OkEx Israel Event: Crypto Derivatives

Notes from a panel on the cryptocurrency derivatives market in 2020, featuring our Head of Research Ori Cohen.

Amber: In recent years, the world has seen many macro-changes, including Brexit, oil price changes, protests, Covid-19, etc. What’s going on?

Ori: The world has become crazy, and volatility is how we measure the craziness. Crypto volatility is historically very high. The options market is the only tool that can protect an investor from this type of volatility, but only if they use it right. However, it can emphasize the problem with volatility if used incorrectly as well.

Uriel: The market conditions are looking bullish for Bitcoin and digital assets. The macro conditions are becoming more and more attractive (for Bitcoin), with all the money printing going on. In the next 5–10 years, we are bullish on Bitcoin and digital assets. However, the volatility of trying to trade assets such as BTC is very high and makes trading this difficult. It is a market that is difficult for non-professional traders to succeed in.

Lennix: I agree with the above. There is currently very strange behavior in the equity markets. The fundamentals are really bad and it is undeniable that stock markets should be crashing. But there is a decoupling between equity markets and fundamentals. In fact, the stock market is actually looking really good. And BTC price is actually very correlated with equity markets. The Federal Reserve’s policies have thus far avoided a financial crash, and people are still expecting a strong economic rebound at the end of Covid-19. BTC will then expose its benefits by becoming uncorrelated with equity markets when fundamentals begin to come back. Many investors will come to realize that equity markets are overvalued and move some of their capital to crypto.

Amber: In 2020, there are also opportunities in this circumstance. What do you think of the new products coming out, like leveraged tokens? Are there good opportunities to make some money?

Ori: The perpetual market and futures market have matured significantly, with OkEx as a leader in the futures market. Still, the options market is not solid and mature yet. As professionals in options trading, it’s still premature. It’s becoming more and more mature but it’s not there yet. The skew derived from the options is still not solid. And synthetic futures from options are still very expensive compared to other futures. We are surely waiting for this and will definitely be a major player when the market becomes more mature. It’s still problematic for us to enter this options market this early.

Lennix: How much more expensive are synthetic futures compared to this?

Ori: The cost is the spread. I take the best strike to buy futures and sell futures, using the call-put parity function. The spread derived from these options and the fees on the options are 5x greater than the perpetuals. This is because of two reasons. On one hand, the perpetuals are very liquid and the spread is very small. Meanwhile, on the options market, the makers are afraid of large moves. As an algo trader from traditional markets, we use the options market to hedge futures. But with the perpetual, it is much more attractive so you have no reason to use options, unless you want to fully hedge some long position with buying puts or some short position with buying calls.

Lennix: In traditional markets, shouldn’t synthetic futures be more expensive than listed futures? Or is this not the case?

Ori: It depends. The options market is adopted at different levels in different countries. For example, in Israel, the options market leads the real market, whereas in Europe, the options market is not as strong. In Korea, the options market is very strong. So, in places where the options market is the leader, most of the players use the options market rather than the futures market. Whereas in Europe, for example on the Eurex, most players use futures rather than options. There are some countries, especially in the East and in Israel, where the options market is more developed and players prefer to use them because they are more flexible. I really hope that the crypto players will use this.

Back to the original question

Uriel: On the day to day basis, we are looking and exploring new instruments and products out there. We decided to use OkEx because it is known for having a solid infrastructure for crypto instruments and derivatives. We look for two things primarily. The first is liquidity. If you’re trading relatively large volumes, most markets don’t have sufficient liquidity. Most instruments outside of Bitcoin and maybe some of the top 10 assets don’t have sufficient liquidity for commercial or high volume trading uses. Having liquidity is more important than having new products that might have interesting risk-reward. The second thing is the stability of the infrastructure and experience we have with different markets. Many professional funds were almost wiped out, not only because they were trading the wrong pairs, but also because the infrastructure had trouble supporting more exotic products when the markets crashed. On March 12th, many traders tried to get in and out of positions with high or low leverage, but infrastructure-wise, it was not easy. In high volatility periods, a product with liquidity and track record is important for professional traders. Yet, I do think there is significant innovation in the space, with exchanges launching interesting new products. The crypto market is moving much faster than the traditional markets.

