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

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Futures and options allow traders to deposit only a tiny fraction of the value of a trade and bet that prices will rise or fall by a certain point over a certain period of time. This can increase traders’ profits as they can borrow more money to increase 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 instruments and infrastructure that support it are not as developed as those in traditional financial markets.

Next year will be the year crypto derivatives reach a new level of market growth and maturity, as 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 decentralized finance (DeFi) applications and also due to more professional and transparent intermediaries planning to enter space. Eventually, this will lead to more institutions getting involved.

Understanding why traditional financial institutions use derivatives more than traditional cash 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 United States are treated as long-term capital gains for tax purposes and their use for hedging purposes is i.e. the ability to protect against unexpected price fluctuations.

When more institutions get involved, relative volatility decreases, making derivatives trading a better use of capital. Additionally, as more institutions add crypto assets to their balance sheets, derivatives will become an essential tool to hedge against short-term volatility.

The industry is still in its infancy

Like 2022, 2023 will also be a unique year for crypto derivatives. There will be an increase in centralized and decentralized options infrastructure and the continued development of new crypto primitives like structured vaults, eternal options, and experiments with derivatives.

The cryptocurrency industry is moving further into regulated markets as it tries to attract more users and competes with existing traditional financial companies like brokerages that already allow people to trade stocks and other financial assets.

Most derivatives deals happen on Binance, OKX, and Bybit, which are based outside of the US and are unregulated. However, based on data from CoinGlass, CME Group is the only regulated US market to gain traction.

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

Large buying firms will continue to buy small licensed derivatives trades

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

In January 2021, Coinbase purchased FairX, a small futures exchange in Chicago. The purpose of the agreement was to facilitate traders’ access to the derivatives markets. A retail-focused futures exchange startup called The Small Exchange has also launched a crypto futures product that requires less money up front. Citadel Securities, Jump and Interactive Brokers all backed the company.

Related: What Is Crypto Market Capitulation and What Does It Mean?

The growth of decentralized derivatives markets

Like centralized platforms, perpetual futures represent the bulk of decentralized derivatives volume. First led by perpetual protocol and now by dYdX, the daily volume of decentralized perps averages $3 billion per day.

Even though growth has been robust, decentralized perpetual volume represents less than 5% of all crypto derivatives volume. Over the next two years, we expect this segment to grow significantly.

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As more and 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 being developed.

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

Derivatives could attract more traditional investors

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

Fidelity Digital Assets is now offering its institutional clientele the ability to borrow using crypto as collateral so that larger corporations can add Bitcoin to their assets more easily using these services.

In 2023, it is likely that crypto will be easier to use as collateral for day-to-day business, allowing businesses to take on more risk using cryptocurrency derivatives.

Derivatives have been instrumental in the 2020-2021 crypto bull market for both 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 can be used in stocks, currencies, and commodities, but their use in cryptocurrencies has grown steadily since 2017.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed herein are the sole authors and do not necessarily reflect or represent the views and opinions of Cointelegraph.

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