We have all heard stories of the liquidation of billions of dollars worth of futures that caused Bitcoin and Ether to drop 25%, but the truth is that cryptocurrency has been hampered by x100 leveraged tools since the time of the money industry’s cryptocurrency BitMEX exchange introduced perpetual futures in May 2016.
Trading derivatives goes beyond retail-oriented instruments as institutional clients, mutual funds, market makers and professional traders can benefit from using their hedging skills.
In April 2020, the $ 130 billion mutual fund Renaissance Technologies received the green light to invest in the Bitcoin futures market using CME-listed instruments. Not like retailers, these mammoths focus on arbitrage and undirected risk.
The short-term correlation with traditional markets may increase
As an asset class, cryptocurrencies are becoming an indicator of global macroeconomic risk, regardless of whether investors like it or not. Not just Bitcoin, but most commodity instruments will be affected by this correlation in 2021. Even if the Bitcoin price goes down, this short-term risk-free strategy will weigh heavily on the price.
BTC / USD price chart (blue, right) vs. 10-year US yield (orange, left) | Source: TradingView
Note that Bitcoin price has a stable correlation with the 10-year US Treasury bill. Whenever investors demand higher returns to hold these fixed income instruments, there will be additional demand for exposure to cryptocurrencies.
Derivatives are essential in this case as most mutual funds cannot invest in cryptocurrencies directly, so the use of managed futures contracts, such as B. Futures contracts Bitcoin on CME, gives them access to the market.
Miners will use long-term contracts as protection
Traders do not realize that short-term price movements have no bearing on their investment from the miner’s point of view. The more professional the miners get, the less the need to sell their bitcoins becomes. This is exactly why derivatives were created in the first place.
For example, a miner could sell a quarterly futures contract that expires in three months and effectively holds the price during that period. Then the miner knows his profit in advance, regardless of the price movement from this point in time.
Similar results can be achieved by trading Bitcoin options contracts. For example, a miner could sell a $ 40,000 call option in March 2022 – enough to cover it if the price fell to $ 43,000. In return, this miner’s profits above the $ 43,000 threshold will be cut by 42%, making the option instrument act as insurance.
The use of Bitcoin as collateral for traditional funding will increase
Fidelity Digital Assets and the crypto exchange and lending platform Nexo recently announced a partnership to provide crypto lending services to institutional investors. They will enable Bitcoin-covered cash advances that cannot be used in traditional financial markets.
The move is likely to ease pressure from companies like Tesla and Block (formerly Square) to keep Bitcoin on their balance sheets. Its use as security for day-to-day operations significantly increases access restrictions.
At the same time, even companies that don’t seek direct exposure to Bitcoin and other cryptocurrencies can benefit from the industry’s higher margins compared to traditional fixed income securities. Lending and borrowing are perfect use cases for institutional clients who don’t want direct exposure to Bitcoin’s volatility but are also looking for a higher return on the asset.
Investors will use the options market to generate “fixed income”.
The derivatives exchange Deribit currently holds 80% of the market share of Bitcoin and Ether options. However, US-regulated options markets such as CME and FTX.US (formerly LedgerX) will gain in importance at some point.
Institutional investors like these tools because they offer the ability to create semi-permanent strategies such as covered call, iron condor (an option strategy with two orders, place orders – one order to buy long and one to buy short), Bull Call Spread and Other Strategies. In addition, by combining call options and put options, traders can place option trades with a predetermined maximum loss without the risk of liquidation.
It is likely that central banks around the world will keep interest rates close to zero and below inflation, forcing investors to seek markets that offer higher yields, although there is some risk involved.
It is precisely for this reason that institutional investors will enter the crypto derivatives market in 2022 and change the current industry.
Downturn is coming
It is now known that the crypto derivatives market has the potential to increase volatility. These forced liquidations reflect the futures instruments used to reach excessive indebtedness, a situation commonly committed by retail investors.
Institutional investors, however, will have a wider presence in the Bitcoin and Ether derivatives markets, increasing the bids and the size of supply and demand for these instruments. Hence, retailers’ liquidation of billions of dollars will have less of an impact on price.
In short, more and more professional investors involved in crypto derivative products will lessen the impact of large price movements by absorbing this flow of orders. Over time, this effect should be reflected in a reduction in volatility or at least in avoiding problems like the crash in March 2020 when the BitMEX servers were “down” for 15 minutes.
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