Bitcoin Rally Fuels Market In Crypto Derivatives (#GotBitcoin?)
New structured products draw concern as digital currency climbs back above $10,000. Bitcoin Rally Fuels Market In Crypto Derivatives (#GotBitcoin?)
Wall Street has dreamed up an array of derivatives tied to stocks, commodities and mortgages. Now such contracts are being developed for bitcoin.
In recent months, some cryptocurrency firms have begun touting structured products linked to the price of bitcoin, with complex formulas determining how much they pay out.
It is still a small market, and the firms say their products aren’t aimed at mom-and-pop investors. But the trend is raising red flags among some market veterans, especially as bitcoin’s rebound above $10,000 has rekindled investor interest in the digital currency.
Craig McCann, a former Securities and Exchange Commission economist, warns that it is a bad idea to take bitcoin—a highly volatile, speculative asset traded on unregulated exchanges—and use it as a building block for complex instruments.
“There are all kinds of problems associated with any structured product tied to bitcoin,” said Mr. McCann, who now leads Securities Litigation & Consulting Group, a firm that provides expert witnesses for companies involved in securities lawsuits. “It doesn’t belong in anybody’s portfolio.”
Cipher Technologies, a crypto hedge fund in Greenwich, Conn., began offering structured products on bitcoin earlier this year. The firm has done several such deals, mainly with entities that manage money for wealthy families and individuals, said Cipher’s founder and managing partner, Gerald Banks.
“We would not fathom pushing this to anyone who would not be fully versed in the risk or in the nature of the underlying asset,” said Mr. Banks, who helped develop Merrill Lynch’s structured-products business in the 1990s and early 2000s.
One of Cipher’s products is a bond-like contract known as a reverse convertible. In such a deal, the client loans money to Cipher in return for monthly interest payments, with Cipher paying back the loan once the contract expires. But before then, if bitcoin falls below a predetermined level—a 19% drop, in one version of the product from earlier this year—then Cipher returns the principal to the client, minus the amount bitcoin has lost.
KuCoin Launches Bitcoin Derivatives Trading With 20x Leverage
IDG-backed cryptocurrency exchange KuCoin has just launched a platform offering crypto derivatives trading.
Announced Monday, the KuMEX trading venue is now live in public beta and will offer initially a bitcoin perpetual contract (XBTUSDM), quoted in U.S. dollars, with up to 20x leverage.
Aimed to make pricing “more fair and rigorous,” KuCoin said, KuMEX uses a bitcoin spot index providing a volume-weighted average of the U.S. dollar price of bitcoin across six exchanges: Coinbase Pro, Bitstamp, Kraken, Gemini, Liquid and Bittrex.
The spot index also avoids a contract being liquidated “because of the low liquidity of the trading platform or the large price fluctuations of one or two spot exchanges,” the exchange explained.
KuMEX offers some protection from risk with an insurance fund it says is “fully transparent,” with the balance to be disclosed on the platform each day.
“This fund ensures that investors who are forced to close their positions will not lose money that exceeds their position margin,” according to the announcement.
Should the insurance fund turn out to be insufficient to cover losses, KuMEX also has an “auto-deleveraging” system, said to be less “inflexible” than settlement via more standard socialised loss mechanisms.
To encourage new retail investors to get involved with crypto derivatives, KuMEX is offering a lower investment threshold than found at some other providers.
“The XBTUSDM contract value is 1 USD, which enables traders to make a more flexible investment. At the same time, KuMEX offers a negative fee for Makers at a rate of -0.025% with a certain amount of fixed commission, encouraging users to provide liquidity to the platform through making the market and earning some commission as an incentive,” says KuCoin.
KuCoin CEO Michael Gan said:
“Compared to the spot market, derivatives are much riskier due to the leverage used, so we are more cautious in providing such services. KuMEX is a derivative trading platform independently developed by our team, and from its inception, we have positioned it as a genuine and advanced financial product, so that all users can trust the platform and trade on it freely, without worrying about the loss caused by any form of manipulation. ”
After the full launch of the platform, 50 percent of net KuMEX revenue will be assigned for distribution to holders of the exchange’s token, KuCoin, the release states.
