Crypto Derivatives Managers' Insight Report
Crypto DerivativesManagers’ Insight ReportQ2 2022
IntroductionWelcome to the inaugural AcuitiCryptocurrency Derivatives ManagementInsight Report. This is the first of a quarterlyseries of reports delving into the attitudesand approaches of senior executives in thecryptocurrency derivatives markets.Survey data in this report is sourced frommembers of Acuiti’s Crypto DerivativesExpert Network, a group of senior executivesat prop trading firms, hedge funds, banks,brokers and exchanges. The purpose ofthis report is to identify challenges andpromising opportunities that participantssee in this still nascent market.growing the market, boosting traditionalsell-side intermediation and how marketstructure will evolve.In addition, this report contains anexclusive Q&A with Jad Comair, founderand president of Melanion Capital, whichlaunched the Melanion BTC EquitiesUniverse UCITS ETF last year.The Acuiti network is interactive and memberscan submit topics and questions on the marketthat they want to pose to their peers. Pleaseget in touch if you are not already a member ofthe network but would like to join.Key themes that the network identified inthis report are getting regulation right forRoss LancasterHead of ResearchRoss.lancaster@acuiti.ioBE IN THE KNOW!Join Acuiti for a closed-door, invite-onlyCrypto Derivatives Managers’ Meeting and:Learn from expertsand fellow seniorexecutivesTake part in thediscussion and shareyour opinionDATE & TIME:LOCATION:Thursday May 19th, 202214:00 - 18:30CodeNode, 10 South Pl,London, EC2M 7EB(followed by an optional informal dinner)Connect withfellow industrypeersREQUEST AN INVITATION
Table of ContentsPAGE 4Market StructurePAGE 6Demand for new coinsPAGE 6Market evolutionPAGE 8Regulatory infrastructurePAGE 9How are firms trading crypto derivatives markets?PAGE 11Derivatives market sharePAGE 12DVOL: How does BTC volatility trade?PAGE 13Q&A with Melanion’s Jad Comair3
Market structureMarket StructureIn this report, we focus on marketstructure, the evolution of the exchangeenvironment and ask how the traditionalderivatives market will evolve alongsidethe innovations native to cryto.The market for crypto derivatives has grownrapidly in recent years. Since Binance, thelargest futures exchange today, was foundedin July 2017, the overall futures market hasgrown to a peak of 4.96tr in 2021.Deribit currently dominates flow in Bitcoinoptions with 90% of total volumes, hosting 16.3bn of volumes in February while Okexsaw 475.4m and Binance 27.1m.That has happened alongside a growingmarket share relative to spot, withderivatives markets accounting for 62.7%of all crypto trading in February1.CME Bitcoin futures and options –products better recognised in theinstitutional investor community –accounted for 36bn and 362.8m ofvolume respectively.Binance accounts for most activity in thefutures market, with 47.6% of total volumes. InFebruary, the exchange recorded averagedaily volumes of 600bn in Bitcoin futureswhile OKex saw ADV of 200bn, Bybit 140bn and FTX 119bn2.The dominance of native crypto derivativesmarkets comes despite the uncertainregulatory regime they operate in. Thisis resulting in the growth of a bifurcatedmarket between traditional and nativefinancial institutions.Sell-side disintermediation?Members of the Acuiti Crypto Derivatives Expert Networkidentified greater intermediation from traditional sell-sidefirms as the factor that could have the biggest positive nonregulatory impact on the environment for trading cryptoderivatives (see chart on next page).12CryptoCompare, Exchange Review, February 2022 (Source)Source4
Apart from regulation, which of the below would have the biggest positiveimpact on the environment for trading crypto derivatives?Greater intermediation from traditional sell-side firmsMore participation from the traditional institutional buy-sideThe introduction of clearinghousesMore advanced risk systemsMarket surveillance and clear trading rulesA more sophisticated custody environmentMore reliable exchange infrastructureGreater transparency in liquidations and the associated P&LProof of coin or other recurring confirmation assets are secureBroader choice of listed currency pairs0%To the same end, a greater traditionalbuy-side presence was the secondfactor that Network believes will havethe biggest impact on growth. This is afast growing market and 80% of ExpertNetwork members that provide servicesto traditional institutions reported fastgrowing demand from buy-side participantsfor trading in crypto.Some sell-side firms such as GoldmanSachs and TP ICAP have made forays intocrypto derivatives, providing liquidityin ETC Group Physical Bitcoin and CMEBitcoin Futures. Last month Goldmansconducted