Rising Bitcoin and Ether derivatives markets are shooting for the spot

The crypto derivatives market is dominated by Bitcoin (BTC) and Ether (ETH), with the main platforms being Huobi, Chicago Mercantile Exchange, OKEx, Bybit and Deribit. The CME has also dipped in the Ether pool by launching its Ether futures on Feb. 8, which amounted to $30 million notional volumes on the first day.

Prior to this launch, there was a huge $1-billion options expiry on Feb. 5, which lead to bulls targeting the $40,000 price range, according to the underlying options data. But this expiry was superseded by Elon Musk tweeting in support of Bitcoin just after the expiry event; this did indeed allow Bitcoin to pass the $40,000 mark before going into new all-time highs due to Tesla’s purchase of $1.5 billion worth of BTC.

Luuk Strijers, chief commercial officer of crypto derivatives exchange Deribit, told Cointelegraph: “The usage and popularity of options is growing, which can be seen from the ever-increasing open interest numbers, volumes and number of clients trading.” He further added: “The bigger the expiry, the higher the likelihood of an impact on the underlying market.”

Spot the derivatives market

In the traditional markets, derivatives play a leading role in spot prices and the price discovery of an asset, but that’s largely due to the fact the traditional spot markets are only a fraction of the size of the derivatives market.

Meanwhile, in the cryptocurrency markets, the spot markets are way bigger than the size of derivatives markets. But with the derivatives market burgeoning in size, the relation to the spot markets seems to be getting stronger.

One such metric that points to whether the market is bullish or bearish toward BTC is the 30% to 20% delta skew. It refers to the premium difference between neutral-to-bullish call options against similar put options.

Jay Hao, CEO of crypto exchange OKEx, outlined to Cointelegraph that the growing influence of the derivatives market over the spot markets is a positive development, saying: “As the derivatives market grows in size and importance, this is a pattern that we would expect to see.”

However, contrary to the patterns that are expected to be emerging in the derivatives market in relation to the spot markets, the price impact is often unclear. Shane Ai, responsible for product research and development of crypto derivatives at Bybit — a cryptocurrency derivatives exchange — told Cointelegraph:

“Increases in futures OI need to be compared against the increase in spot volumes. Contrary to popular belief, delta-one swap and futures dominance over spot volumes have seen significant declines since December last year. While incentives exist to punish overleveraged longs when funding gets extreme, they no longer hold sway over spot prices.”

Ben Caselin, head of research and strategy at AAX — a digital asset exchange — told Cointelegraph that the extent to which the spot price of BTC is impacted by the derivatives market is overstated. However, he also pointed out to functionality of derivatives markets to the spot markets, saying: “Derivatives play a role in raising a more sophisticated infrastructure around Bitcoin as an asset. It attracts different investors who otherwise might not be ready to engage Bitcoin directly.”

Tesla’s investment will open up the derivatives market

Institutional investors often look to derivatives to hedge other risks that their portfolios carry. This could be said for the cryptocurrency markets as well, especially since institutional investors now seem to be getting highly interested in Ether, too. A report from CoinShares stated that out of the $245-million institutional inflow seen in the crypto market in the first week of February, $195 million (80%) was invested in Ether products leading up to the launch of CME Ether futures contract on Monday, Feb. 8.

This suggests that institutional investors are beginning to diversify their crypto exposure further by investing in other cryptocurrencies apart from Bitcoin. This perception is only furthered by the fact that Elon Musk has brought a lot of positive attention to Bitcoin and even other smaller cryptocurrencies like Dogecoin (DOGE).

His vocal support of Bitcoin through Twitter, combined with his firm Tesla buying $1.5 billion worth of Bitcoin and even possibly accepting Bitcoin payments for Tesla products will only push forward the market and cause more institutional investors to follow. Hao further spoke on how this will impact the derivatives markets:

“As we see more Fortune 500 companies following Tesla’s lead and more institutional money flow into the space, we will see a rise in demand for derivatives as a tool for hedging volatility and employing a more efficient risk management strategy to offset potential losses.”

Strijers pointed to how the price impact of such announcements move the derivatives market as well: “Events like this have an immediate price impact and, thus, an effect on the prices of all derived instruments (price and IV surge >150%). We have seen the short-dated (daily) options moving 1,000+% in a few minutes.” Strijers also shed some light on the perspective that institutional investors have a higher need for derivatives products than average retail investors:

“Institutional adoption like MicroStrategy, Tesla, Grayscale, etc. paves the way for more institutional entrants, many of which prefer to trade traditional instruments like spot and options. We see this by the number of new corporate registrations, traditional options market makers entering the crypto space, and growing numbers of trades executed as a block.”

Ether derivatives market is growing

With the world’s largest derivatives exchange in CME listing Ether futures on its platform, it signifies a new push for institutional investors to get into a fast-growing Ether market. Considering that the highly lucrative returns of 303% for Bitcoin over 2020 is one of the main reasons for mainstream attention, while ETH witnessed 469% gains in 2020, also becoming a sought-after asset for institutional and retail investors alike.

In fact, the open interest in Ether futures recently hit an all-time high of $6.5 billion, with the underlying futures premium pointing out that investors aren’t necessarily keen on liquidating the Ether they own amid the ongoing bull run.

Strijers elaborated further about the growing interest in Ether even surpassed Bitcoin at the moment: “CME launching the ETH futures is another indicator of institutional interest in ETH as an investable asset.” Furthermore, he added that on some days, Grayscale ETH Trust attracts more inflows than BTC, indicating that the interest in ETH derivatives is rising.

Ai takes it a step further by suggesting that investors are more keen on Ethereum’s fundamentals than CME’s Ether futures launch: “Compared to BTC in 2017, ETH today has far more avenues for institutional hedging; the CME listing is a non-event in reality. The ongoing narrative of EIP-1559 and Grayscale’s acquisitions are far more instrumental in attracting institutions.”

Compared to Bitcoin, which is seen as a decentralized store of value, the Ethereum blockchain offers a lot of use cases for various applications in the decentralized finance space. This opens up more opportunities for ETH to be utilized within the industry.

Furthermore, due to the increased focus on the possible inflationary impact from COVID-19 support packages, various assets, including commodities, are trading at all-time highs. Retail rebellion observed in the GameStop fiasco is also helping to bring more initiated retail investors to diversify through crypto assets than just allocating toward Bitcoin.

Hao highlighted the popularity of perpetual swaps among these investors: “Instead of waiting for a contract's expiry and delivery, perpetual swaps save time by rolling over the contracts regularly. This would be a plus to retail investors at convenience.”

Futures trading is also increasingly popular among retail investors since the trading is done on margin. This is leading to increased activity on centralized exchanges, the rise of option and prediction markets in DeFi, better educational resources than ever before, and more hype proliferated by various social media platforms. These positive changes are making it easier for retail traders to diversify their trading strategies across assets, instruments and time frames.