Last November, the Singapore-based exchange raised $20 million in Series A funding from investors including IDG Capital, Matrix Partners and Neo Global Capital.
3 Insights On Crypto Derivatives And Risk From Veteran OTC Traders
For all the talk about liquidity, bitcoin and other crypto-assets are thinly traded. Investors that buy and sell large volumes can’t do so directly, without slippage, or a change in the price between order and execution.
They turn to over-the-counter (OTC) desks to manage those trades, whether buying crypto for the first time, or trading to generate alpha (above-market returns).
As a result, these desks handle anywhere from 30 percent to 65 percent of total crypto market volume, depending on whose estimate you believe. To get a look inside this business, CoinDesk Research talked to two veteran OTC traders in a live webinar on Oct. 28.
Martin Garcia is managing director and co-head of trading at Genesis Trading. Yinfeng Shao is a former trader at Circle and now the CEO of a development-stage OTC firm, Reciprocity Trading.
OTC desks take on tremendous, temporary risk. Traders like Martin and Yin are tasked with managing that risk by moving large amounts quickly and offsetting it on derivatives markets, including BitMEX, Huobi, OKEx, CME Bitcoin Futures and Bakkt. (For background, CoinDesk Research has produced a white paper on the state of crypto derivatives markets. You can download it for free here.)
As a result, they are among the most sophisticated traders on crypto derivatives exchanges. Here are a few of the insights Martin and Yin shared during our hour-long conversation.
1. Investors’ Mentality Has Shifted
The mentality of investors has changed since the earlier days of crypto, from venture-like to hedge-fund-like.
“There’s a lot more velocity amongst the traders that are out there, whereas in the early days it was very much more a buy-and-hold” strategy, Martin said. “People these days understand that this market is super volatile and a lot of the different crypto funds and people that are out there, they are trying to add alpha for their shareholders.”
2. Derivatives Markets Move The Spot Market
First of all, market moves get started on derivatives exchanges more often than on spot exchanges.
“Because there are so many trading venues, it’s a constant question of, where is the action starting?” Yin said. “Often it’s starting on derivatives exchanges because that’s where a lot of people have connections and that’s where a lot of the most highly levered bets are taking place.”
“Crypto already is a fairly random, volatile walk in terms of price action and the collection of these derivatives and the exchanges that list them effectively act as leverage on top of that,” he went on. “Whenever you start to make a move, there’s a good chance it will get exacerbated because of the amount of open bets that are out there.”
In isolated examples, like the May 17 flash crash, a small amount on spot markets can cause a large move on the offshore derivatives markets, specifically BitMEX, allowing traders to manipulate the spot price in favor of their derivatives markets position.
Theoretically, that’s possible on regulated crypto derivatives markets like CME’s, but it’s more expensive and difficult because the leverage is not as high.
That’s Not The Only Way Derivatives Markets Can Fail.
“Where things tend to break down a bit and you get a lot more slippage is when you’ve simply exhausted everybody’s ability to really use the derivatives instruments to hedge, so whether that’s the amount of collateral that everyone’s posted is insufficient, or the market conditions are such that you really can’t get access to some of these platforms,” Yin said.
3. Two Products Dominate Derivatives
The most popular product is the perpetual swap, reputedly invented by BitMEX. Crypto futures are a close second. A handful of OTC desks can provide swaps and custom derivative products, including contracts for difference, but those two products have dominated market volume so far.
Bitcoin options are emerging, but remain a small percentage of overall volume. As providers including Bakkt and CME have announced plans to bring options on bitcoin futures into the markets, Yin and Martin said these may prove attractive for large investors entering crypto, looking for a hedge against a big downside in a volatile market.
“I think it means there are more sophisticated hedging strategies. It allows people to be more comfortable with spot exposure, if it can be more easily hedged out,” Martin said. “These markets move really quickly and a lot of the bigger places that want to start trading, there’s a significant amount of headline risk attached to this. How do they protect against the crazy downside move? Options may very well help eliminate some of those risks for them.”
