Comparing Traditional and Crypto Markets
Crypto derivatives volumes have hit a new record high in May 2020. The early generation of crypto investors mostly worked with a hold-and-sell perspective. With the inevitable evolution of the market and the advent of cryptocurrency derivatives, investors with varied agendas — such as the desire to trade Bitcoin (BTC) volatility in both directions, hedging against major market movements, mitigating risks, etc. — began to flock to this asset class.
Derivatives are complex financial instruments that enable these agendas but often prove to be overwhelming for inexperienced and uninitiated investors to manage. As derivatives are pegged to an alternative asset class such as cryptocurrencies, these instruments are made even more challenging for an average investor to comprehend and thus, makes them more skeptical of these investments as compared to traditional derivatives that are also complex in nature.
In spite of this, the crypto derivatives market has rapidly expanded, especially in the years since the crypto bull run of December 2017. The stage they have reached in their lifecycle can be compared with the early evolution of derivatives in the traditional capital markets, such as the Chicago Board of Trade becoming a part of the Chicago Mercantile Exchange, whose current underlying assets are mainly equities, bonds, currencies, commodities, major indexes and even interest rates.
Since the early development of crypto derivatives on elementary trading platforms like ICBIT in 2011, they have garnered considerable interest from staunch believers in the crypto market, hitting average volumes of about 1,500 BTC a day. Back then, the only product available to traders were BTC futures, they enabled a trading price arbitrage based on future prices and even helped them to mitigate price volatility of BTC.
Fast forward nearly a decade to the COVID-crisis-affected world of 2020, and crypto derivatives hit a record high of $602 billion in May, with major exchanges like OKEx, BitMEX, Huobi, and Binance maintaining their dominance. Among them, Huobi accounted for the largest trade volume, at $176 billion and up 29% month-on-month, followed by OKEx and Binance with $152 billion and $139 billion trades’ worth, respectively. However, it is worth noting that in the same month, CME’s futures saw a 44% drop in volume, which is indicative of the lack of institutional trust in crypto derivatives during times of economic uncertainty.
Higher volatility in the crypto derivatives markets due to larger movements in the underlying currency allows for a higher return. According to research by Eurekahedge in 2019, crypto funds have an average return of 16% as compared with the 10.7% return from hedge funds, which are typically the top-performing funds in the traditional capital markets. Pankaj Balani, CEO of Delta Exchange — a Singapore based cryptocurrency derivatives exchange — discussed this difference with Cointelegraph:
“Returns have to be looked at in conjunction with per unit risk taken to generate that return. The volatility of an asset class is a measure of the risk that an asset class carries. Crypto certainly carries a higher risk than mature asset classes and hence returns have to be higher in order to attract capital.”
However, with the increased price stability of BTC, the scope for these abnormally high returns are bound to reduce over time. Unlike most derivatives markets, crypto derivatives indexes pull data from markets that are open 24 hours a day, seven days a week, allowing for longer trading periods for investors in various time zones.
As the cryptocurrency market is mostly limited to currency-based derivatives, there are only a certain number of products that exist: perpetual contracts/swaps, futures/forward contracts and options. In traditional markets, the number of products are endless due to the various types of underlying assets, and even those are evolving at a rapid pace due to the tranching capabilities of some of those products, such as collateral debt obligations.
Even when up against foreign exchange derivatives, the volumes are not comparable due to the difference in the number of established fiat currencies and cryptocurrencies. However, the increased interest in options in recent times is acting as a launching pad for many new American and European options products in exchanges such as Bitmex, OKEx, CME, CBOE, Deribit and Ledgerx. The graph below shows the monthly derivatives volumes in comparison to the average monthly figure of $13 trillion just for FX derivatives.
Currently, crypto derivatives markets are largely unregulated. While this is lucrative for a segment of high-risk, alternative investors, it proves to be a deterrent for conventional orthodox investors mainly due to the ambiguity in settlement (high counterparty risk), whereas traditional capital markets operate using custodians or central clearing counterparties — highly regulated institutions that take on and manage counterparty risk, such as the Options Clearing Corporation.
