While futures volumes on unregulated exchanges,
principal among which is BitMEX, are often impressive, volumes and open interest on mainstream exchanges are less so. And the options market is still in teething stages.
But, this is not to say that this won’t change and the crypto derivatives won’t catch fire. In this, as in other
areas, it would be no surprise if cryptocurrencies defied the most cautious predictions.
In December 2017, the CME and the Chicago Board of Options (CBOE) began to offer Bitcoin futures, so these two
leading exchanges have been offering derivatives on crypto for almost a year.
In the third quarter, Bitcoin futures volume on the CME increased by 41%, while average daily volume was around
5,000 contracts and average open interest was around 2,873. So, on the one hand, this isn’t bad; on the other, it’s hardly eye-wobbling either. In contrast, a very mature and well-traded
contract like the Eurodollar future has average open interest in excess of 14 million.
The daddy of the crypto derivatives market is clearly BitMEX, based in Hong Kong, and founded in 2014. It offers
both futures and a perpetual contract. The bulk of its volume is in the latter, which was designed to free retail customers from the onerous technical burden of rolling cash-settled contracts at
expiry to maintain exposure.
In July, BitMex traded over one billion XBT perpetual contracts in a 24-hour period, with a notional of over
$8bn. At the time, Bitcoin was trading at a high of over $8,400 and the price surge sucked in a wave of retail customers. For a three month period, daily volume was between $1bn and $4bn a day,
though latterly it has dropped off to around $500m.
BitMEX is completely unregulated and offers customers the chance to acquire $100 of exposure for margin of only
one dollar. Its buyers are largely Asian retail customers, particularly from Korea, says Emmanuel Goh, co-founder of Skew, a new London-based firm specialising in crypto-currency options analytics.
BitFlyer, a Japanese exchange which opened its doors in 2014, also offers a futures equivalent in the form of a
perpetual swap and its customer base is chiefly domestic. It offers three trading pairs, the most liquid of which is easily Bitcoin versus yen. At the beginning of November, it saw daily volumes of
around $30m equivalent.
REGULATORS TAKE STANCE
This, then, is the state of play in crypto futures. As ever, new market developments move much faster than
regulators and the latter are playing catch-up. However, at the end of October, the Financial Conduct Authority (FCA) released a long-awaited report from its so-called CryptoAsset Taskforce which said that in the first quarter of 2019 it would launch a consultation in which a ban on crypto derivatives for
sale to retail buyers would be considered.
According to the FCA, the ban, if applied, would mean that UK retail buyers would not be able to trade crypto
derivatives on any UK trading platform and also UK firms would be prohibited from offering such instruments to any retail client.
It added that although European Economic Area (EEA) firms would also be banned from marketing crypto derivatives,
there is nothing to stop UK consumers from buying these products through platforms in other jurisdictions on a reverse solicitation basis. Clearly, where there’s a will there’s a way.
It is interesting, however, notes Emmanuel Goh, that while the FCA is mooting a ban for crypto derivatives, it
has not said “it’s a fad, or it’s a scam. They recognise the value position of crypto but they just want to make sure retail customers are not trading products that they really shouldn’t touch.”
For the record, Commodity Futures Trading Commission chairman, Chris Giancarlo, recently said in interview that
crypto currencies are ‘here to stay’ and could achieve adoption in two-thirds of global economies which currently lack stable currencies. However, it behoves regulators to adopt a “thoughtful and
intelligent response, just as the US congress did 20 years ago in the early days of the internet.”
The acid test in the derivatives of any asset, however, is the extent to which there is a thriving options
market. The capacity of users to buy and sell puts and calls is the engine of growth. This is where the institutional market comes to play. For example, a highly liquid stock like Amazon trades
around $9bn a day in cash equities; the notional principal of option volume is around the same.
In the crypto market, there are only four venues in which options can be traded and total liquidity is only
around $5m a day. Yet there are several large user groups which could make use of an options market.
NATURAL OPTION USERS
Firstly, there are the producers, such as miners, which are paid only in Bitcoin and thus exposed to price
volatility. Their position is equivalent to, say, producers in the oil market which use calls to lock in prices. “Prices in Bitcoin can be extremely volatile, but if you can neutralise that you can
scale the business,” says Goh.
Exchanges, moreover, which are paid fees only in Bitcoin are exposed to the Bitcoin versus dollar exchange and so
would in theory make heavy use of the option market. There are also merchants who currently accept Bitcoin as payment but report in dollars or sterling and would presumably welcome an opportunity to
hedge this exposure.
Then there are the investors who use Bitcoin as a store of value, like gold. It’s interesting to note that in
2018, 50% of Bitcoin ownership didn’t budge despite the famed volatility of the price action. Gold investors typically sell calls against the asset to generate yield, and this could become a feature
of the crypto derivatives market.
Finally, macro hedge funds might make increasing use of Bitcoin as a safe haven in times of acute global
political and economic stress if they could buy calls.
Options markets need liquidity to survive. If users are not able to come and go out of the market and source
prices with ease and rapidity, any contract will die a death. The runways of the major exchanges are littered with the wreckage of many such contracts which crashed and burned.
At the moment, there is no such liquidity in crypto options. A trade with a notional of no more than $50,000 is
about average, and $1m notional trades are some way distant. But there is nothing to suggest that, with supportive regulation in the tier one financial centres and innovative products from the
exchanges, that this shouldn’t happen.
VOL OR NO VOL
One final caveat: the professional options markets thrive on volatility. Unless prices are volatile, there is
less encouragement to either hedge positions and even less for professional accounts to take positions. And though the history of crypto shows significant volatility, things become much less so in
the last few weeks.
The CBOE November contract moved in only an 8% range during October, and most of that occurred between October 8
and 11. In the 47 weeks of Bitcoin futures (XTC) on the CBOE, the average monthly range has been 15.65%, but since April this has slumped to 10.6%. In the week-ending October 26 price volatility was
Currently at the money three month implied volatility is at 55, its lowest print for 18 months, and there is
probably room for a further decline as implied vol trades at a 20bp premium to realised vol.
In many ways, this lack of volatility is not a bad thing. There have been no major events, such as a security
breach or negative regulatory response, to spike vol higher. But, if they persist, these levels would discourage large scale professional participation in crypto options.