Listen to the full webinar for Yinfeng and Martin’s unfiltered opinions on risk, liquidity and derivatives in crypto markets.
Tassat Gets CFTC Approval To Issue Bitcoin Derivatives In US
New York-based financial technology firm Tassat — formerly known as trueDigital — has succeeded in overcoming the first hurdle in its bid to launch a fully-regulated crypto derivatives exchange.
According to an announcement from the United States Commodity Futures Trading Commission (CFTC) on Nov. 7, the regulator has approved the transfer of a swap execution facility (SEF) registration from fellow New York-based financial services firm trueEX to Tassat.
Tassat had first reached the agreement in principle to acquire — subject to CFTC approval — trueEx’s SEF registration back in July of this year.
The company is now waiting for news regarding its prospective acquisition of trueEx’s Designated Contract Market (DCM) registration, which would allow it to operate an exchange listing futures or options contracts with oversight from the CFTC.
Physically-delivered BTC Derivatives For Institutional Investors
In its press release, the CFTC stated that trueEX and Tassat fulfilled the requirement for transferring a SEF registration by providing evidence that Tassat would be able to operate in compliance with the provisions of the U.S. Commodity Exchange Act and related CFTC regulations.
The agency revealed that there are now a total of 19 registered SEFs, including Tassat, and noted that TrueEX had been granted its registration as a SEF by the CFTC on Jan. 22, 2016.
The registration brings Tassat closer to launching a crypto derivatives exchange with full oversight from the CFTC, where it hopes to list physically-delivered Bitcoin (BTC) derivatives for institutional investors. As CEO Thomas Kim said in July when the plans were first unveiled:
“Adding the exchange to our ecosystem delivers a complete end-to-end offering, currently unavailable today, that encompasses tokenization, payments, market data and settlement for the benefit of our clients and partners.”
In March, Tassat — when it was still known as trueDigital — had partnered with crypto data firm Kaiko and digital assets analytics company Inca Digital Securities to widen the distribution of its over-the-counter reference rates for Bitcoin and Ethereum (ETH), the latter of which it created in partnership with ConsenSys.
TrueDigital was initially established as a subsidiary of TrueEx, which has long been active in the crypto space and was the first in the industry to secure a DCM registration for Bitcoin swaps from the CFTC back in 2012.
This summer, another crypto exchange ErisX, procured a derivatives clearing organization license from the CFTC as part of its plans to make digital asset futures contracts available for trade on its regulated derivatives market later this year.
Crypto Derivatives: A Corner of the Market or the Market Itself?
Emmanuel Goh is co-founder & CEO of skew. – a financial technology startup headquartered in London since 2018. These opinions are his and do not necessarily reflect the view of CoinDesk.
The following article originally appeared in Institutional Crypto by CoinDesk, a weekly newsletter focused on institutional investment in crypto assets. Sign up for free here.
The Race Is On
One business day before the much-awaited ICE/Bakkt launch, the CME announced it would be listing bitcoin options in Q1 2020. ICE returned the favor by announcing it would also be launching options contracts but in December this year/
Why are two of the largest exchanges in the world competing so openly for a space that was considered, until recently, as secondary by most industry insiders?
Almost every week, a new player is announcing its intention to enter the increasingly crowded crypto futures market. Most recently crypto behemoths Binance and Bitfinex launched their own futures products, with varying degrees of success.
This optimism wasn’t always there. The rise of Hong-Kong based BitMEX – home to the most liquid bitcoin contract globally – was for a long time met with skepticism by industry leaders, who dismissed the product as only serving gambling addicts with the use of high leverage.
The crypto futures market really took off in 2018. Volumes increased by a factor of ten compared to 2017 levels – a year widely seen as the peak of the crypto market. Bitcoin futures and other perpetual swap instruments are now trading, on average, 10x more volume than the underlying bitcoin spot market according to data compiled by skew and Bitwise.
In hindsight, it is relatively simple to explain why. As the market entered a prolonged downturn starting in 2018, market participants looked for ways to profit from, or at least hedge against, the falling prices. The growth in futures markets came from that need to short the market.