Various crypto exchanges have also been making efforts to mitigate this counterparty risk and make collateral transfers faster, while Deribit has launched an external custody solution. Meanwhile, Binance and BitMEX have created insurance funds to prevent the auto deleveraging of successful traders’ positions. That being said, these efforts are still in their nascent stages and the mechanisms have not proven their worth just yet.
In the derivatives markets, institutional investors rule the roost in terms of volumes due to the capital requirements that came about with the Volcker Rule. However, in the case of crypto derivatives, institutional investors are just beginning to enter the market amid heavy skepticism. Co-founder and CEO of capital market platform Cross Tower, Kapil Rathi commented to Cointelegraph on the issue:
“One feature that is consistently different when digital assets are compared with traditional assets is the private key, which raises intricate questions as to what constitutes ‘possession and control’ and ‘custody.’ U.S. regulators are now evaluating these very complex questions. As the crypto market matures and answers to these regulatory questions develop, the same will hold true for the derivatives market. We believe the CFTC’s recent guidance with respect to the meaning of ‘possession and control’ will allow for the development of certain products in the retail market.”
On the nature of individual and institutional investors as well as their respective requirements, Kapil further commented that institutions may have different reasons behind including derivatives in their portfolios, as they may be “hedging their derivatives exposure in real-time or engaging in multi-leg transactions,” and therefore factors such as speed and liquidity of the platform will be critical. He further added:
“Growth and mainstream adoption of every asset class requires the participation of both individual and institutional investors. Within the two categories of individuals and institutions, there are subsets of users who require different types of tools and capabilities to execute their strategies. For example, within the category of individual investors, certain sophisticated investors are not afraid to build their own automated trading strategies and connect to exchanges via low latency gateways and interfaces.”
Pricing is another aspect to consider. Traditionally, equity futures are typically priced using variables such as risk-free interest rate and dividends, and currency forwards are priced based on foreign and domestic interest rates of the two currencies in the transaction. Additionally, equity options are typically priced using the Black-Scholes option pricing model and currency options are priced using the Garman-Kohlhagen option pricing model.
Since cryptocurrencies are their own asset, this makes a point of debate: whether to price as a commodity or a currency. Currently, BTC derivatives are traded at different prices on various exchanges, creating ambiguity as to which of these prices should be used to price the options contracts. Uniform pricing techniques need to be developed along with seamless technology to encourage broader institutional involvement. Balani commented that prices can vary between venues due to different spot indexes, cost of capital for market makers and demand-supply dynamics on an exchange, he added:
“The prices for options contracts on any exchange are linked to those of futures on that exchange or the spot index price used on that exchange. This information is easy to factor-in and any gap in pricing can be easily adjusted for. Having said that, different venues will have different pricing for implied volatility and whichever exchange has the most aggressive pricing will eventually attract the volumes.”
Despite the many differences in the two markets, there are several points at which they converge due to the inherently similar nature of derivatives as an instrument. Generally, derivative volumes are often a function of leverage/margin, as a higher margin allows investors an opportunity to have larger speculatory and hedging positions that usually only institutional investors have access to due to the related capital requirements.
This is a phenomenon also noticeable in crypto derivatives. When Japan’s FSA asked BitFlyer to reduce the maximum available leverage from 15x to 4x on May 28, 2019, its trade volume declined overnight by at least 50%, similar to the drop in trade volume after the Volcker Rule was passed under the Dodd Frank Act, introduced in the aftermath of the 2008 financial crisis.
Related: Bitcoin Options, Explained
Since 2018, there has been an increasing use of the Financial Information eXchange, or FIX, protocol among crypto exchanges, which is a platform used for communications in the traditional capital markets to exchange real-time information related to transactions and markets. This enables the exchanges to increase their efficiency and speed of transactions, as FIX is able to process hundreds of messages every second in each session.
Continuous evolution of products in the derivatives world is inevitable, making it difficult for regulators to keep pace, like with the role of collateralized debt obligations or mortgage-backed securities in the 2008 financial crisis. An increase in regulations globally like in the case of the United States Securities and Exchange Commission and the Commodity Futures Trading Commission working on the Crypto-currency Act 2020 will allow for better price discovery and price stability, as seen in the case of Bitcoin from the evolution of perpetual swaps and futures contracts, hedging and risk management for investors. This, in turn, will increase investor confidence in cryptocurrencies as an asset class.
