3 ways cryptocurrency derivatives could evolve and impact the market in 2023

Futures and options allow traders to drop only a small fraction of the value of a trade and bet that prices will go up or down to a certain point within a certain period. It can increase traders’ profits because they can borrow more money to add to their positions, but it can also significantly increase their losses if the market moves against them.

Even though the crypto derivatives market is growing, the tools and infrastructures that support it are not as developed as those of traditional financial markets.

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

Growth of crypto derivatives in 2023

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

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

Some reasons for the growth are the ability to leverage capital, the fact that derivative contracts in the US are treated as long-term capital gains for tax purposes, and their use for hedging purposes, i.e. the ability to hedge against fluctuations in unexpected price.

When more institutions are involved, relative volatility decreases, making derivatives trading a better use of capital. Furthermore, as more and more institutions add cryptocurrencies to their balance sheets, derivative instruments will become a vital tool to hedge against short-term volatility.

The industry is still in its early stages

Like 2022, 2023 is also set to be a unique year for cryptocurrency derivatives. There will be an increase in the infrastructure of centralized and decentralized options and the continued development of new cryptographic primitives such as structured deposits, eternal options and experiments with derivatives.

The cryptocurrency industry is moving deeper into regulated markets as it seeks to get more users and competes with existing traditional financial firms such as brokers who already allow people to trade stocks and other financial assets.

Most of the derivatives deals happen on Binance, OKX and Bybit, which are based outside the US and are not regulated. However, based on data from CoinGlass, CME Group is the only regulated US market that has gained traction.

In November 2022, it was responsible for about 10.7% of the open interest on Bitcoin (BTC) and Ether (ETH) futures.

Large corporate purchases will continue to purchase small licensed derivatives operations

It is becoming increasingly difficult to tell where retail markets end and institutional markets begin. The retail-focused businesses bought by cryptocurrency exchanges are run by some of the largest and most experienced firms on Wall Street.

In January 2021, Coinbase bought FairX, a small futures exchange in Chicago. The goal of the deal was to make it easier for traders to enter the derivatives markets. A retail-focused futures trading startup called The Small Exchange has also released a crypto futures product that requires less cash up front. Citadel Securities, Jump and Interactive Brokers have all backed the firm.

Related: What is Cryptocurrency Market Capitulation and What Does It Mean?

The growth of decentralized derivatives markets

Like centralized venues, perpetual futures comprise the bulk of the volume of decentralized derivatives. First led by Perpetual Protocol and now by dYdX, the daily volume of decentralized criminals averages $3 billion a day.

While growth has been robust, decentralized perpetual volume accounts for less than 5% of all crypto derivatives volume. Over the next couple of years, we expect this segment to grow in a big way.

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As more projects and protocols rely on decentralized perpetual exchange protocols, the value of the platforms that support them will continue to grow. Along with decentralized futures, options and structured products, market participants will be excited to see more crypto-native innovations such as eternal options developed.

Protocols like Deri, which offers both perpetual futures and eternal options, allow users to trade derivatives in a very DeFi-native way, giving them the ability to hedge, speculate and arbitrage, all on-chain.

Derivatives could appeal to more traditional investors

Institutional traders like these instruments best because they can provide stable returns, similar to fixed income, and these trades are executed with strategies such as bullish call spreads and hedged calls. Additionally, institutional traders can combine call and put options to set a risk limit without risking liquidation for option trades.

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

In 2023, cryptocurrencies are likely to be easier to use as collateral for day-to-day activities, which will allow businesses to take more risk using cryptocurrency derivatives.

Derivatives have played an instrumental role in the 2020-2021 cryptocurrency bull market for retail and institutional traders. For many investors, borrowing money and using derivatives is the easiest way to increase their bets on a variety of positions. They are available for use in stocks, currencies and commodities, but their use in cryptocurrencies has been steadily growing since 2017.