The market evolved rapidly from very little two years ago. In Q4 2017, the Financial Times published, in a well-researched article, how shorting the stock of chipmaker Nvidia – the products of which were very popular with cryptocurrency miners – could be one of the most convenient ways to get short exposure to cryptocurrencies.
A Crypto Anomaly? Not Really…
Traditional markets also experienced a “derivatives moment” in response to increased volatility in the market. The seventies were a period of incredible financial turbulence as Richard Nixon abolished the Bretton Woods system in 1971, moving to a fiat monetary system, and allowing all currencies to float. The world subsequently went through the first oil shock in October 1973, sending the price of black gold skyrocketing in what was previously a quiet market.
A few months prior, in 1973, in a (not so) curious twist of events, Fischer Black and Myron Scholes found a simple analytical formula to price options, which won the 1997 Nobel Prize two decades later. The conjunction of those two events is widely seen as having started a glory period in derivatives products across all asset classes.
It wasn’t just a fad. The Office of the Comptroller of the Currency in Washington estimates banks currently have exposure to more than $200 trillion notional of derivatives. Derivatives have gradually become the place where the majority of interested parties are coming to trade – across all markets.
“We Will Tame Bitcoin” – Emeritus CME chairman Leo Melamed
Should We Believe The Prediction From The Legendary Futures Trader?
There has been a consensus view that bitcoin is too volatile to be a medium of exchange – triggering a wave of “stable coin” projects in 2017 and 2018. The inelastic supply function of bitcoin is, by construction, indifferent to demand or supply shocks – making all the adjustment occurring through price and creating volatility as a result. Good logic, but not necessarily true in practice. For instance, this argument is also valid for gold, which is one of the lowest volatility assets around, with an average daily move of 0.6% in 2019 according to data obtained from the Federal Reserve of Saint Louis.
There are a number of factors that contribute to an asset’s volatility. One of them is its market structure. Academics have extensively researched the impact of developing derivatives markets on the volatility of underlying assets and have overwhelmingly concluded that derivatives help to stabilize prices.
This is particularly true for options, as flows are usually dominated by call overwriting (selling calls to overlay an underlying position) as investors are looking to generate extra yield. The income fund launched by LA-based Wave Financial is a first step in that direction within the crypto markets.
Bitcoin’s volatility will decrease structurally as those markets keep growing.
Derivatives rhyme with leverage, which essentially allows you to do more with less. That’s great, but only to a certain extent. As Warren Buffet famously said, derivatives are financial weapons of mass destruction and require careful risk management.
Regulators have as a result been working on curbing the use of leverage globally. In May 2019, Japan’s FSA asked bitFlyer to reduce leverage for its perpetual swap product. The UK FCA is taking even more drastic action by planning to ban the offering of crypto derivatives to retail investors. The regulator also asks retail brokers to warn their customers of the risks of investing using derivatives products, across all asset classes.
“CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 72% of retail investor accounts lose money when trading CFDs with this provider.” – Welcome message on a popular retail brokerage platform
If 72% of investors lose money trading CFDs on low volatility underlyings, what could go wrong trading 100x levered products on the infamously volatile bitcoin?
It is likely that, over time, regulators or simply Darwinism will increasingly put the derivatives market in the hands of professionals.
Not Only About Volumes
Most participants – including us at skew. – spend probably too much time worrying about volumes. Derivatives volumes are mostly a function of leverage. When Japan’s FSA asked bitFlyer to reduce the maximum available leverage from 15x to 4x on the 28th of May, its volumes declined overnight by at least 50%.
Derivatives are zero sum contracts between two counterparties. Traders and investors have to maintain collateral against those open positions. Leading venue BitMEX asks for a minimum maintenance margin of 0.5% and a minimum initial margin of 1%. The CME on the other hand asks for 37% of initial margin. That means if you would like to open a $1 million long position on BitMEX, you can post as little as $10,000 in collateral versus at least $370,000 at CME.
The total $ amount of bitcoin futures contracts opened – called open interest – at CME currently stands at $150 million contract in comparison with $1.1 billion at BitMEX. Because of margin requirements it is likely there is a similar amount of money “working” to trade Bitcoin derivatives at CME and BitMEX despite the later trading 10x more volumes. The “herd” might be closer than people think.