The launch of crypto derivatives exchanges that are backed by major institutions will also provide a major boost to investor confidence. For example, Bakkt is an exchange owned by the Inter-Continental Exchange (which is the company that owns NYSE) and trades both in physically settled and cash-settled futures. A Binance exchange spokesperson commented on the matter: “All adoption will contribute to increased investor confidence. Adoption and participation from traditional institutions usually get more media attention, partly because of their legacy brand, and that in itself can be a good thing.”
The lack of physical settlement across the board in exchanges proves to be a major deterrent for investors, as cash settlement allows for market or price manipulations from large, single players. Physical settlement resolves this, as it allows for a more sophisticated arbitrage mechanism between the contracts and underlying spot prices. Thus, to encourage more traditional investors to join the market, it is essential that physical settlement is provided across all major exchanges along with cash settlement, as they are both lucrative to different sections of investors.
Unlike the underlying assets of traditional markets, the supply of cryptocurrency is limited. This allows for derivatives prices to fluctuate even more, as the instruments are inherently highly sensitive to supply-demand factors of their underlying asset. The scarcity of cryptocurrencies also gives room for higher price speculation opportunities due to increased volatility, but also a higher chance of price manipulation at the same time.
In the current scenario, where there is high volatility in the market and a continually increasing interest in crypto derivatives coming from the likes of JP Morgan and Morgan Stanley as they launch FTX Derivatives in Africa and crude oil futures. What’s more, even the BTC miners might get into the mix to improve their supply-demand stability, making it clear that crypto derivatives will experience growth in subsequent years.
Despite the promise of growth that crypto derivatives show, there are gray areas that need to be addressed by regulators in various global markets as they are in Singapore, whose financial regulator proposed crypto derivatives being allowed on domestic exchanges. To discuss the matter further, Cointelegraph spoke to Jay Hao, CEO of OKEx, which deals with derivatives. He opined that regulation is a key factor:
“For more institutions to enter the space, they need to be sure that the correct procedures are in place for their clients. They also need to work closely with exchanges to establish a proper definition of crypto within the regulatory framework. The classification of the underlying is the basis of the discussion related to crypto derivatives. […] Some ways regulators can work with exchanges without stifling their growth are adopting a suitability test, restricting leverage, examining the Margin rule and clearing. Most of this can somehow be adopted by existing derivatives frameworks.”
To enable traditional retail and institutional investors to flock to the crypto derivatives market in volumes comparable to the traditional derivatives markets, it is essential that regulators step in with a reasonable set of policies eliminating the shortcomings of the current system but are not detrimental to the growth expected in the near future. However, according to a recent Fidelity survey, 36% of institutional investors in the U.S. and Europe have digital assets in their portfolio, compared with 22% in 2019 — a highly encouraging sign.
Related: Derivatives in Crypto, Explained
How Blockchain Technology Can Help Fighting Against COVID-19
Many financial and human resources are being deployed in the effort to fight the ongoing COVID-19 pandemic. Technologies are also being used in this fight: artificial intelligence for research, 5G to increase information transmission speed and many others.
Blockchain is not being left out of this fight, as it now plays an important role in helping institutions and governments around the world respond to COVID-19, and is currently being integrated into healthcare and food supply chains.
Blockchain platforms can be used to monitor pandemic material distribution, donations, relief distribution and other responses in a fast and transparent way without the violation of user data.
Digital identity is another way blockchain platforms can help defeat COVID-19: Companies can collaborate through blockchain platforms to help to research the best way to combat the coronavirus, and contact-tracing applications can be built on blockchain to allow anonymity.
Blockchain can bring reliability, transparency and security to medical data. Several organizations have been accused of manipulating data during this pandemic, blockchain can help to solve them by providing transparent and immutable medical data. A blockchain-based global pandemic map can be used to track the spread of the virus, the number of infected citizens and the number of recovered citizens.
