State of Crypto Derivatives 2021
As we start the year of the Ox, the story of most important trends and light speed changes the crypto derivatives industry went through during this lunar year. From Tether gaining dominance and the emergence of options markets to the fall of BitMEX and the rise of FTX and DeFi derivatives & everything else making today’s cryptocurrency markets what they are, before they transform again
The insane journey Bitcoin’s prices took over the last year was closely intertwined with the exchange landscape. From $3,936 per-Bitcoin to new all time-highs, everything in the markets is connected, each change creating a domino effect. We wrote this detailed recap, for both crypto-native and newcomers, to pin-point the important trends and give them perspective as we end the year of the rat!
1) Futures and perpetual swaps overtake spot markets
Over the last year cryptocurrency perpetual swaps and futures gained the center stage. From being almost non-existent before 2017, now they represent roughly 85% of Bitcoin trading volume.
A little history: Following the success of BitMEX’s Bitcoin perpetual swap in 2017 and while the ICO bubble deflated through 2018, dozens of online derivatives exchanges were founded. As cryptocurrencies’ volatility dropped by 90% in 2018, The high leverage offered for Bitcoin by futures exchanged served as replacement for the trading of volatile small-cap cryptocurrencies. Identifying the trend and seeking to stay competitive and invest their 2017 profits, most successful spot exchanges added futures contracts through 2018 and 2019, starting with Bitcoin and Etherum.
According to CryptoCompare’s report, derivatives volumes rose over the last year from billions of dollars a day to tens of billions, continuously breaking daily and monthly records as Bitcoin’s price rise accelerated by the end of 2020.
While BitMEX offered the first Bitcoin perpetual swap back in 2014 and OKEx launched Bitcoin futures the same years, most of today’s leading derivatives only launched recently: In 2017 the CME launched Bitcoin futures. In 2018 Deribit, OKex and Bybit launched perpetual swaps and Huobi launched futures contracts. In 2019 Kraken, FTX, Biftinex and Binance launched perpetual swaps and futures. And in 2020 Huobi added perpetual swaps.
During the bear market exchanges raced to improve their technology, features and usability in order to appeal to traders and gain traction and this year saw these efforts bear fruit, as the bull run drew more and more speculative volume.
2) Tether takes its place alongside Bitcoin
In 2020 the supply of stablecoins passed $25 billion — a YTD growth of over 400%, much of which was caused by Tether’s USDT becoming an increasingly popular choice for collateral in cryptocurrency futures, taking a place beside Bitcoin backed Bitcoin contracts.
Dating back to 2018, Tether was used for spot trading in 40% of cryptocurrency exchanges, fears surrounding Tether’s solvency and banking situation were high. But as Tether refused to implode and instead increasingly stabilized, the fear was replaced with trust or perhaps complacency. Besides being a favorite medium of exchange in the cryptocurrency industry in 2020, Tether (USDT) and other stablecoins have become a standard collateral for cryptocurrency futures contracts alongside Bitcoin. The Binance BTC/USDT perpetual swap is currently the most liquid Bitcoin product on the planet, and other leading exchanges have added BTC/USDT pairs over the last year, in addition to the standard inverse Bitcoin swap.
The increased usage of USDT collateralized contracts is due to several reasons:
- Increased Tether issuance on Ethereum’s ERC-20 standard made USDT simpler to implement and use, due to the popularity of standard ERC-20 tokens across exchange and the user base.
2. March 2020’s ‘doomsday’ crash on BitMEX emphasized the downside of inverse contracts as the only Bitcoin contract on an exchange (more about this in the next sections). If BitMEX had had a BTC/USDT pair on March 12th, it’s possible that the crash would have been less severe.
3. USDT collateralized vanilla contracts are more simple to trade, and are easier to use with cross collateral (e.g. trading BTC/USDT and ETH/USDT with the same collateral) than Bitcoin.
4. Increased trust in Tether’s longevity and stability, Binance leading the way with its flagship BTC/USDT contract, and FTX offering collateralization with almost any type of asset.
It will be interesting to see how this develops in 2021 considering the increased regulatory scrutiny of our industry and Tether’s legal challenges, and the difficulty of proving Tether’s backing.
