History of Bitcoin Derivatives Development
The derivatives market is becoming an increasingly important part of the Bitcoin ecosystem, and the total open interest observed across all platforms continues to grow and set new records every month. In this article, we will recall how and where the development of derivatives in the market began and what consequences this may lead to.
For many, it is already an obvious fact that derivatives have become a dominant part of the cryptocurrency market. This has led to an overall decrease in volatility and an increase in market efficiency.
Until 2018, Bitcoin showed dynamic growth without any restrictions on the spot market, uniting cryptocurrency supporters and ideological people, while the futures and options markets are gathering a new type of traders - interested exclusively in personal gain, and not in the future development of Bitcoin and the crypto industry itself in particular.
The emergence of these financial instruments shows how Bitcoin has evolved as a new asset class. From a simple digital collectible, the leading cryptocurrency has become one of the most actively traded assets worldwide.
What are Bitcoin Derivatives?
Derivatives are contracts, including futures, options, and even perpetual swaps, that allow investors to bet on the price of an asset or stock going up or down at a certain point in time, and also allow traders to hedge their positions.
Miners also use futures to hedge future earnings and reduce cash flow uncertainty. Institutional traders also often use this method: Bitcoin buyers are hedged by shorting a futures contract, and vice versa - Bitcoin shorts are hedged by longs on futures.
Before the first futures appeared, there were exchanges that provided a small margin leverage, which reached x2-3. That is, users could borrow funds twice as much and open positions on the increase or decrease in the rate of assets that had a good trading volume.
Before this, one of the most popular trading strategies was widespread, called HODL or DCA strategy, ordinary averaging, that is, buying an asset with long-term investment in anticipation of growth in value at different stages of time.
These strategies have proven themselves well in the first 5-6 years of Bitcoin's existence. While its popularity was growing, so was its value. That is, the law of supply and demand works very well in this market. But in the current situation, as derivatives develop, the market has been able to attract traders who are more interested in trading on rate speculation and trading on market volatility.
Futures began to develop actively in late 2017, during the bull market rally.
Instruments aimed at institutional investors have been slow to gain market share, with regulated exchanges acting as “second assistants” to unregulated market participants offering derivatives on bitcoin. CME futures have allowed institutional investors to short bitcoin without having to own the asset itself, and have also allowed companies to hedge their risks.
Many analysts and even former CFTC representative Christopher Giancarlo claim that the launch of the first bitcoin futures by the American exchanges CME and CBOE at the end of 2017 contributed to the total collapse of the market.
Christopher, in turn, says that the approval for the launch of BTC futures on CME Group came from the Trump administration in order to sharply reduce the Bitcoin rate. In order not to repeat the story with the mortgage crisis, therefore this time they reacted to the growing Bitcoin a little faster. And in just a year from the launch, they collapsed the market by more than 80%.
Early exchanges focused on making it easy and safe for users to buy cryptocurrency. Once spot markets became mature, demand for cryptocurrency trading increased significantly and exchanges gained the trust of users.
At the beginning of 2018, the influx of new users into the industry was colossal, which led to the exchanges starting to introduce restrictions on registration, allocating certain hours for this. Since over 100 thousand new participants were registered per day.
Over the past two years, demand for cryptocurrencies has begun to decline, including trading volumes on spot exchanges and asset volatility.
Moreover, the growth of assets was no longer as impressive and did not bring the profit for which many market participants came to this market.
Since February 2018, leading derivatives exchanges have accounted for about 80% of Bitcoin trading, and they have begun to outperform the main Bitcoin-to-dollar spot market during the bull run since 2017.
The cryptocurrency market, as derivatives develop, is attracting more and more traders from the kitchen of forex and other stock exchanges without having to go through the traditional banking system. And cryptocurrency exchanges allow investors and traders to open a trading account in minutes.
After a prolonged bearish trend, exchanges began to introduce margin trading and eventually added highly leveraged futures trading.
Slowly but surely, Bitcoin trading began to resemble traditional markets with the introduction of margin, futures, and options trading, which allowed traders to borrow USD as collateral to buy or sell digital assets with 50 and even 125 leverage. That is, by opening a position with 50 leverage, traders could lose their position if the rate went against them by at least 1.5%, but if the asset rate went in your favor, then the position would double accordingly.
Most derivatives exchanges use auto-liquidation, where any excess proceeds are added to an insurance fund. The insurance fund effectively replaces the central clearing house found in traditional markets – to ensure that any trades are paid out or risk is covered in the event of a large price move that could bankrupt one of the parties.
Thus, in 2019, we observed the start of futures trading on existing spot exchanges, including Huobi Globak, OKEx, Binance, BitMax and BiKi. In addition, in 2019-2020, new players entered the crypto derivatives market - FTX, Deribit, Bybit, Phemex and others.