This is a great setup for the offshore exchanges which are able to make significantly more money from the same amount of capital as they collect their fees from the volumes traded.
An Increasingly Central Question: What Is The Price Of Bitcoin?
Victims of their own success, derivatives venues were hit in 2019 with a first-world problem.
As trading occurs on margin, derivatives exchanges have been careful to design a spot price index derived from the price of what were, initially, much larger physical exchanges. The index is used to settle the contracts at expiry, and decide when to initiate margin calls. It was a smart way of preventing manipulation of the then not-so-liquid crypto derivatives contracts.
However, as the derivatives market has grown exponentially, we have now entered a period where the underlying physical exchanges are much smaller than the derivatives exchanges – only 10% of total volumes in aggregate. It has become tempting to try to manipulate the less liquid underlying exchanges to yield some profits trading the derivatives.
This was most visible earlier this year in May when a relatively small-size order on physical exchange Bitstamp triggered a wave of liquidations at BitMEX and took the entire market down.
Exchanges seem to have been increasingly aware of the problem and have been attempting to strengthen their indices – sometimes with unfortunate consequences, as with a recent miscalculation at Deribit costing the exchange $1.3 million.
“There’s a whole ocean of oil under our feet! No one can get at it except for me!” – There Will be Blood’s Daniel Plainview
With the CBOE officially out, expect the competition between CME and ICE to be heating up in 2020 as the two exchanges roll out their options offering.
It would be particularly encouraging to see corporate hedging flows taking off, led by mining companies and supported by physically delivered and options contracts. The Mexican government is said to have spent $1 billion on put options this year to hedge its 2020 oil production. Still some way to go for crypto derivatives.
Former Morgan Stanley Developers Launch Crypto Derivatives Exchange
Eight former core developers from financial services company Morgan Stanley have launched Phemex, a new cryptocurrency derivatives trading platform, in Singapore.
In a press release shared with Cointelegraph on Dec. 4, the former Morgan Stanley developers claim the platform is ten times faster than traditional crypto trading platforms, while offering 100x leverage to both retail and institutional investors in Bitcoin (BTC), Ethereum (ETH) and Ripple (XRP) perpetual contracts.
Exchange Is “On Par With Nasdaq”
In the near future, these contracts will reportedly also be backed by traditional financial products, such as stock indexes, interest rates, foreign exchange, agricultural commodities, and metals and energy. Phemex co-founder Jack Tao said:
“We are the first exchange to truly bring Wall Street level sophistication to the worldwide crypto derivatives markets. Our matching engine, trading engine, and risk engine were six months in the making, putting the platform technically on par with Nasdaq.”
Tao, who spent 11 years as an executive at Morgan Stanley, told Cointelegraph that the platform was looking to add options trading soon. In launching Phemex, Tao assembled a team of more than 30 senior developers. He explained:
“We’re not just providing the functionality for trading. As executives from Morgan Stanley, we know what kind of ways, what kind of direction, or what kind of architecture can support high-frequency trading, stability, and low latency. This is where Phemex excels — our expertise allows us to compete with and outperform existing platforms.”
Tao told Cointelegraph that since the Nov. 25 launch, Phemex has seen volume of around 1000 BTC per day on BTC/USD contracts.
Singapore Regulators Take A Closer Look At Crypto Derivatives
In November, Singapore’s central bank and financial regulator, the Monetary Authority of Singapore (MAS), proposed to bring crypto derivatives trading under its purview. The MAS’ proposal would make the trading of derivatives based on underlying assets like Bitcoin and Ether subject to the city-state’s Securities and Futures Act. For Phemex, a Singapore-domiciled company, the proposal by the MAS comes at a perfect time as it may soon allow cryptocurrency-based derivatives to be traded on regulated platforms.
Retail Investors Aren’t Interested In Crypto Derivatives, Says eToro Executive
Despite being one of the largest crypto derivatives platforms, an eToro executive said he isn’t losing sleep over the U.K.’s proposed retail ban.