the first OTC non-deliverableoption trade by a US bank with GalaxyDigital Holdings. However, most othertraditional sell-side firms have beenhesitant to enter the market outsideoffering clients clearing for derivatives onCME.In place of traditional sell-side firms, a hostof new, native crypto sell-side providershave emerged to offer access and services10%20%30%40%50%to crypto derivatives markets. As in theexchange world, this poses a challenge totraditional financial infrastructure.Perhaps the most interesting developmentin this respect comes from FTX, which hasapplied to the CFTC to operate a regulated24/7 derivatives markets offering a range oftraditional products in addition to cryptowith a market structure that effectivelydisintermediates the role of the traditionalclearing member.The CFTC has launched a consultationon the proposals and, while it is notexpected to approve the market to tradein traditional futures and options any timesoon, it is likely to approve it for cryptoderivatives as a test case. This representsone of the most significant potentialinnovations in derivatives market structuresince the advent of electronic trading.Crucially it is also a tantalising glimpseof how innovations in the native cryptomarket will fundamentally change marketstructure beyond bitcoin and digital assets.5
Which coins would you like to seederivatives listed on?1. Solana(SOL)2. Tether(USDT)3. USD Coin4. Polkadot(USDC)5. Cardano(ADA)(DOT)Do you think that the traditional sell-side could be displaced by new entrants ordisintermediated entirely in crypto derivatives?Yes, displaced by new entrantsYes, disintermediated entirelyNo, they will retain their role in the marketThe question ultimately is what impactthis will have on the traditional sell-side.While over a third of the Acuiti CryptoDerivatives Expert Network thought thattraditional sell-side firms would retaina role in the market when established,nearly two-thirds thought that theywould be displaced by new entrantsor disintermediated entirely. Withoutadequate regulation to give the sell-sidethe opportunity to develop services, thisremains a major risk for these firms.Market evolutionMore than two thirds of the Expert Network thinkthat crypto will become a less volatile asset class asthe market matures. If current proponents’ effortsto educate and bring more institutional liquidity andpricing methodologies into the markets succeed thiscould stabilise the market. But given many marketparticipants are attracted to the volatility in crypto, areduction in volatility will also pose challenges to digitalassets.6
How do you see the high volatility environment of crypto evolving?It will settle down in the coming monthsIt will settle down when crypto is a mature conceptHigh volatility is an inevitable and permanent factorof cryptocurrenciesWhile not as fragmented as the spot cryptomarket where hundreds of exchangescompete, the crypto derivatives marketremains splintered. Currently there are around8 derivatives markets with notable liquidityin futures, options or perpetual contracts.The market has also grown bifurcatedbetween the native crypto market andthe traditional markets. The latterhave experienced difficulties in makingan impact with CME the only majortraditional financial exchange to boast anysignificant liquidity today.That is likely to change as exchangeslaunch new and innovative products suchas ETFs and perpetual futures. However,the native market remains well ahead interms of derivatives liquidity despite thedisadvantage of not being the incumbentor being able to operate in an establishedregulatory environment.The barriers between the native andtraditional markets are beginning to blur,however, following several deals includingCoinbase and FTX both buying traditional,regulated markets in the US.Do you think that the number of crypto derivatives exchanges will continue togrow or consolidate over the next five years?80%60%40%20%0%GrowMembers of the network expected aconsolidation of the number of cryptoderivatives exchanges and mostly saw it asa positive for the market – although somewarned of emerging monopolies. Somethought that there would be a significantRemain about the sameConsolidatechange in the hierarchy of cryptoderivatives exchanges over the next threeyears, although most respondents thoughtthe largest players would retain theirposition. However, 29% thought that newentrants would disrupt the incumbents.7