You’re welcome to read our detailed overview on Tether USDT in our June 2020 newsletter.
3) King BitMEX dethroned & ‘doomsday’ crash
From the start of 2020 it was clear the competition was aiming for BitMEX’s spot as the biggest Bitcoin trading venue. BitMEX gained popularity by offering the first stable Bitcoin perpetual swap allowing up to 100 times leverage. BitMEX only accepts Bitcoin deposits with its flagship BTC/USD contract collateralized with Bitcoin. With no KYC until recently, it was fast and simple to set up an account from anywhere. But through 2020 BitMEX’s selling points started working against it.
During 2019 BitMEX was operating in full capacity and maintaining possibly the busiest exchange infrastructure on the planet. Meanwhile competitors increasingly worked hard to draw users with different liquidation mechanisms, as well as a larger variety of new products and energetic marketing.
Pre-halving ‘doomsday’ crash
“It looks like March 12th influenced BitMEX in a way its competitors could only wish for,” we wrote in our April newsletter. When the March 12th crash hit financial markets it was especially painful for Bitcoin traders, as many took positions in anticipation of a halving rally.
As the Covid-19 fears hit many financial markets with strong price drops, liquidations in Bitmex were stronger due to the price of the collateral, Bitcoin, shrinking, while the price of the contract (BTC/USD) was falling, meaning the speed of liquidation drove the price even lower than a normal liquidation cycle.
“The leverage was high and the market started coming down and that sent people into liquidation, which in turn caused more liquidations. This in turn affected the collateral, which was Bitcoin. Its price is dropping, and suddenly the collateral isn’t enough.Collateral shrinking with the denominator falling.” explained Efficient Frontier’s CEO Roei Levav. “In the meantime, the exchanges stopped responding to algo-traders, which meant it was hard to create demand and stop the crash, which continued until the trading halted.“ he explained.
Though many exchanges suffered technical problems during ‘Black Thursday’, most of the attention and criticism was aimed at BitMEX due to it being the biggest trading venue, netting very large losses to traders. The March crash caused some loss of trust in the platform, with the understanding that a BTC inverse contract may not be the way of the future.
(We covered the infamous crash as it was happening here and post-mortem here.)
BitMEX VS the SEC
On October 1st 2020, several days after BitMEX started a KYC program, news broke that BitMEX’s founders were charged with illegally serving US citizens on an unregulated derivatives platform. In addition the CTO and founder of the exchange Samuel Reed was arrested. Following this, BitMEX opened the exchange for real time withdrawals and in the following week close to 84,242 (at the time worth $926.6 million dollars), 63% of all funds in the exchange, left BitMEX and did not return.
Red candles show the amount of Bitcoin withdrawal from BitMEX each day, the biggest withdrawals happening following October 1st
BitMEX now ranks 6th in OI and volume between the leading exchanges and still draws more than $1 Billion in trading volume a day. But it’s far from its record 151,000 bitcoins of open interest in March 2019. Today BitMEX reports only 14,000 Bitcoins of open interest.
According to CryptoQuant, Both Binance and Houbi experienced their biggest 2020 deposits in the days following the news on BitMEX, and FTX as well experienced an uptick in deposits in the days following. Thus came to an end the reign of the glorious and most profitable BitMEX.
4) Binance comes at the king and wins, FTX revolutionizes token trading
Two exchanges that shined in 2020 were FTX and Binance. Binance, the biggest trading venue for altcoins through 2017, was interested in keeping its place as the top cryptocurrency exchange in the world and used its large budget and user base to rapidly scale its futures market. Entering the derivatives space only a bit over a year ago, Binance gained a lot of market share with their flagship derivative product the BTC/USDT swap, slowly but surely rising to the top spot in terms of volume and OI over the course of 2020, replacing BitMEX with the most liquid Bitcoin product in the world.
Since September 2020, Binance has overtaken BitMEX in the liquidity of the BTC perpetual swap. The above chart shows the projected difference in price caused by a $10 million buy or sell order. The smaller the change, the more liquid the market
According to skew.com, Binance now has the most liquid cryptocurrency instrument in the space, according to ask/bid liquidity.