Over breakfast in a central London restaurant, inside what used to be the Midland Bank, Iqbal Gandham, eToro’s U.K. managing director since 2016, said the country’s decision to ban retail access to all crypto derivatives would likely have a “minimal” impact on its business.
With more than 10 million users worldwide, eToro is one of the largest trading platforms in the world. Gandham said the company has noticed a shift in the behavior of retail traders, who value the fact they can buy an actual cryptocurrency asset and transfer it out into their personal wallets.
“Two years ago people didn’t understand real [assets] and derivatives, they just thought they were buying bitcoin. Now people are more comfortable in owning their own wallets and transferring crypto, they understand that if they can’t transfer it out then it can’t be real,” Gandham said.
The U.K.’s chief financial watchdog, the Financial Conduct Authority (FCA), surprised the industry last summer when it unveiled plans to ban the “sale, marketing and distribution to all retail consumers” of crypto derivatives, including contracts for difference (CFDs).
At the time, the regulator said retail investors were “ill-suited” to such products because they were unable to “reliably assess the value and risks of derivatives or [exchange-traded notes] that reference certain cryptoassets.”
Although regulated platforms, such as Hargreaves Landsdown, have already banned retail access to crypto derivatives, the FCA isn’t expected to make a final decision until later this year.
eToro first offered bitcoin CFDs in 2014. It gradually increased the number of supported cryptocurrency-based options, but only allowed users to buy the underlying asset in September 2017.
“Had you asked me this question in 2016/17, I would have said ‘a really, really big impact, we need to change our business,'” Gandham said. But the majority of eToro’s customers now buy the underlying crypto, rather than any CFD product.
eToro currently offers retail users crypto assets or crypto CFDs at a maximum leverage of 2:1. A spokesperson told CoinDesk approximately 87 percent of eToro’s retail users buy the asset. In the first month of 2020, that number increased to 90 percent.
In the case of catering to retail investors, eToro is “moving away from the derivatives market,” Gandham said.
Few crypto derivative providers share eToro’s sanguine attitude to the upcoming ban. Daniel Masters, executive chairman at CoinShares, which is the owner of XBT Provider, one of the largest crypto derivatives developers in Europe, told CoinDesk the company had “vigorously resisted” the FCA’s proposal.
During the consultation phase in Q4 2019, CoinShares spearheaded a campaign against the ban and criticized the regulator for cherry-picking data and for an overall “lack of understanding” concerning the asset class.
“Banning such instruments has many adverse consequences,” Masters told CoinDesk. The ban “will not protect investors,” but will push them to offshore providers with little to no investor protection, he added.
Gandham agreed the ban will likely be a net negative for investor protection. “I don’t understand the premise of banning [retail crypto] derivatives,” he said, because a blanket ban would push trading underground and overseas, which would likely expose consumers to more risk.
Still, Gandham is convinced the ban will only have a muted effect on cryptocurrency trading in the U.K. Crypto derivatives, in his view, are better suited for institutional or professional traders who aren’t affected by the ban and who want exposure to the asset but would be burdened by having to hold the physical asset.
Of course, there will always be a handful of retail investors wanting 100x leverage on platforms like BitMEX, Gandham said. But he believes the vast majority of eToro’s clients, who are in it for the long haul, will not even notice the difference should the ban come into effect.
Startup Vega Tests Blockchain Focused on Derivatives Trading Products
Blockchain startup Vega has launched the testnet for its protocol, which allows parties to build trading products on a decentralized network.
Over the last two years, Vega has been “working on building a protocol that allows people to deploy and run networks that can trade decentralized derivatives effectively,” Vega co-founder Barney Mannerings told Cointelegraph in an interview.
Vega received over $5 million during its 2019 funding round, seeing investments from players such as Pantera Capital and Ripple’s Xpring.
Vega Opens Its Test Network
Vega has launched a testnet for this software, offering partners and investors the opportunity for involvement before opening the offering to the entire community, Mannerings said. He added:
“Over the next few weeks and months we’re going to allow people to start using that test network to understand how that protocol works and to give us feedback on what’s been built, and that’s effectively part of a roadmap that leads up eventually to the release of a production-ready version of that software.”
