alternatives to the US Dollar, and in this case, one was confident enough in Bitcoin to convert nearly all of its cash reserves into the cryptocurrency. This phenomenon is global with Asian companies not to be outdone. This week’s announcement by Singapore Exchange about its entry into digital asset products is a telling barometer for the institutional interest globally.
“This is no surprise as Asian institutions make up the lion’s share of trading volumes in spot, futures and derivative products, said James Harris, at CryptoCompare, “expect more to come, especially in the Asia Pacific region, and soon.” A number of larger exchanges around the world are also long on digital assets including the London Stock Exchange Group, Nasdaq and the Swiss Stock Exchange (SIX-Group) who is building a full digital exchange, SDX, in partnership with R3 and are also exploring platforming the Swiss National Bank’s (SNB) digital currency.
Spot markets have since rallied in sporadically but are struggling to stay above $12,000, trading mostly in a narrow range between $11,300 and $11,800 while DeFi coins like YFI have surged in unprecedented parabolic runs that have made instant millionaires overnight only to see some of those lose all their gains almost as quickly, as in the case of YAM. A likely contributor to this tentative price action is the weariness traders have that another storm cloud is often on the horizon. Ethereum Classic (ETC) had three 51 percent attacks last month alone. This week saw South Korean regulators raiding the offices of BitThumb, one of the world’s largest crypto exchanges, over allegations of fraud related to an IEO and a potential buyout offer.
Bitcoin fell nearly five percent and other digital assets were dragged down with it. In an orderly market, circuit breakers would be triggered. Trading would be suspended, and investors would have been protected. These measures don’t exist in digital asset spot markets and flash crashes lead investors of all types to incur losses they otherwise wouldn’t in traditional, fully regulated markets. Until the risk of this unpredictability can be better managed, it might be a while before more sophisticated investors look too far beyond traditional derivatives markets which are, after all, notionally the largest market in the world.