Binance which expected to print a profit of between $800M to $1 billion in 2020, added in 2020 24 USDT marigned futures products, Cross Collateral trading, options trading, coin margined trading, and FTX inspired Leveraged Tokens, a DeFi index and leader board, now totaling over 160 derivative products. On December 18th 2020 Binance marked a new all-time high in 24-hour volume of over $36 billion.
The biggest success story in the cryptocurrency trading space in 2020 has definitely been FTX, an exchange that opened its doors only a year and a half ago but has already captured the attention of cryptocurrency traders with its large variety of contracts, including famously facilitating betting on the outcome of the US elections.
Growing in 2020 from 15 employees to 37, FTX took advantage of its offshore status and impressive ability to execute in a short time frame, bringing new standards and a new variety to the cryptocurrency markets. FTX were the first exchange to create their own tradable indexes, leveraged tokens and prediction markets, which combined with an impressively speedy listing of ‘hot’ crypto assets, made FTX an extremely appealing venue for speculators. For the first time users could speculate under the same roof on the price of anything from Bitcoin or a “Shitcoin Index” to AirBNB pre-launch stocks and outcome of the US elections. It houses 1100 markets, 690 of them added in 2020. FTX drew attention with over 20 trading competitions giving away to the winners over $3 million worth of prizes, and with the constant Twitter presence of both the exchange and its CEO, Sam Bankamn-Fried. FTX reported adding over a hundred thousand new users to the platform in 2020, with active daily users increasing by 786% and in 2020 1,000% growth in volume compared to 2019, with a daily average of above $1 billion in trading and on its biggest day, trading over $12 billion in volume.
5)DeFi plays a role in derivatives
Explaining the entire DeFi phenomena is beyond the scope of this article, but the chart below provides a great summary, showing the meteoric growth in on-chain trading on Ethereum’s blockchain from 2019 to 2020 to 2021.
From a humble trading volume of $21 million every day in January 2020, since August 2020 ( or ‘DeFi Summer’ as we coined in our July newsletter.), no month in 2020 had volumes across all on-chain exchanges go under $18 billion, or $600 million a day on average. And this isn’t merely reported numbers; on-chain transactions are expensive and impossible to fake, so each dollar in trading volume represents blockchain fees paid to Ethereum miners.
But one thing still largely absent (perhaps not for long) from the on-chain spot trading landscape is shorting and leverage, which centralized exchanges were quick to provide and use to capture part of the DeFi flow. FTX was fast to list spot and perceptual contracts for DeFi tokens starting in June through September, and even built a DeFi Index composed of popular tokens.
Hedging yield farming and market distortions
Yield farming, programs where depositing tokens to the temporary disposal of a new on-chain DeFi application yields free cryptocurrency, has been a growing trend over the last year, with billions of dollars in cryptocurrency used for generating free tokens and yealds. In order to benefit from the liquidity mining while hedging the price risk in highly volatile cryptocurrency markets, especially with large positions, traders used DeFi tokens perepteual swaps to short their large long positions in tokens which were busy generating yield in on-chain defi protocols.
The demand for short positions from centralized exchange such as FTX was even more visible during distortions in the DeFi markets: On July 12th, Ameplforth, a token which is ment to track the price of the US dollar, reached a high of $3.82 when confused speculators piled into it. Following FTX listing $AMPL perpetual swap on July 23rd, more informed traders were able to short the former stablecoin. The demand for shorting was so high that long positions were being paid 3.5%, and at some points even more than 0.3% an hour to hold a long position in $AMPL. (These payments were due to the perpetual swap’s Funding Rate explained here, meant to incentive balance between long and short positions.
derivatives coming to DeFi
In 2020 many on-chain derivative projects were founded and launched and during the last 6 months won their first users. Some of the most popular to date are Hegic and Opyn offering on-chain options contracts on Etherum vs USDC and MCDEX and DXDY which provide on-chain perpetual swaps for several assets.
Will 2021 be a big year for on-chain derivatives? We think so, that’s why we’ve started a series of in depth blog posts ,aiming to cover all the major project and the emerging financial technology.
