Cryptocurrency: The future of futures?


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Many merchants getting into cryptocurrency markets from conventional finance might look to derivatives as automobiles for value hypothesis and hedging. There are many decisions in relation to exchanges and devices; nevertheless, merchants ought to take into account just a few 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 getting into cryptocurrency from the normal markets shall be accustomed to futures contracts with a set expiration date. Though mounted expiration contracts may be present in cryptocurrency markets, a major proportion of crypto futures buying and selling is in perpetual contracts, often known as perpetual swaps. This variation of a futures contract doesn’t have a set finish date, which means the dealer can maintain an open place indefinitely.

Exchanges that supply perpetual contracts use a mechanism often 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 value is increased than the spot fee — longs pay shorts. Conversely, a adverse funding fee signifies that shorts pay longs.

Furthermore, merchants that come to cryptocurrency from conventional finance could also be used to the portability of their positions throughout completely different exchanges. In distinction, cryptocurrency exchanges typically function as walled gardens, which means it’s not possible to switch derivatives contracts throughout platforms.

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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 have been nonetheless grappling with extra basic questions across the authorized standing of digital property. BitMEX paved the way in which for cryptocurrency futures buying and selling through the use of 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 presently, however solely a small variety of them have achieved regulated standing.

Each the Chicago Mercantile Exchange (CME) and Bakkt are regulated by the US 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 by way of the SIX Swiss Alternate.

The regulatory state of affairs might preclude merchants in some international locations from taking part in buying and selling on non-regulated venues. This circumstance is especially true of the U.S., the place exchanges are aware 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, probably in response to rising demand. The CME, for instance, not too long ago branched out beyond Bitcoin futures and choices to offer Ether (ETH) futures too. As well as, Bakkt additionally presents Bitcoin month-to-month futures and choices.

Unregulated platforms provide futures contracts and perpetual swaps in opposition to 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, not less than 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, significantly on condition that many provide excessive leverages of as much as 125 occasions. Subsequently, shedding positions that attain the upkeep margin shall be liquidated.

Exchanges sometimes divert any income from liquidations into an insurance coverage fund, which exists to guard merchants’ income when their counterparty doesn’t have adequate margin to cowl the commerce. The presence and relative well being of an insurance coverage fund is an important consideration when utilizing an unregulated alternate. And not using a fund, or if the fund turns into too low to cowl the losses incurred by liquidations, worthwhile merchants tackle the danger of getting their positions “auto-deleveraged” by the alternate.

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

Low limitations to entry

The cryptocurrency futures markets typically 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 limitations to entry for exchange-traded futures are excessive as a result of contract sizes concerned, that are supposed 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 presently exceeding $31,000, these contracts are evidently solely supposed for these prepared to make a major funding.

Nonetheless, blockchain presents vital potential to rework the futures markets past cryptocurrencies by asset tokenization. Suppose a futures contract for the Nasdaq-100 or S&P 500 was made out there as a token. In that case, it may very well be traded in fractional increments, decreasing limitations 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 situation might profit these seeking to introduce a extra fine-grained diversification to their portfolio, which is presently solely potential by way of contracts for differences (CFD). Whereas they carry out an identical function within the monetary markets, CFDs are solely out there by way of brokers, which reduces transparency for the dealer. It additionally fragments the out there liquidity within the broader markets.

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

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

The views, ideas and opinions expressed listed below are the creator’s alone and don’t essentially mirror or characterize the views and opinions of Cointelegraph.

Andy Flury is a serial entrepreneur and quantitative buying and selling skilled. Andy is a former Swiss Air Pressure pilot and led tasks on the Swiss intelligence company and varied main banks. He additionally served as senior venture supervisor and software program architect at Siemens Switzerland AG. In 2010, Andy turned accomplice 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.