Coinbase (COIN), the cryptocurrency exchange that purchased the largest cryptocurrency options exchange, Deribit, for $2.9 billion earlier this year, expects a wave of traditional financial institutions (TradFi) to begin using digital asset derivatives for investment or hedging purposes, said Usman Naeem, global head of sales of derivative products of the Nasdaq-listed company.
Institutions interested in globally regulated crypto derivatives are typically asset managers, who have a fiduciary duty to speculate or conduct strategies beyond simply providing liquidity, which falls within the domain of market makers, Naeem said in an interview with CoinDesk. They most often come from the United States and Europe and are a fundamentally different type of business.
“Looking back, the vast majority of the activity, probably more than three-quarters, was in Asia,” Naeem said. “I think it’s going to rebalance a little bit and we’re going to see non-market maker institutions based in the U.S. and Europe really getting into derivatives.”
Coinbase began life in early 2012 as an on- and off-ramp for Bitcoin. and evolved into an exchange, successfully capturing much of the spot market, which at the time was in the United States. But as of 2017, crypto innovations like perpetual futures have driven up to 85% of volume and liquidity outside the United States, primarily to the APAC region.
In response to this, Coinbase in 2022 acquired FairX, a derivatives platform registered with the Commodity Futures Trading Commission (CFTC), to offer regulated futures contracts in the United States. This was followed by the purchase of Deribit in May.
The rebalancing of the crypto derivatives market in Asia and places like Dubai, where criminals are popular, will also see an adjustment in the type of strategy towards one more aligned with traditional finance, Naeem said. Traditional fund managers don’t just want to buy $10 million or $20 million worth of bitcoin, he said. They seek to grow by managing risk, which involves using derivatives to hedge.
“As more risk-managed long-term holders come on board, I think we’ll start to see a volatility service that more closely replicates what’s happening in traditional finance,” Naeem said. “Rather than just speculating on a 50% rise in bitcoin, perhaps they will sell some of the upside to help fund downside insurance. This dynamic will drive a massive shift in volatility services, which will bring more liquidity and stability; a more reliable and understandable derivatives market.”
This is all well and good, but what about incidents like the crypto crash earlier this month, which resulted in liquidations of around $7 billion, in a very short time frame. Doesn’t such extreme volatility keep institutions on the sidelines?
Naeem emphasized that flash crashes are not exclusive to crypto and that, for the most part, the digital assets industry’s infrastructure has worked.
“The liquidations happened; the stunts happened as planned,” Naeem said. “Keep in mind that the dynamics of perpetual futures work very differently than centrally cleared futures or spot contracts, so they require stricter risk controls to unwind positions. Also keep in mind that everything happened within a window of about 12 minutes.”