The Protocol Allows Folks To Build Trading Products
Vega has its own blockchain, tailored for markets and trading products, offering participants the chance to launch trading products on something other than the currently-available broad spectrum blockchains.
Current blockchain’s such as Ethereum are not specifically made to host trading markets built on top of them. Vega’s blockchain specifically caters to this niche, according to Mannerings.
Vega’s Solution Is Similar To Amazon’s AWS, But Not Really
Vega’s offering is essentially infrastructure software, Mannerings explained, although it is different than what Amazon Web Services, or AWS and others are doing in their brick and mortar-type offerings.
“AWS is operated by Amazon, whereas what we’re building is kind of like the node software that can be used to run that blockchain, but once it hits the production environment, that won’t be operated by us,” Mannerings said. “It will be operated by the participants and the people who want to use it.”
Mannerings continued, pointing to one similarity with AWS. “Once people deploy this and start to use it, they will be able to create and trade on derivatives markets in whatever they want,” he said.
Vega’s co-founder likened the operation to infrastructure software that allows easy access for entities to build trading products and markets. “That’s sort of a bit like how AWS enables people to create web applications or databases without having to know as much about the underlying hardware,” he explained. Mannerings again, however, specified the difference that Vega is not running the servers and data centers behind the operation.
Vega aims for its software to be an open network similar to Bitcoin or Ethereum, allowing interested parties to build on it, although the software is not open-source quite yet.
Decentralized finance, or DeFi, has gained prominence in the market over the last few years, with projects such as Celsius offering participants access to crypto-based loans, away from centralization. Vega adds to the DeFi space, offering another way people can engage in alternative finance.
Synthetix Exchange May Soon Offer Derivatives Trading On Ethereum
Ethereum-based synthetic asset issuance platform Synthetix is adding new features, which includes derivatives trading.
In a March 10 blog post, Synthetix announced plans for trading in binary options in the third quarter of this year. Binary options are a type of derivative financial product where the buyer either receives a payout or loses their investment.
“Synthetic binary options will likely generate significant trading volume as they will be able to leverage the liquidity of the debt pool, allowing a trader to take a large position almost immediately without needing to find a counterparty.”
In addition, the non-custodial crypto exchange listed several improvements to its existing products, including the “launch of sX v2, new crypto Synths and crypto index tokens.”
New Features Include Leveraged And Futures Trading
For its second quarter, Synthetix is supporting new assets like “equities and exchange-traded funds.” The exchange is planning to offer leveraged trading on tokens.
“Leveraged trading drives a significant amount of volume on crypto exchanges, and while synthetic futures will compete directly with centralised futures platforms, there is a lot of value in supporting tokenized leverage. We will initially test leveraged tokens using fiat currencies like the Euro and AUD. We expect to support 5x and 10x BTC tokens both long and short soon after we launch fiat leverage tokens. Following the rollout of BTC we will expand the offering to other large cap crypto tokens.”
The Ethereum-based platform revealed its plans for several features in 2020, including optimistic rollups, Ether/DAI/BTC collateral, trading incentives, advanced order types, and synthetic futures. For these futures, Synthetix said it would support any asset:
“Synthetic futures trading will be much more flexible and will support any asset on sX. This opens up the possibility for leveraged trading on many different asset classes simultaneously, including cryptoassets, equities, and commodities. We expect leverage will initially be capped at 10-20x…”
Crypto Exchanges Considering Binary Options
Synthetix isn’t the only crypto exchange seeing the potential of offering derivatives trading. Even before the Supreme Court of India lifted a ban on banks dealing with crypto, the Unocoin exchange was planning to launch derivatives options on its platform.
Crypto Synthetic Assets, Explained
1. What Is A Synthetic Asset?
The term “synthetic asset” refers to a mix of assets that have the same value as another asset. Traditionally, synthetics combine various derivative products — options, futures or swaps — that simulate an underlying asset — stocks, bonds, commodities, indexes, currencies or interest rates.
For example, rather than purchasing a stock, an investment firm may purchase a call option and sell a put option on the same stock. The use of synthetic assets here allows the firm to make use of multiple financial vehicles rather than a single investment asset.