Related: How Blockchain Will Revolutionize Healthcare
The management of health insurance claims can be managed through blockchain and smart contracts.
On the other hand, a blockchain-based decentralized payment method can play a vital role in defeating the virus, as companies can receive payment through cryptocurrencies without the risk of spreading the virus through cash. Additionally, high-speed cryptocurrency payment systems help to facilitate cross-border transactions within a few seconds, allowing the transfer of funds using distributed ledger technology with the use of multiple synchronized ledgers and multiple processing nodes, which has the potential to reduce the risk from a single point-of-failure.
Donation campaigns are being set up to raise money for medical research and equipment, providing relief materials during the pandemic. For example, the Covir blockchain project recently partnered with Octopus robots to fund Biosafety licenses for robots that decontaminate large buildings during and after the COVID-19 pandemic. Covir’s main goal is to help Octopus robots gain licenses so its robots can be available worldwide.
Blockchain can be used to promote transparency during fundraising and donation campaigns while providing a means to track the origin of funds and detect if those funds are used for the right purposes.
Related: Your Crypto Taxes Can Be Donated to Charity Instead
Tokenization provides a unique opportunity to rebuild society after the COVID-19 pandemic. The damage caused by the pandemic will no doubt be huge, with economic recession and a high rate of unemployment felt across the world. Blockchain platforms have made tokenization possible, enabling the division of assets in the smallest possible way. Tokenization allows the person with the smallest amount to invest and contribute to building the economy.
Kelvin Cheng, the chief operating officer at BigONE exchange believes tokenization can help the economy by allowing companies to divide their assets and allowing investors to participate in tokenized assets. As he explained to Cointelegraph:
“Tokenization can digitize a company’s core resources, including the capability of making profits and core assets. Asset tokenization of holding the token is equivalent to holding shares, in which people holding the token can be considered as a ‘token holder’ who can enjoy the company’s benefits. The more token the person has, the more benefit the person can get. Profit digitized means that a company’s profit can issue a dividend or buy back according to the status of the holding of the token.”
Blockchain provides a unique way to contribute, build and track the COVID-19 recovery process. Perhaps when the pandemic is over, we can look at how blockchain helped get us through it, and doubters might be convinced about adopting the tech for everyday use.
The views, thoughts and opinions expressed here are the authors alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This article was co-authored by Oluwatobi Joel and Virginia Mijes.
Oluwatobi Joel is a freelance copywriter, community manager, blockchain expert, and serial entrepreneur. He has worked with various blockchain startups as a marketing strategist. He’s also interested in innovative projects in the blockchain space.
Virginia Mijes is a consolidated business professional in the technology sector with more than 25 years of managing multinational corporations and SMEs. She is a senior blockchain consultant and vice president of Associació Blockchain Catalunya as well as a trainer, entrepreneur and contributor. She is very active in the movement for women’s empowerment.
Human Rights Foundation Funds Bitcoin Privacy Tools Despite ‘Coin Mixing’ Legal Stigma
An unknown wallet holder mistakenly, it seems, sent a $2 million transaction fee on the Ethereum blockchain, Elrond is testing its network in a “trial by fire” and Libra’s Dante Disparte thinks governments entering the stablecoin race is good for Libra. Here’s the story:
Related: Blockchain Bites: Libra’s Future, Elrond’s ‘Trial by Fire’ and LocalBitcoins’ Volume
Author: Leigh Cuen
Tesla Stock Soars Above $1,000, Surpassing Bitcoin’s Market Cap
Today the value of Tesla stock set a new record high at $1,027, bringing the market capitalization to $188 billion, and also surpassing the total market cap of Bitcoin (BTC), which hovers at $181 billion.
While the value of Tesla stock and Bitcoin price are not interconnected, there is a symbolic comparison between the two as the same investor FOMO which drove several Bitcoin rallies in the past appears to be present in the stock market.
The stock price of Tesla hits an all-time high. Source: Tradingview
Recently, Tesla CEO Elon Musk announced plans to move forward with the release of an autonomous semi-trailer truck and analysts speculate that this decision is partially fueling the stock’s rally.
