Cryptocurrency firms are pushing the highly regulated U.S. derivatives market as they seek to meet demand from retail traders to make supercharged bets on digital assets.
Crypto derivatives volumes registered nearly $3 billion last month, accounting for more than 60% of cryptocurrency trading, according to data provider CryptoCompare. Most activity takes place at offshore locations such as those overseen by exchange giant Binance, which are subject to little or no regulatory oversight.
Crypto groups are now looking to create beachheads in the closely watched US market by buying up smaller companies that already hold licenses to operate in America.
The crypto industry is moving further into regulated markets as it seeks to build a larger user base and challenge existing financial firms such as brokerages that already offer stock and other trading Financial assets.
Coinbase, one of the biggest platforms, agreed in January to buy FairX, a small Chicago futures exchange, to make the derivatives market “more accessible” through its “easy-to-use” app.
The move comes after Crypto.com struck a $216 million deal late last year for two UK IG index retail businesses; CBOE bought ErisX, a digital asset trading firm; and FTX US bought derivatives platform LedgerX.
Derivatives are often used with borrowings to increase bets on financial assets. Although they are available on a wide range of products such as stocks, currencies and commodities, they are most often deployed by professional investors.
Rosario Ingargiola, Founder and CEO of Bosonic, a crypto settlement service for institutional investors, pointed out that retail crypto exchanges play a role closer to retail brokers in the forex markets than traditional exchanges.
“In the United States, crypto exchanges cannot offer leverage on spot crypto without being a regulated futures commission merchant,” Ingargiola said.
“That’s a big part of why you see bigger crypto exchanges buying [Commodity Futures Trading Commission]-regulated platforms that allow offering derivative products like options and futures to retail clients, as there is a huge demand for leveraged products in the retail client segment.
Futures and options allow traders to deposit only a fraction of the value of a trade, effectively betting that prices will rise or fall by a certain point over a predetermined period of time. This can increase the size of profits for traders, who can increase their positions with borrowed money, but adverse market movements can also significantly increase the size of losses.
Last year marked a breakthrough for crypto derivatives. For the first time, volumes in the derivatives market exceeded the spot or cash market. In January, derivatives trading accounted for about three-fifths of the overall market, the highest proportion on record, according to CryptoCompare.
The vast majority of derivatives trading is done on unregulated offshore platforms Binance, FTX and OKEx. The only regulated US market to gain traction is CME Group, which accounted for around 4% of global crypto derivatives trading last month, based on data from CryptoCompare. Last year, the CME launched “micro” versions of its Bitcoin and Ether futures contracts to attract retail investors.
“The retail trend is real. We bet it’s not a fad,” said Martin Franchi, managing director of NinjaTrader, a retail futures broker, which last month agreed to buy Chicago rival Tradovate Holdings for $115 million. .
“The addressable market has changed by the millions. We see a ripple effect. From commission-free trading, they go to options, then they go to futures,” he said. “Crypto futures are where the two worlds intersect. The spotlight on the future will become stronger.
Already, the boundaries between retail and institutional markets are blurring. Some of Wall Street’s biggest and most experienced names in trading are behind the retail-focused companies captured by crypto exchanges. Small Exchange, for example, was backed by Citadel Securities, Jump, Interactive Brokers and Peak6, a private equity vehicle led by former Chicago options trader Matt Hulsizer.
Some predict that the crypto market will follow the same path as the forex market, which offers much the same product to retail and institutional investors.
B2C2, a crypto trading company, predicted that crypto exchanges would lose ground to brokers whose apps also offer the same easy-to-use user experience as Coinbase. These consumer trades are typically executed on over-the-counter markets and hedged by futures contracts. And unlike the forex market, retail investors can still trade directly on an exchange, said Chris Dick, the group’s senior trader.
But the success may lie in the kinds of competing futures that are likely to be offered.
On crypto futures exchanges, traders who have increased their bets by borrowing have their positions automatically cut when the price of a digital token reaches a certain threshold, known as the liquidation price. This has led to accusations that it exacerbates market volatility rather than mitigating it.
The process also clashes with the traditional futures market, where investors’ positions are left open if they can provide more collateral overnight. Otherwise, they can be auctioned off and transferred to another market player.
The CFTC strongly encourages all exchanges listing futures contracts beyond vanilla cryptocurrency products to discuss their plans in advance. But a CFTC-regulated exchange, including those owned by a crypto company, can certify its own cryptocurrency products.
“It’s going to be an interesting dynamic,” said Chris Zuehlke, partner at DRW, a Chicago-based trading firm and global head of the firm’s cryptocurrency arm, Cumberland. “Is [auto liquidations] the right model? We need to debate what is best practice.