6) Institutional money breaks CME and Grayscale records
In 2020 the barriers between the Bitcoin world and the traditional financial world finally broke down. The exact date can be pinpointed to May 7th 2020 when hedge fund pioneer Paul Tudor Jones publicly announced one of his funds has invested in Bitcoin due to inflation concerns, becoming the first public institutional investors to officially invest in the 12 year old asset.
Flocks of more institutions followed, until it turned into a flood of names becoming hard to keep track of, among them: Ruffers, Stanley Druckamiller, ARK Investment, Kinetics, Slatston Wealth, Boston Private Wealth, Rothchilds investment corp, Guggenheim and Renaissance Technologies. This flood of buyers ran Bitcoin’s price up to a high of $42,000 per-coin to date.
Open Interest in CME Bitcoin futures and options exploded since PTJ’s May announcement
Many of the institutional investors did not take custody of their coins but instead used the CME derivatives, where volume and OI rose substantially. Open interest in the CME’s Bitcoin futures passed $200 million for the first time in January 2020 and by the end of the year touched $1.6 Billion. Since Paul Tudor Jones’ announcement CME’s Bitcoin open interest jumped from $38 million to Open Interest to $436 million, not returning to previous lows.
Number of entities holding over 25 Bitcoins in the CME Bitcoin futures was 58 in January 2020 and rose to 110 before falling to 87 by the end of the year
Another beneficiary of increased imitational trust was Grayscale’s Bitcoin and Ethereum funds. Grayscale’s public funds allow retail investors to purchase Bitcoin and Etherum shares in their stock or retirement accounts at a premium, while allowing only institutional and accredited investors to capitalize the fund by purchasing real Bitcoin which Grayscale buys on their behalf and deposits to the fund. The investor can then usually sell these shares with a high premium , benefiting from the high demand for these shares by the public. This is assuming the institutions are willing to stomach a 6 months lock up period.
Institutional and accredited investors holding in USA’s Grayscale’s Bitcoin fund rose in 2020 more than three fold in 2020, from 276,000 Bitcoins in January, then valued at $2.5 billion, to 607,000 Bitcoins valued $17 billion dollars, close to 3% of all Bitcoins in circulation. — and now 27B or something
Grayscale’s Ethereum fund rose from 505,000 Ethereum tokens in January to 2.9 million tokens by the end of the year, valued at $3.6 billion.
7) Options emerge
Bitcoin options, complex products associated with professional investors, had strong growth in 2020, becoming visible and tradable in the cryptocurrency space for the first time, though have not yet reached mature levels of spreads and liquidity.
Dominance of exchanges in Bitcoin options according to Open Interest and volume. Deribit.com hosts 84% of current reported options open interest and 74% of the options trading volume for Bitcoin options. Source: skew.com
Deribit, currently the most popular Bitcoin (and Ethereum) options venue pioneered options in cryptocurrency when it opened to the public in 2016 after several years of development. The CME and Bakkt followed in 2017 and 2019, and in 2020 Deribit was joined by 3 leading cryptocurrency exchanges: OKEx launched option trading in January 2020, Houbi in September and on December 28th 2020 Binance announced their own European style options.
2020 was the first year where there was a substantial amount of Bitcoin options trading. “It is now liquid enough so that implied vol levels and expiries are worth reading into for market participants including non options traders.” Skew.com wrote in November.
In 2020 Ethereum options trading volume rose close to 100 times, from $28 million weekly volume to a reported 2.26 billion. The Open Interest rose almost 60 times within a year from $16 million to $928.4 million. Option OI for Bitcoin contracts rose 19 times from $311 million to $5.99 billion, and options volumes ascended more than three fold from $1.67 billion to $5.65 billion by the last week of 2020.
Despite the growth according to Efficient Frontier head of research, Ori Cohen, Bitcoin and Etherum exchange traded options are still far from HFT tradable, due to lack of liquidity, despite the increased participation of traders. Ori noted that in some traditional markets, such as the Euroex, options trade mostly on OTC desks and the public order book remains illiquid. Over the next few years we’ll see what direction the Bitcoin options markets choose.
Thank you to Efficient Frontier’s trading and research teams for assisting with this analysis.