While the hype surrounding the semi truck may have played a part in driving Tesla price upwards today, the entire stock market has been on an uptrend throughout the past week.
The Nasdaq, an exchange dominated by FAANG stocks including Microsoft, Apple, and Microsoft, is also continuing its rally above its record high. Despite the abrupt coronavirus-driven 37% plunge of the Dow Jones Industrial Average (DJIA) in March, the Nasdaq is up more than 10% year-to-date.
The retail frenzy around the stock market has become so intense that professional traders say they have never seen anything close to it in the past several decades.
Dennis Dick, a trader with Bright Trading LLC, told Reuters:
“In my 20 years of experience I’ve never seen retail traders push stocks around like they’re doing right now.”
Bitcoin, in contrast, has not seen nearly as much retail demand since May. The top-ranked digital asset saw a strong uptrend from March to April as the price of BTC rebounded from $3,600 to $8,000 and eventually topped out at $10,440.
However, the noticeable shift in retail demand for risk-on assets like Bitcoin to stocks raises uncertainty around BTC in the short to medium-term.
Bitcoin spot volume consistently dropped since May. Source: Skew
As retail investors in the U.S. predominantly focus on stocks, traders question where the next demand source for Bitcoin will come from. Based on Bitcoin’s price trend in the last six months, the most likely source of demand in the near-term are institutions.
According to Fidelity, more than one third of institutional investors in the U.S. are invested in either Bitcoin or Ether.
Combine this with the record high inflow of institutional funds into Graycale’s publicly-traded Bitcoin investment vehicle and one could conclude that institutions may lead the next Bitcoin rally.
Since late May there has been a lack of volatility in the cryptocurrency market as retail trading activity in Bitcoin futures and spot markets have seemingly shifted into the U.S. stock market.
In order for Bitcoin to begin a new sustained upsurge, the crypto asset needs to see higher levels of spot volume as seen in mid-May.
Microsoft Releases Bitcoin-Based ID Tool as COVID-19 ‘Passports’ Draw Criticism
Microsoft’s Bitcoin-based decentralized identity tool, ION, went live with a beta version on mainnet Wednesday as one of many efforts by members of the Decentralized Identity Foundation (DIF) to fast-track tools anyone can use for COVID-19 crisis response programs.
Microsoft and ConsenSys’s uPort project are both leading DIF members. Separately, Microsoft is also collaborating with the bitcoin startup Casa to create a user-friendly interface for managing multiple digital identities.
“We’re excited to help ION take full advantage of technology like Bitcoin to vastly improve authentication, security and privacy on the internet,” Casa CEO Nick Neuman said in a press release.
“We are thrilled to have Casa collaborating on ION with us, which showcases the potential of building real-world applications that leverage the strong foundation Bitcoin provides,” Microsoft project lead Daniel Buchner said in a statement.
First announced last year, ION is meant to enable user-controlled logins that suit independent companies or services, rather than having system-providers (like Facebook) owning a user’s login credentials. ION can be used for many use cases that aren’t strictly related to health certificates or contact tracing, though the continued spread of coronavirus has influenced its potential usage.
“Almost every group in the blockchain industry is coming up with use cases,” said ConsenSys employee and DIF leader Rouven Heck, referring to potential partnerships with government agencies.
Related: Microsoft Releases Bitcoin-Based ID Tool as COVID-19 ‘Passports’ Draw Criticism
“There are conversations happening at the moment but it’s not a formal agreement,” Heck said.
“Everybody wants to move fast and has a high interest in demonstrating this technology can be very powerful.”
The race is on for companies to work with governments on such high-tech emergency ID measures. There are generally two approaches, contact tracing and digitized medical records, while some Asian governments combine them. For example, dozens of blockchain startups joined forces to start creating an “immunity passport” approved by the World Wide Web Consortium (W3C) Verifiable Credentials standard.
However, some people see both approaches as controversial, even dangerous.
In May, attorney Elizabeth Renieris resigned from her advisory role at the ID2020 consortium for decentralized ID (DID) creators, including Microsoft, saying she “cannot be part of an organization overly influenced by commercial interests that only pays lip service to human rights.”