Lennix: Do you think the liquidity of the crypto market has been weaker since March 12th?

Ori: Yes, we do see that liquidity has gone down in crypto markets since then. And I totally agree with Uriel; it is important for a trader to know that he can come in and out of his position when he needs to. The connectivity issues that we see in crypto markets don’t happen in traditional markets; it is much more stable there.

Uriel: In our experience working with OkEx, we have direct access to the OkEx technical team and chat with them once a month. They always have a good response to support more advanced trading needs, which doesn’t happen in the traditional markets. You cannot speak with these guys in the traditional markets and if you speak, it will take years to change things.

Lennix: To be honest, the real exchange has been around for only 3 years. Before that, it was really just a trading UI. They evolve with similar standards as traditional exchange. We understand that as an exchange, we have a lot to learn from an infrastructure perspective. The latency is already much faster compared to several years ago. Most exchanges already have robust API features. But the robustness and stability of the system is determined by the internal system, as well as the cloud providers. Many cloud service providers are not built for high frequency trading and occasionally cause issues in stability. We are not fighting at the microsecond level; we are still talking about milliseconds. In a sense, this makes crypto more fair, as you don’t have to spend millions to gain an advantage.

Ori: Your game is much harder, because it is much easier to spin up a new exchange in crypto (meaning that competition is more difficult than in traditional markets). You have 10x concurrent users that come from across the world, 24/7. Your battle is much harder.

Uriel: Another topic that is not directly related to your question but still important is security. Trying to bring traditional money to crypto, one of the difficult questions is security. Our industry has done much work to secure digital assets (ie custodianship, exchange, hot and cold wallets). With exchanges though, it seems like there is still work to be done to convince bigger, traditional money to put money into the space. We are seeing significant progress here with companies like Fireblock and Copper. We may still need 1 or 2 more years for bigger funds to enter the space.

Lennix: We are not in the custodian space and don’t need to store very large amounts. Right now, we don’t have a custodian (in this industry) with the proper licenses, insurance, financial status, and confidence that they are sufficiently bigger than major exchanges like Binance. Let’s say Binance got hacked 4000 BTC, they would just pay it right off. But we don’t have a custodian that could do this. Maybe one day we’ll see large banks or Fidelity custody a significant amount. With companies like Copper and Fireblocks, we are interested in exploring and potentially working together, at least at small scale.

Amber: We see the industry has been growing significantly. 2019 was an inflection point for the derivatives market, and trading volumes have reached their highest point. More and more venues are offering options products. What do you think will be the tipping point for the options market?

Ori: For now, I think that there are many exchanges offering new products and it looks like everyone is trying to find the next thing. Of course, we have the major exchanges like OkEx, Binance Futures, FTX, etc. leading the industry. It’s not only a matter of which product you have; it’s also a matter of what the trader thinks of the exchange and how much he thinks he can put on the exchange and each product. Maybe the crypto market will develop similarly with traditional markets or maybe it’ll be different. It perhaps will take one or two years but it’ll be more solid and more unified then. It will help that major exchanges offer the same products (with the same specs) and not different products. For example, it would be helpful if the options on different exchanges had settlement on the same day with the same price. Of course, now it’s very diverse. But maybe we’ll come to the point one day where there will be a few major exchanges and few major products, which may help simplify things for the traditional markets participants. When I started trading on the Tel Aviv Stock Exchange, the options market was more developed than the crypto market is now, but still not that much further away. While that took 10 years to develop, I think it may take just one year for it to do so in crypto.

Lennix: What does it take for retail to get into the options market? We see successful retail adoption of the options market in Korea, Israel, Amsterdam and India. But we see a failure to scale in the Hong Kong and China markets. What will it take for retail to understand such a difficult product?