Do you think that there will be a significant change in the hierarchy (i.e. those withthe most volume) of current crypto derivatives exchanges in the next three years?Yes, new entrants will disrupt the incumbentsYes, but the largest will retain their positionNo, the market is now maturing and most of the currentfirms will retain their positions0%As the market matures exchanges arelooking to grow through offering moreservices to the market. One ongoingdebate revolves around whetherexchanges should be licenced to offercustody services to institutional clients.FTX argued strongly in favour of this in arecent paper. Views of the expert network10%20%30%40%50%60%70%are fairly split on whether they should also belicenced as custodians, with 60% sayingthat they should not, citing concerns ofsecurity and a market dominance. Proptraders were the market participants mostlikely to back exchanges taking on custodyresponsibilities, while brokers were mostopposed to the idea.Regulatory infrastructureInstitutional market participants are fairly unanimousin calling for a better regulatory framework for cryptoand crypto derivatives markets - so long as it is donecorrectly. The long-standing hope is that clearlydefined and constructed frameworks will attract betterand more robust liquidity into the market. This wouldenable greater engagement from traditional buy andsell-side firms.8
In terms of regulation, what is missing or needs development in the ecosystemfor trading crypto derivatives?Platform regulationStablecoin regulationCustody regulationTrading rules / surveillance regulationKYC / AMLFATF Travel Rule0%There are multiple fronts on which themarket can be regulated. Members of thenetwork saw platform regulation as thepriority area for regulation but stablecoin andcustody also ranked highly.Trading rules and surveillance, includingreporting violations to authorities, were alsoseen as priority areas for greater oversight.Many traditional firms are still wary of the10%20%30%40%50%60%70%80%reputational risks of crypto, given headlinesaround money laundering and fraud in thesemarkets.While regulation is a key concern in themarket, there are still also technical issuesthat crypto derivatives need to overcome.Auto close out of positions was as by farand away the most major challenge citedin this respect.Top challenges for firmstrading crypto derivatives :1. Auto close out of positions2. Latency of venues3. Exchange fees4. Uptime of venues5. Absence of a CCP6. Custody arrangements7. Exchange market data fees9
How are firms trading crypto derivativesmarkets?Plurality is a strong feature of crypto derivatives markets. This applies to venues and products,with high levels of fragmentation in the former, compared to non-crypto asset classes. Almostall trading firms in the Acuiti network had access to multiple crypto exchanges for theirderivatives trading and two thirds traded on six or more venues.Diversity is even stronger in coins,with over 80% of firms trading spot inmore than 11 coins as part of their corestrategies.As the market for derivatives evolves, morecoin pairs will be offered. There is also agrowing market for structured products.While supply is still limited, their trajectoryfor growth will surely only strengthen asmarket participants look to better tailortheir pay-offs.Respondents showed a preference foroptions over futures saying they had thebest risk vs reward payoff and greaterdiversification benefits.Members of the network saw the biggestopportunity for arbitrage in tradingderivatives between different underlyingcoins over and above spot and derivativesor trading across exchanges.Around a third of respondents weretrading crypto derivatives on DeFiplatforms. This represents a substantialincrease on the 15% that said they weretrading on DeFi platforms when Acuiti lastconducted a survey on crypto derivativesin Q1 2021.10
Derivatives market shareOptions volume market share (BTC)*80%60%40%20%0%Source: it.comLedgerXBinanceFutures open interest market share 5%10%15%20%30%Source: Skew*As of end of March 2022**As of April 8 202211
DVOL: How does BTC volatility trade?for an interesting trade for volatility traderstrading DVOL against the VIX.DVOL is a measure of BTC volatilitycalculated using Deribit’s options order bookto provide an implied volatility for Bitcoin.One trend to watch when trading DVOLis the impact of the growth in adoption ofDeFi Options Vaults (DOV). DOVs, such asThetanuts, allow users to stake some assetsto a decentralized vault, which generates ayield from selling the options premium.The chart below shows the DVOL levelvs the index price for BTC over the past12 months. Two points are particularlynotable. Firstly, volatility in BTC is movedmore by market news about BTC ratherthan world events.The growth in the adoption of DOV isincreasing the organic retail flow sellingoptions, which are then hedged byinstitutions on platforms like Deribit. Asthese DOVs get more popular, it resultsin lower volatility and can result in lowerimplied volatilities despite rising