Monday, December 6, 2021


Many merchants coming into cryptocurrency markets from conventional finance might look to derivatives as automobiles for worth hypothesis and hedging. There are many decisions in terms of exchanges and devices; nonetheless, merchants ought to take into account a couple of key variations between crypto futures and conventional futures earlier than dipping a toe into this quickly rising market.

Associated: 3 things every crypto trader should know about derivatives exchanges

Completely different devices

Merchants coming into cryptocurrency from the standard markets will likely be accustomed to futures contracts with a set expiration date. Though fastened expiration contracts might be present in cryptocurrency markets, a major proportion of crypto futures buying and selling is in perpetual contracts, also called perpetual swaps. This variation of a futures contract doesn’t have a set finish date, that means the dealer can maintain an open place indefinitely.

Exchanges that supply perpetual contracts use a mechanism generally known as “funding fee” to periodically stability the worth variances between the contract markets and the spot costs. If the funding fee is constructive, the perpetual contract worth is greater than the spot fee — longs pay shorts. Conversely, a unfavourable funding fee implies that shorts pay longs.

Furthermore, merchants that come to cryptocurrency from conventional finance could also be used to the portability of their positions throughout totally different exchanges. In distinction, cryptocurrency exchanges usually function as walled gardens, that means it’s unattainable to switch derivatives contracts throughout platforms.

Associated: Professional traders need a global crypto sea, not hundreds of lakes

Regulated vs. unregulated buying and selling platforms

Many of the buying and selling in cryptocurrency futures — round 85 to 90% — is but to be regulated. This case primarily arose as a result of cryptocurrency futures markets sprang up whereas regulators had been nonetheless grappling with extra basic questions across the authorized standing of digital belongings. BitMEX paved the way in which for cryptocurrency futures buying and selling by utilizing coin-margined and collateralized contracts. In doing so, the corporate averted the regulatory necessities related to fiat on-ramps. There are round a dozen main buying and selling platforms at the moment, however solely a small variety of them have achieved regulated standing.

Each the Chicago Mercantile Exchange (CME) and Bakkt are regulated by the USA Commodity Futures Buying and selling Fee (CFTC). In Europe, Kraken Futures operates under a multilateral trading facility license awarded by the UK Monetary Conduct Authority. In Switzerland, Vontobel and Leonteq offer mini-Bitcoin futures contracts through the SIX Swiss Change.

The regulatory scenario might preclude merchants in some international locations from collaborating in buying and selling on non-regulated venues. This circumstance is especially true of the U.S., the place exchanges are conscious that the CFTC is now pursuing BitMEX for violating Anti-Cash Laundering rules and the Financial institution Secrecy Act.

Nonetheless, the U.S.-regulated crypto futures platforms have expanded their vary of devices past pure Bitcoin (BTC) futures, doubtless in response to rising demand. The CME, for instance, lately branched out beyond Bitcoin futures and choices to offer Ether (ETH) futures too. As well as, Bakkt additionally gives Bitcoin month-to-month futures and choices.

Unregulated platforms provide futures contracts and perpetual swaps towards a broader vary of altcoins, though solely to merchants in international locations the place they’re permitted to function. In any case, most liquidity stays concentrated in BTC and ETH futures, at the least for now.

Operational implications

Differing regulatory landscapes, mixed with how perpetual contracts are managed, end in some sensible variations between crypto futures and conventional futures. As there isn’t any central counterparty clearing system, exchanges expose themselves to a excessive diploma of danger, notably on condition that many provide excessive leverages of as much as 125 instances. Subsequently, shedding positions that attain the upkeep margin will likely be liquidated.

Exchanges sometimes divert any earnings from liquidations into an insurance coverage fund, which exists to guard merchants’ earnings when their counterparty doesn’t have ample margin to cowl the commerce. The presence and relative well being of an insurance coverage fund is a vital consideration when utilizing an unregulated alternate. With no fund, or if the fund turns into too low to cowl the losses incurred by liquidations, worthwhile merchants tackle the chance of getting their positions “auto-deleveraged” by the alternate.

One other essential operational consideration is alternate downtime. Lots of the unregulated platforms have a popularity for servers crashing during periods of high volatility, leading to merchants being unable to shut their positions earlier than being liquidated. Subsequently, it’s price researching a platform’s historical past of downtime earlier than opening an account.

Low obstacles to entry

The cryptocurrency futures markets usually have a really low barrier to entry. A dealer can open an account, bear the “know your buyer” course of, deposit funds, and begin buying and selling inside a matter of minutes.

In distinction, the obstacles to entry for exchange-traded futures are excessive as a result of contract sizes concerned, that are meant for institutional merchants. This case can also be mirrored within the regulated crypto futures choices. Each the CME and Bakkt, the 2 regulated crypto futures buying and selling venues, have contract sizes of 5 BTC and 1 BTC, respectively. With costs at the moment exceeding $31,000, these contracts are evidently solely meant for these keen to make a major funding.

Nonetheless, blockchain gives vital potential to remodel the futures markets past cryptocurrencies by way of asset tokenization. Suppose a futures contract for the Nasdaq-100 or S&P 500 was made accessible as a token. In that case, it might be traded in fractional increments, decreasing obstacles to entry and introducing new sources of liquidity into conventional markets.

Associated: Understanding the systemic shift from digitization to tokenization of financial services

Such a state of affairs might profit these trying to introduce a extra fine-grained diversification to their portfolio, which is at the moment solely potential through contracts for differences (CFD). Whereas they carry out an identical function within the monetary markets, CFDs are solely accessible through brokers, which reduces transparency for the dealer. It additionally fragments the accessible liquidity within the broader markets.

Regardless of their speedy development, cryptocurrency futures markets are nonetheless very a lot of their infancy, notably for the reason that institutional influx to crypto is barely getting began. Because the markets develop and develop, we’ll doubtless see new and extra refined devices emerge, together with some blurring of the boundaries between conventional and digital finance. Moreover, it appears doubtless that the regulatory scenario will proceed to evolve as extra funds circulate in. One factor is for positive: cryptocurrency futures have an extended future forward.

This text doesn’t include funding recommendation or suggestions. Each funding and buying and selling transfer entails danger, and readers ought to conduct their very own analysis when making a call.

The views, ideas and opinions expressed listed here are the writer’s alone and don’t essentially replicate or characterize the views and opinions of Cointelegraph.

Andy Flury is a serial entrepreneur and quantitative buying and selling knowledgeable. Andy is a former Swiss Air Pressure pilot and led initiatives on the Swiss intelligence company and numerous main banks. He additionally served as senior challenge supervisor and software program architect at Siemens Switzerland AG. In 2010, Andy turned companion and head of algorithmic buying and selling at Linard Capital AG, a Switzerland-based quantitative hedge fund. Andy holds a grasp’s in industrial administration and manufacturing engineering from ETH Zurich and an Government MBA from the College of St. Gallen.