Microsoft would not make executives available for an interview, though the company did provide a statement.
Microsoft’s open source ION project uses the Bitcoin blockchain for something comparable to a coat-check ticket.
Rather than include all the data about the coat (or person), which would be hard to scale, it offers a Bitcoin-ledger reference number to the data’s chronology. The heavy data is actually stored between ION nodes using the InterPlanetary File System (IPFS). Whoever is anchoring the data pays a small fee to bitcoin miners to record the reference number.
“The focus is to make things highly interoperable,” Heck said, referring broadly to the urgent work being done on solutions across the space.
Part of the reason why organizations involved with DIF are working to make their technologies compatible across use cases and systems is interoperability might, at the very least, make it easier to build privacy features that apply across the spectrum.
“Uport at ConsenSys are also working on projects,” Heck said. “Microsoft’s ION stack or Uport’s stack should be compatible.”
Even so, some privacy advocates say the project’s safeguards are lacking.
Former W3C employee Harry Halpin, now CEO of the privacy-tech startup Nym, said some of these efforts are simply repackaging previous work.
“ID2020 is just the latest attempt to violate people’s privacy using feel-good rhetoric. It’s also part of a larger business plan. Microsoft and IBM’s entire bottom line is to build identity systems,” Halpin said. “Governments need to establish identities of who owns these keys, so they say, ‘OK, we’ll have an open standard, call it decentralized, and make it mandatory.’”
In the face of such harsh criticism, blockchain advocates are working to identify and minimize the ethical risks of the tools they continue to build.
According to W3C member and nonprofit Blockchain Commons founder Christopher Allen, it’s not clear the contact tracing like Google and Apple are offering will work unless the vast majority of all Americans use them. Since it’s hard to get enough people on board for contact tracing to work, he worries the most salient result may simply be accelerated data collection.
“Probably the most dangerous type of information, out of all types of personal information, is location data,” Allen said, explaining contact tracing would require privacy tech at multiple layers, from the app level on the phone to the internet infrastructure someone uses.
“It’s incredibly hard to protect,” he said.
In reference to an open source emergency app in Israel, which does have privacy measures yet was operated in cooperation with various government entities, Allen said it’s clear “this data is already out there being collected and [location data] correlation is happening.”
Zcash Foundation researcher Henry de Valence agreed such systems are not the best use case for distributed ledger technology, or really any software.
“I don’t think people should build those systems and I don’t think they would be effective at preventing the spread of disease,” he said, adding he does not see so-called immunity passports as any better. “There’s no cryptographically strong way to prove immunity one way or another.”
Some countries, like Honduras, have already implemented some type of blockchain solution for certificates that give people a type of ticket for medical services or free movement outdoors.
However, in these cases, the government generally came up with a policy and found a startup to create the relevant tooling, rather than tech startups coming to policymakers with prospective offerings. One exception, which isn’t widely adopted so far and didn’t use blockchain technology, was NSO Group pitching surveillance technology to American police. Despite the societal risks, crypto companies are taking NSO Group’s proactive approach.
Allen is slightly more optimistic about decentralized identity tools for self-sovereign medical records.
“This architecture is ripe for solving this particular problem,” Allen said, warning this is only in reference to the digital certificate itself. (Whether the medical tests actually prove immunity is a different matter entirely.)
As someone who collaborates with both immunity passport teams and companies involved with the DIF, he said they are taking disparate approaches based on their own evaluations of the tradeoffs. He’s not sure which will be better and hopes the market will decide.
“We don’t know what the best answer is and we don’t have a strong rubric for what the best level of decentralization means,” Allen said of the immunity passport coalition. “Parties like DIF, with Microsoft and ConsenSys … [have] a different set of rubrics to decide the answer to their solution.”
On the other hand, Zcash’s de Valence remains skeptical.
“It’s the duty of technologists to ask what types of systems we’re creating and what kinds of social structures do those things create,” he said.
Although Allen warned no technology offers a panacea, especially with regards to government overreach or recurring outbreaks, he expects some type of new “verifiable credential” technology will probably emerge from this crisis.
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