realisedvolatilities.The second, is how DVOL is uncorrelatedto VIX. While the VIX, and equity volatilitygenerally, spiked sharply around the Russiainvasion of Ukraine, DVOL increased onlymarginally. In addition, while the VIX movedup when the Fed increased rates last month,DVOL fell. This trend suggests the potentialDVOL: The Bitcoin Volatility IndexIndex Price80kBTC Large spike in DVOL as price crash in response toChina banning crypto mining2. China orders shutdown of crypto mining operationsin Sichuan province, one of the biggest bitcoinmining centers in China3. Rumours of Amazon accepting crypto paymentswith job posting. Jack Dorsey and Elon Musk areamong prominent speakers to take the stage sharingoptimism on Bitcoin4. Bitcoin price rebounds and volatility spikesas US Senate continues debate regarding thecryptocurrency tax ar’225. SEC approves the first bitcoin futures ETF6. Bitcoin falls in price from its all time high whilevolatility remarkably stays around 80, as Fed Reservescale back quanititative easing. Also taproot upgradegoes through without issues7. Bitcoin sharp drop follows plunge in tech stocks asconcerns of Omicron spread8. Fed signals upcoming rate hikes9. Russia invades Ukraine10. Fed raises rates for first time since 201812
InterviewCrypto Derivatives: the state of playwith Jad Comair,president of Melanion CapitalJad Comair is president of Melanion Capital,which launched its first Bitcoin thematicETF last year. The firm has also created aSPAC, Melanion Digital, that will invest ingreen and clean Bitcoin projects. Here, Jaddiscusses the crypto derivatives landscapeand how regulation can be designed to helpthe market prosper.What is the state of play in crypto derivatives markets at the moment?Unlike the cryptocurrency markets, mostof the trading in crypto derivatives hasbeen historically done offshore. Whetheroptions, futures or perpetual swaps, it isthe offshore exchanges that have biggestmarket share. This is because they don’thave the onshore regulatory constraintsand could therefore allow retail investorsto get leverage on crypto. They now havethe biggest market share and the tightestspreads as they have the highest volumes.But we are now seeing more and moreoffshore players trying to come backonshore because of regulatory pressure.Regulators around the world differ a lot. Theycan go as far as pursue market participantsfor illegal activity like in the USA, or blacklistand label as non-recommended as Europeanand some other authorities do.There is a lot of hype and uncertaintyaround how this ecosphere will develop andas a result we are seeing more unregulatedexchanges looking to become regulated.13
How are the onshore and offshore markets developing?Derivatives are considered financialinstruments in most onshore jurisdictions.That means needing the whole wholescaletraditional set up and existing licences tobe able to offer financial products. This ishow CME Group was able to issue Bitcoinfutures and options – as a well-establishedand regulated exchange they had all theparts in place.So there are very few new players cominginto the onshore derivatives market, as it isvery heavily regulated.We have seen some new players trying todo onshore but most activity is throughcrypto itself rather than the derivativesbecause they have completely differentregulatory treatment to crypto theunderlying.In France, to offer custody and tradingsolutions on crypto you need to havelicence requirements that are mainlydeclarative. These are non-binding andmuch lighter than if you want to offerthe same service for traditional financialproducts, which crypto futures andoptions fall into. That is more or less thesame situation for the developed countriesin Europe and some parts of Asia.What level of overlap do you see between participants in crypto and cryptoderivatives markets?There is definitely overlap between cryptoderivatives and crypto. From a retailperspective, crypto derivatives are wherethe big offshore flow is. Traditional cryptois more professionalised, onshore.In crypto derivatives, the liquidity is muchmore parcelled. The players are muchsmaller with retail and small shops active -you don’t have the big names that you wouldsee in the traditional derivatives space.These big traditional players struggle toenter crypto derivatives.Once the regulation evolves sufficiently,the traditional players will step in and beable to bring much more significant cryptoderivatives volumes onshore.What regulation is needed to make this happen?First, we need to have a clearer view on allthe traditional issues that are relevant inany asset class. So KYC and AML - all thestuff that you need to have the traditionalactors, mainly the banks, onboard.Regulations must evolve to allow themto offer services in these markets. Thebig entry barriers for banks are strictregulations and a lack of explanation onhow these new products should be treated.Our ETF is an equity ETF based on the betacorrelation of equities with Bitcoin. Butbecause Bitcoin is in the prospectus wecome across a lot of closed doors. Peopledon’t want to touch it as they see Bitcoinand know there is little regulation.There is also a generational issue. We have alot of missed opportunities with traditionalplayers who still think crypto will eventuallygo to zero and won’t spend time looking at it.14