The high-end estimate for the value of all derivative contracts is upwards of $1.2 quadrillion — a number exponentially bigger than global real estate ($217 trillion), the global debt ($215 trillion), global stock markets ($73 trillion) and the world’s supply of gold ($7.7 trillion).
On one hand, derivatives can be used to help take price risk out of a variety of assets like commodities to debt. On the other hand, derivatives can promote and exacerbate market inefficiencies, encouraging a zero-sum game among traders rather than creating true market value.
The use of derivative products allows investors to earn returns without a physical settlement, arbitrage trade, transfer risk and hedge against price fluctuations.
2. What Are Crypto Synthetic Assets?
Cryptocurrency-based synthetic assets aim to give users exposure to a variety of different assets without needing to hold the underlying asset. This could be anything from fiat currencies, such as the United States dollar or the Japanese yen, to commodities like gold and silver, as well as index funds or other digital assets.
By using these unique synthetic assets, investors can still hold tokens that track the value of some assets without needing to leave the cryptocurrency ecosystem. Crypto synthetic assets also offer users all the benefits of decentralization, as they are open to all users across borders by using secured smart contracts and other instruments, and the data is stored on distributed ledgers.
3. What Kinds Of Crypto Synthetic Assets Are There?
Abra is a decentralized investment platform that allows users to use their cryptocurrency as collateral to create synthetic assets. Abra’s synthetic asset model leverages smart contracts enabled with Bitcoin (BTC) and Litecoin (LTC).
In practice, if an investor wanted to buy Google stocks worth $1,000 through Abra, the firm would peg $1,000 of the user’s BTC against the price of Google’s stock. If Google goes up or down, the equivalent amount of BTC will be added or subtracted from the user’s contract.
In the above example, the investor would essentially be taking a short position on BTC while taking a long position on Google, the hedged asset. Meanwhile, Abra would take a long position on BTC while shorting Google.
Synthetix is an Ethereum-based platform that allows investors to mint and trade synthetic cryptocurrency on its peer-to-peer platform. This enables users to gain access to synthetic products that simultaneously give them exposure to non-cryptocurrency assets such as gold, USD and stocks. There is currently more than $69 million locked in synthetic derivative contracts.
Synthetix currently has three decentralized apps: the Synthetic exchange, Mintr — which enables users to stake the platform’s native SNX token so they can earn fees and mint Synths — and a Dashboard that presents an overview of the entire Synthetix Network.
The Synthetix team has built a multi-tier issuance platform, an exchange and a type of collateral, creating a market for cryptocurrency-backed synthetic assets. Synthetix allows users to issue various synthetic assets, including fiat, derivatives, cryptocurrencies and different asset classes. Examples could be Bitcoin, euro, USD, Tesla stocks, gold, etc.
The user puts collateral, in the form of SNX tokens, in order to create these synthetic assets. Then the user would be able to swap or exchange one synthetic asset for another, repricing the collateral through an oracle without an intermediary.
Universal Market Access is a decentralized platform for financial contracts that utilizes a “provably honest oracle mechanism” and smart contracts to empower users to create their own financial products.
Essentially, UMA users can create financial products, using protocols such as ERC-20 to create tokenized derivatives that grant them exposure to real-world underlying assets similar to how traditional exchange-traded funds function.
4. Why Are Crypto Synthetic Assets A Big Deal?
Cryptocurrency-collateralized synthetic currency models powered by smart contracts can have enormous implications in the traditional finance industry. In their essence, these models offer cryptocurrency holders the leverage to trade traditional assets as well as their derivatives while remaining in the digital ecosystem.
Decentralization grants open-access to a global community of investors. Before products such as Abra, Synthetix and UMA became available, only a select few institutional investors could access the global derivatives market. Now, anyone with a smartphone and an intermediate understanding of the synthetic asset underworkings can access these powerful investment vehicles.
With cryptocurrency synthetic asset platforms opening the doors to derivatives for thousands of new investors, only time will tell what kind of impact a potential flood of new cryptocurrency-collateralized derivative contracts will have on the traditional financial landscape.