3 Ways Crypto Derivatives Could Evolve and Impact the Market in 2023

Futures and options allow traders to put up only a small portion of the value of a trade, betting that prices will rise or fall to a certain point within a certain period of time. This can increase traders’ profits as they can borrow more to add to their positions, but it can also greatly increase their losses if the market moves against them.

Although the crypto derivatives market is growing, the tools and infrastructure that support it are not as developed as in traditional financial markets.

Next year will be the year that crypto derivatives reach a new level of growth and market maturity, as the infrastructure has been built and improved this year and an increasing number of institutions have become involved.

Growth of crypto derivatives in 2023

In 2023, the volume of crypto derivatives will continue to grow due to two factors: firstly, the growth of relevant infrastructure such as applications for decentralized finance (DeFi) and also more professional and transparent intermediaries who plan to enter the space. Ultimately, this will lead to more institutions getting involved.

Understanding why traditional financial institutions use derivatives more than traditional spot markets is a great way to learn more about the market.

Some of the reasons for the increase are the ability to use capital, the fact that derivative contracts in the US are treated as long-term capital gains for tax purposes, and the ability to hedge against unexpected price changes.

When more institutions are involved, relative volatility decreases and trading derivatives makes better use of capital. Also, as more institutions add crypto assets to their balance sheets, derivatives will become a critical tool to hedge against short-term volatility.

The industry is still in its infancy

Like 2022, 2023 will be a unique year for crypto derivatives. There will be growth in options infrastructure, both centralized and decentralized, and the continued development of new cryptocurrencies such as structured vaults, perpetual options, and experiments with derivatives.

The cryptocurrency industry is moving deeper into regulated markets as it tries to gain more users and compete with existing traditional financial companies such as brokerages that allow people to trade stocks and other financial assets.

Most derivatives trading takes place on Binance, OKX, and Bybit, which are located outside of the US and are unregulated. However, based on data from CoinGlass, the CME Group is the only regulated US market that is attractive.

It was responsible for about 10.7% of open interest in Bitcoin (BTC) and Ether (ETH) futures in November 2022.

Big buying firms will continue to buy small licensed subsidiary operations

It is becoming increasingly difficult to tell where retail markets end and institutional markets begin. Retail centers where cryptocurrency exchanges buy are managed by the largest and most experienced firms on Wall Street.

In January 2021, Coinbase acquired FairX, a small futures exchange in Chicago. The purpose of the agreement was to make it easier for traders to access the derivatives markets. Small Exchange, a retail-focused futures exchange startup, has also launched a crypto futures product that requires less money. Citadel Securities, Jump and Interactive Brokers backed the companies.

Related: Cryptocurrency Market Capitulation and What Does It Matter?

Growth of decentralized derivatives markets

Like centralized venues, fixed futures account for most of the volume of decentralized derivatives. Decentralized perps, initially managed by Perpetual Protocol and now dYdX, have an average daily volume of $3 billion per day.

Despite strong growth, decentralized permanent volume is less than 5% of all crypto derivatives volume. We expect this segment to grow tremendously over the next two years.

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As more projects and protocols are built on top of decentralized permutation protocols, the value of the platforms that support them will continue to increase. Along with decentralized futures, options and structured products, market participants will be excited to see more cryptocurrency innovations such as perpetual options.

Offering both perpetual futures and perpetual options, protocols like Deri allow users to trade derivatives in a very DeFi-native way, allowing them to hedge, speculate and arbitrage.

Derivatives can appeal to more traditional investors

Institutional traders prefer these instruments because they can provide fixed returns similar to fixed income and these trades are executed with strategies such as bull call spreads and covered calls. Also, institutional traders can combine calls and options to set a risk limit without the risk of liquidation for options trading.

Fidelity Digital Assets is now offering its institutional client base the ability to borrow using cryptocurrency as collateral so that large companies can add Bitcoin to their assets with the help of these services.

In 2023, it is likely that cryptocurrency will become easier to use as collateral for everyday business, allowing companies to take more risks using cryptocurrency derivatives.

Derivatives played an important role in the 2020-2021 crypto bull market for retail and institutional traders. For many investors, borrowing and using derivatives is the easiest way to increase their bets on various positions. They can be used in stocks, currencies and commodities, but their use in cryptocurrencies has been steadily increasing since 2017.