Headlines about how crypto consumesenergy and it used to evade sanctions don’thelp either. All these players pay attentionto headline risk. It took years to build theirreputations and they need more knowledgebefore they go and put their necks on the line.But they cannot ignore the asset class eitheras they are losing customers to it. They aresitting between two chairs and not knowinghow to approach the issue. That is whyregulatory solutions are needed. After thatthey will be happy to step into the market.These more traditional players will be wipedout if they don’t react to this trend though.They are very good on the regulatory of theequation part but very bad on execution.Do you see increasing consolidation among crypto derivatives exchanges?It is tricky. Some big players want to goonshore and that can lead very quicklyto them going and buying an onshorevenue. But at the same time, they cannotgo 100% onshore as then they can’t offerthe flexibility of an offshore exchange. It isvery hard for them to have both.So, I think there will be M&A for onshorevenues, with newcomers buying onshoreexchanges. Also, any offshore players goingonshore will open an opportunity for newoffshore players to go take their place.It’s a situation with a lot of changingnames and constant evolution.But it’s going to stay split like that untilmaybe 10 years’ time, when they willconsolidate, and more traditional bigplayers will enter the market.How are derivatives products evolving? Some structured products are alreadybeing traded Autocallables are structured products thatoffer a pay-off and are very common inthe traditional financial space. There area lot of traditional products that can bestructured with crypto as the underlying.With an autocallable you are able to buy aproduct that restrikes every year, so youare not just long crypto. And investorslike the payoff as if it goes wrong one yearthey still have another year to recouptheir losses. You still only have one or twoshops offering it worldwide though. So youcan buy them today but it’s still very earlystages.15
About AcuitiAbout DeribitAcuiti is a management intelligenceplatform designed to provide seniorexecutives with unparalleled insight intobusiness operations and industry-wideperformance. Acuiti helps identify markettrends, enhance decision-making andbenchmark company performance. Theplatform anonymises and aggregatesinformation from its exclusive networks ofsenior industry figures in specific marketsto provide insightful in-depth analysis. TheAcuiti Crypto Derivatives Expert Networkis a virtual forum of senior executives inthe market. Each quarter we provide thisreport based on questions and responsessubmitted by the network. Interestedin joining the network? Contact AliceKristiansen at alicekristiansen@acuiti.io.Nine out of 10 Bitcoin options tradedworldwide are traded on Deribit. Trueto its Dutch roots, Deribit is a derivativeexchange with traditional principlesincluding a high degree of self-regulation,dedicated hardware with colocationservices in Equinix LD4, Market MakerProtection enhancing the tight bid offerspreads, Block Trade & RFQ Solutions, lowlatency round trip times, variety of custodysolutions, all of which make it trusted andpreferred by some of the largest traditionalmarket makers, buy-side and sell-side.Pioneering Bitcoin and Ethereum options,the exchange hosts the largest choiceof expiring futures on these currencies,whilst expanding to cover many Altcoinperpetuals settled in USDC and Solanafutures & options. Deribit will also belaunching the first tradeable BitcoinVolatility Futures (based on our DVOLindex). This effectively is the VIX forcrypto.To find out more, contact Deribit’s ChiefCommercial Officer at Luuk StrijersLuuk S@deribit.com
More advanced risk systems Greater transparency in liquidations and the associated P&L Market surveillance and clear trading rules Proof of coin or other recurring confirmation assets are secure Broader choice of listed currency pairs 0% 10% 20% 30% 40% 50% to crypto derivatives markets. As in the exchange world, this poses a challenge to
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