We‘ve all heard stories of billion-dollar future contracts liquidations stuff the rationalization of 25% intraday price crashes in Bitcoin (BTC) and Ether (ETH) but the truth is, the industry has been plagued by 100x leverage instruments since BitMEX launched its perpetual futures contract in May 2016.
The derivatives industry goes far vastitude these retail-driven instruments, as institutional clients, bilateral funds, market makers and professional traders can goody from using the instrument‘s hedging capabilities.
In April 2020, Renaissance Technologies, a $130 billion hedge fund, received the untried light to invest in Bitcoin futures markets using instruments listed at the CME. These trading mammoths are nothing like retail crypto traders, instead they focus on arbitrage and non-directional risk exposure.
The short-term correlation to traditional markets could rise
As an windfall class, cryptocurrencies are rhadamanthine a proxy for global macroeconomic risks, regardless of whether crypto investors like it or not. That is not sectional to Bitcoin considering most commodities instruments suffered from this correlation in 2021. Plane if Bitcoin price decouples on a monthly basis, this short-term risk-on and risk-off strategy heavily impacts Bitcoin‘s price.
Notice how Bitcoin‘s price has been steadily correlated with the United States 10 year Treasury Bill. Whenever investors are taxing higher returns to hold these stock-still income instruments, there are spare demands for crypto exposure.
Derivatives are essential in this specimen considering most bilateral funds cannot invest directly in cryptocurrencies, so using a regulated futures contract, such as the CME Bitcoin futures, provides them with wangle to the market.
Miners will use longer-term contracts as a hedge
Cryptocurrency traders goof to realize that a short-term price fluctuation is not meaningful to their investment, from a miners‘ perspective. As miners wilt increasingly professional, their need to constantly sell those coins is significantly reduced. This is precisely why derivatives instruments were created in the first place.
For instance, a miner could sell a quarterly futures contract expiring in three months, powerfully locking in the price for the period. Then, regardless of the price movements, the miner knows their returns older from this moment on.
A similar outcome can be achieved by trading Bitcoin options contracts. For example, a miner can sell a $40,000 March 2022 undeniability option, which will be unbearable to recoup if the BTC price drops to $43,000, or 16% unelevated the current $51,100. In exchange, the miner‘s profits whilom the $43,000 threshold are cut by 42%, so the options instrument acts as insurance.
Bitcoin‘s use as collateral for traditional finance will expand
Fidelity Digital Resources and crypto borrowing and mart platform Nexo recently spoken a partnership that offers crypto lending services for institutional investors. The joint venture will indulge Bitcoin-backed mazuma loans that can t be used in traditional finance markets.
That movement will likely ease the pressure of companies like Tesla and Block (previously Square) to pension subtracting Bitcoin to their wastefulness sheets. Using it as collateral for their day-to-day operations vastly increases their exposure limits for this windfall class.
At the same time, plane companies that are not seeking directional exposure to Bitcoin and other cryptocurrencies might goody from the industry‘s higher yields when compared to the traditional stock-still income. Borrowing and lending are perfect use cases for institutional clients unwilling to have uncontrived exposure to Bitcoin‘s volatility but, at the same time, seek higher returns on their assets.
Investors will use options markets to produce “fixed income”
Deribit derivatives mart currently holds an 80% market share of the Bitcoin and Ether options markets. However, U.S. regulated options markets like the CME and FTX US Derivatives (previously LedgerX) will sooner proceeds traction.
Institutional traders dig these instruments considering they offer the possibility to create semi “fixed income” strategies like covered calls, iron condors, bull undeniability spread and others. In addition, by combining undeniability (buy) and put (sell) options, traders can set an options trade with predefined max losses without the risk of stuff liquidated.
It‘s likely that inside banks wideness the globe will worldwide pension interest rates near zero and unelevated inflation levels. This ways investors are forced to seek markets that offer higher returns, plane if that ways delivering some risk.
This is precisely why institutional investors will be inward crypto derivatives markets in 2022 and waffly the industry as we currently know.
Reduced volatility is coming
As previously discussed, crypto derivatives are presently known for subtracting volatility whenever unexpected price swings happen. These forced liquidation orders reflect the futures instruments used for accessing excessive leverage, a situation typically caused by retail investors.
Yet, institutional investors will proceeds a broader representation in Bitcoin and Ether derivatives markets and, therefore, increase the bid and ask size for these instruments. Consequently, retail traders‘ $1 billion liquidations will have a smaller impact on the price.
In short, a growing number of professional players taking part in crypto derivatives will reduce the impact of lattermost price fluctuations by titillating that order flow. In time, this effect will be reflected in reduced volatility or, at least, stave problems such as the March 2020 crash when BitMEX servers “went down” for 15 minutes.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should self-mastery your own research when making a decision.