Whether people expect things to go their way or not, Bitcoin, one of the most popular cryptocurrencies, has been playing a greater role to facilitate value exchange in the international financial market, despite its high volatility over the past 11 years. The market has developed a high demand for universally accessible spot markets to trade and derivatives markets to hedge risks. Crypto exchange operators are, therefore, working on their plans of developing trading platforms to woo global investors. However, conservative parties mock crypto players by likening them to casinos since they have started offering futures, which are painted as the root of the past financial crises. Here it begs a question: is crypto derivatives trading a godsend or a Pandora’s box to the crypto industry?
Boon or Bane? History and Data Don’t Lie
Although those stories may have prompted many investors to back away from derivatives, the reality is not like this. Derivatives are said to have invented in form of the clay tablets in Uruk during ancient Mesopotamia, during when people had to offer food or perform worship service in temples on set dates. In the Roman empire, food futures were available for deploying macroeconomic controls. Multinational trades were frequent during the Age of Discovery, but the issue of commodity price volatility remained unsolved owing to communication barriers, so that merchants might suffer a total loss after shipment from one country or region to another. That was why commodity forward contracts were created by fleets to hedge against price volatility. After the 18th century, more developed stock exchanges introduced tightly defined sets of trading rules to help institutional investors manage exposure. Since then, this has attracted greater participation of global investors in the market.
At present, the birth of futures contracts significantly helps achieve prompt delivery and maintain price stability. They do not only ensure orderly production of goods, but also offset volatility and other unfavorable conditions constraining enterprises from swiftly adjusting their production and marketing strategies. According to the latest data from the Futures Industry Association (FIA), the global futures and options trading volumes increased by 20.2% in 2018 to an all-time high of 30.28 billion contracts compared to 2017. The futures trading volume was up 15.6% to 17.15 billion contracts, and the options trading volume up 26.8% to 13.13 billion contracts. It is noteworthy that the growth of the global futures and options trading volumes in 2018 was the fastest since 2010.
Global futures & options trading volumes 2009–2018 (Unit: billion contracts)
Why are People Polarized on Derivatives?
Many speculators fantasize a lot about getting rich overnight using derivatives for their highly leveraged nature. However, they tend to forget that the risk is also amplified while magnifying gains and overestimate their investment ability and psychological strength. Therefore, the most important fundament of trading derivatives is to develop independent strategies first.
From a larger perspective, the crux of financial instability is the burst of asset bubbles. Derivatives are proved to act as a correction mechanism for investors and the market at critical moments, strengthening the overall stability of the financial industry after numerous trials and errors. Many global operators from key sectors, including oil and aviation, purchase inverse options to hedge the potential negative impacts on energy price and exchange rate fluctuations on inventory values. The explanation that derivatives trading is gambling is unconvincing because it helps support their healthy development.
Derivatives are the Godsend of Crypto Asset Market
Both retail and institutional investors are facing the same issue. In 2012, the volatility of Bitcoin soared to as high as 94%, making both margin and spot traders suffer from unexpected losses. However, even if the media took this case out of context to regard crypto assets as speculative commodities, the long-term value of crypto assets has been evidently presented by the overall rise in their prices so far. The lesson for the industry is that investors need more instruments to withstand short-term volatility. After all, there are only a few ones who can lock their positions for a long while anyway.
Against this backdrop, the introduction of short-term hedging derivatives has come under the spotlight. In June 2013, the first Bitcoin futures contract was launched for shorting. Also, the Chicago Mercantile Exchange (CME) offered Bitcoin futures in 2017, since when the volatility of BTC dropped significantly in a year's time.
Bitcoin price after the launch of CME options
The main value of crypto derivatives
In the past, the lack of crypto derivatives greatly restricted the access of another two groups of investors, namely miners and institutional investors, to the crypto market.
As we all know, miners need to bear the cost of a large number of mining rigs and electricity to operate a mining field. As a result, they only profit from the difference between the mining cost and the price of a cryptocurrency. In late 2018, Bitcoin dropped significantly from about USD17,000 to USD3,000, which directly hurt their livelihood. Even some sources said that miners had started to sell their mining machines by weight. Like airlines and oil companies, miners also need a risk-hedging tool to sustain their mining business. Similar situation for institutional investors and crypto intermediaries.
As they hold a large amount of clients’ funds and hoard crypto assets strategically, they need such a financial instrument to deploy stabler investment strategies, taking into full account their clients’ interests and their own reputation.
Therefore, given the benefits derivatives can bring to both miners and institutional investors, they will undoubtedly become a booster that attracts new capital and impetus to the crypto market.
The volatility of the crypto market is far greater than that of the traditional ones. Crypto exchanges have tightened their risk management for derivatives products while their exploration of the derivatives market is still underway.
OKEx, as one of the crypto derivatives pioneers, is making a leap to another milestone. In December 2019, we officially launched options. As of now, we have become the world’s only cryptocurrencies trading platform offering both inverted (token-margined) and linear (USDT-margined) futures/perpetual swap as well as options. Thanks to our sophisticated risk management system, we have achieved zero clawback even under extreme market conditions over last year.