Coinbase (COIN), the crypto exchange that bought the largest crypto options exchange, Deribit, for $2.9 billion earlier this year, expects a wave of traditional financial institutions (TradFi) to use digital asset derivatives for investing or hedging, said Usman Naeem, global head of derivatives sales at the Nasdaq-listed company.
The institutions that are waking up to globally regulated crypto derivatives are typically asset managers, who have a fiduciary duty to speculate or execute strategies beyond simply providing liquidity, which is the domain of market makers, Naeem said in an interview with CoinDesk. They most likely come from the US and Europe and are a fundamentally different type of company.
“Looking back, the vast majority of activity, probably more than three-quarters, was in Asia,” Naeem said. “I think this will rebalance a bit and we’ll see US and European-based, non-market maker institutions really get into derivatives.”
Coinbase started in early 2012 as an on- and off-ramp for bitcoin BTC$110,176.96 and evolved into an exchange, which successfully captured a large part of the spot market, which was located in the US at the time. But as of 2017, innovations in crypto-like perpetual futures brought as much as 85% of volume and liquidity outside the US, mainly to the APAC region.
In response, in 2022 Coinbase acquired FairX, a derivatives platform registered with the Commodity Futures Trading Commission (CFTC), to offer US-regulated futures. It followed the purchase of Deribit in May.
Rebalancing the crypto derivatives market from Asia and places like Dubai, where perpetrators are popular, will also lead to a change in the type of strategy toward an approach more aligned with traditional finance, Naeem said. Traditional money managers don’t just want to buy $10 million or $20 million worth of bitcoin, he said. They want to scale in a risk-managed way, and that means using derivatives to hedge.
“As more long-term, risk-managed investors come in, I think we’re going to see a volatility service that more closely replicates what’s happening in the traditional financial world,” Naeem said. “Rather than just speculate on a 50% rally in bitcoin, they may sell some upside to help fund the downside insurance. This dynamic will cause a massive shift in volatility services, bringing with it greater liquidity and stability; a more reliable and understandable derivatives market.”
That’s all well and good, but what about incidents like the crypto flash crash from earlier this month, which saw around $7 billion in liquidations at very short notice. Doesn’t such extreme volatility keep institutions on the sidelines?
Naeem pointed out that flash crashes are not exclusive to crypto, and that the digital asset industry’s infrastructure worked for the most part.
“The liquidations were there; the falls came into action as intended,” Naeem said. “Keep in mind that the dynamics of perpetual futures work very differently than centrally cleared futures or spot markets, so they require stricter risk controls to unwind positions. Also keep in mind that everything happened within the space of about twelve minutes.”