Ori: With the Korean exchange, the Koreans use it to bet. It’s not clear that the majority of retail can know how to use options intelligently. The real sophisticated players are all professional and institutional investors. If an institutional investor buys $1B of Bitcoin, they cannot allow it such that their Bitcoin drops more than 10%. So, they will have to pay a monthly retainer for insurance that covers the big losses. In Israel, legally, a big fund who manages people’s money cannot have a naked position. They must have a hedged position. Our parent company made around 5% of the daily volume (in the Tel Aviv Stock Exchange) without any directional decision, just buying and selling options with the skew. And we made 5–10% (in profit), without the need to really (truly) hedge ourselves. We were only trading options to make money. On the other hand, the institutions need options to hedge themselves. Regarding retail, it may require a betting experience or insurance experience for them to understand this, as they may not understand the difficulty of the options product.

Uriel: I want to say that Ori’s point on consistency between exchanges is very important. For retail and even professional traders, if we add the complexity of having different flavors on different exchanges, this makes it harder for retail and funds to be educated on the products. Something we like about OkEx, but which can still be improved, are documentation and tools to help us understand the products. It took us a while to understand the fees, margins, tools, etc. on OkEx, even as professionals. Calculators and examples of the products would help us immensely.

Lennix: You are right. It’ll be fixed in two weeks haha. If you think about options as speculative tools, the beauty about options is that you don’t have risk of liquidation. You don’t have the concept of margin with options, you just buy and sell at a fixed time frame. So I think what Ok needs to do is improve documentation, UIUX, make it easier to understand for everyone. Despite the fact that it is a complex product, if you think about it and package it as a simple and fun product, it may help scale this.

Uriel: It may help that you onboard several market makers or players onboard to help start the options market. They can help finalize the products, the details, the API connectivity. Once the liquidity is there, then organically, more and more retail and funds will join.

Lennix: We do need more product advisory partners and liquidity partners for sure.

Ori: The major KPIs for us when we select an exchange are the liquidity first, the latency and API stability, the fees, and in the end, what we think of the exchange. And maybe this is the most important part. And OkEx gets many points there because the maturity of the exchange is important. When you come to the crypto market, you have to ask yourself if you know the exchange, whether you trust them, and if you have a good relationship with the exchange. These are the critical points for selecting an exchanges.

Uriel: I agree with Ori. Liquidity, API, stability, and overall appearance of the exchange in terms of brand and security. In our market, security, reputation, and brand are very important for selecting an exchange. We also like innovation. For example, FTX is fast and strong at innovation, which is important. But the main factors are still more important than the innovation factor.

Amber: What do you think about the competition in exchanges?

Lennix: I agree with Ori in that exchanges will likely have similar listed products. There is competition between 1. Product innovation, 2. Stability and 3. Latency. Most of the times, or at least sometimes, latency, stability, and product flexibility have a trade-off. For example, if we wanted a portfolio margin that enabled collateralization of any token or contract in one account, this would be possible. But at the same time, if we want to liquidate as quickly as possible, we have to have a coherent liquidation engine that can communicate our liquidation orders across separate databases. If we were liquidating BTC/USDT futures, we would have to instantly update this on the Ethereum and other token databases. Are we liquidating in a delta-neutral approach or are we focusing on downsizing your overall position? All of this is mathematics and systems and latency. Building an exchange is easy but improving the exchange to a point of sophistication to service professional traders: it is not easy. We love the experience of building the exchange with partners.

Ori: It is really hard to build an exchange. That’s why we’re on the trading side haha.

Lennix: It is still early days. The whole crypto market cap is less than the size of certain stocks, like Facebook.

If you would like to receive more content like this, as well as thoughts and analysis on the cryptocurrency derivatives market, subscribe to our newsletter.

If you’re interested in working for a cryptocurrency quantitative trading firm trading over $100M volume a day, we’re hiring!