The effect of derivatives on cryptocurrencies

Although they have had a slow rollout, derivatives for cryptocurrencies have been gaining support over the last year. Many worried that with Bitcoin ETFs stalling in their adoption, this could extend to derivatives. However, the demand for these products has continued to grow for various reasons we are going to examine in this article.

Derivatives are financial instruments that allow you to speculate on the price movement of a good without having to actually take ownership for that good. Some companies use them in order to hedge their positions and smooth out their income, but at the same time, derivatives were a large part of the volatility that led to the last major recession in 2008.

Current Status of the Market

Right now there are not many big players in the game, but more firms developing their own solutions and releasing them, you can expect to see the competition intensify in the next few months. The landscape includes everyone from privately funded investment funds to public exchanges. A big part of the market is about institutions gaining access to cryptocurrencies in a way that is less risky for their client base.

There are companies like LedgerX, which has experienced continually increasing demand for their cryptocurrency derivative products as 2018 has progressed. But where things get interesting is when existing financial players delve into cryptocurrencies.

The Chicago Board of Exchange (CBOE) started offering Bitcoin futures on December 10th, 2017, and this marked a change in the market. When well-regulated derivatives exchanges begin to acknowledge the legitimacy of cryptocurrency (or at least the high demand from their customers) it is a signal of a larger shifting of the tides in the works.

The plot thickens as recent rumours about Goldman Sachs hiring a cryptocurrency trader seem to be all-but-confirmed. Their goal is to figure out their customers’ direct needs and although they do currently clear Bitcoin futures, they are very cautious about further expansion into the cryptocurrency space.

In terms of sentiment, all of these actions together signal a shift in the way the legacy financial industry views cryptocurrency. A common retort used to be that Bitcoin was not a currency, but now that demand has continued to increase, banks are much more willing to cooperate and cater to their customers.

2nd Order Effects

It may be nice to have cryptocurrency derivative products available, especially for the firms who are making tons of money selling them, but it is also important to think about how this will affect the cryptocurrency market as a whole. Derivatives distribute the risk in a way that allows speculators to make bets without actually owning the cryptocurrency. Bitcoin has gained traction, but it is unclear how this sort of institutionalized speculation would affect it in these early stages.

The general argument for derivatives is that they allow for more liquidity and trading volumes of non-blue chip coins. Companies issuing derivatives for these alt-coins would increase the general awareness of these coins and their quality, which could lead to heightened demand for the coins.

Additionally, with every company, exchange, or investor who trades anything cryptocurrency related, regulators feel further pressure to regulate them more fairly. The current “no man’s land” crypto is in can’t last forever, and if the adoption of derivatives helps, then this is a clear benefit.

On the flip side, derivatives allow for bets against Bitcoin as well as the ability to invest in cryptocurrencies without owning them. This could lead to decreased demand, which may affect it negatively, since it hasn’t reached equilibrium like other currencies have.

Cryptocurrencies are an inherently risky asset, and with the introduction of derivatives, there are a lot of different things that could happen in this space. Increased volatility may ensue, but with it may come increased adoption.

Also read: U.K. blockchain startups are looking for contingency plans