Despite all the talk about liquidity, bitcoins and other cryptographic assets are little traded. Investors who buy and sell large volumes can not do so directly, without slippage or price changes between order and execution.
They are turning to over-the-counter (OTC) facilities to handle these transactions, whether it's a crypto purchase for the first time or trading to generate alpha (above-market returns).
As a result, these offices manage between 30% and 65% of the total volume of the cryptography market, depending on the estimate you believe. On October 28, CoinDesk Research met with two veteran OTC traders during a live webinar.
Martin Garcia is Managing Director and Co-Head of Trading at Genesis Trading. Yinfeng Shao is a former trader at Circle and is now the CEO of an over-the-counter OTC company, Reciprocity Trading.
Non-profit offices take a huge and temporary risk. Traders like Martin and Yin are responsible for managing this risk by rapidly moving large quantities and offsetting it in the derivatives markets, including BitMEX, Huobi, OKEx, CME, Bitcoin Futures and Bakkt. (For the context, CoinDesk Research has published a white paper on the state of the markets for cryptographic derivatives, which you can download for free here.)
As a result, they are among the most sophisticated traders in the cryptographic derivatives markets. Here are some ideas that Martin and Yin shared during our one hour conversation.
1. The mindset of investors has changed
The mindset of investors has evolved since the early days of crypto, from investments to hedge funds.
"There is a lot more speed among the traders who are on the market, whereas in the beginning, it was much more of a long-term buying strategy," Martin said. "Nowadays, people understand that this market is extremely volatile and that many cryptographic funds and different companies exist, they try to add alpha to their shareholders."
2. Derivatives markets move the spot market
First of all, market movements start more often on derivatives exchanges than on cash exchanges.
"Because there are a lot of trading platforms, the question is where does the action start?" Yin said. "Often, we start trading derivatives because that's where many people have ties and many of the most indebted bets are taking place."
"Crypto is already a rather haphazard and volatile market in terms of price action and the collection of these derivatives and the exchanges that list them effectively act as an additional lever," he continued. "Every time you start making a move, there is a good chance that it will become exacerbated because of the amount of open bets that are out there."
In isolated examples, such as the May 17 crash, a small amount in spot markets can lead to a sharp shift in derivatives markets, particularly BitMEX, allowing traders to manipulate the spot price in favor of their positions in the derivatives markets.
Theoretically, this is possible in regulated cryptographic derivatives markets such as CME, but it is more expensive and more difficult because leverage is not as high.
This is not the only way for derivatives markets to fail.
"Things tend to go down a bit and cause a lot more slippage, it's when you've exhausted everyone's ability to actually use derivatives as a hedge. So, that the amount of collateral deposited by everyone is insufficient, or that the market conditions are such that you really can not access some of these platforms, "said Yin.
3. Two products dominate derivatives
The most popular product is the perpetual swap, reputedly invented by BitMEX. Crypto futures are a close second. A handful of over-the-counter desks may offer customized swaps and derivatives, including difference contracts, but these two products have so far dominated the volume of the market.
The Bitcoin options appear, but represent only a small percentage of the total volume. As suppliers such as Bakkt and CME announced plans to bring options on future bitcoins in the markets, Yin and Martin said they could be attractive to large investors entering cryptography, seeking coverage against the major disadvantages of an unstable market.
"I think that means that there are more sophisticated coverage strategies. This allows people to be more comfortable with one-off exposure, if it's easier to cover, "said Martin. "These markets are evolving very quickly and many of the larger markets that want to engage in trading are subject to significant risk. How do they protect against the crazy blow to the downside? The options may very well help to eliminate some of these risks. "
Listen to the full webinar on Yinfeng and Martin's unfiltered opinions on risk, liquidity and derivatives in the cryptography markets.
This is the first in a new series of webinars we are organizing. If you like what you hear, contact us (email@example.com) and tell us what topics and guests we should present next.
Ivan Ajvazovskij painting via Wikimedia Commons