Acuiti, the business intelligence platform for insights and analytics in the global derivatives market, recently published its Crypto Derivatives Insights Report based on a survey conducted with its crypto derivatives community of prop traders, hedge funds, banks and exchanges. In a Q&A with DerivSource, Will Mitting, founder and managing director, at Acuiti explains the main findings from the survey and how they offer a glimpse into how this space is evolving and how innovations in native crypto may evolve to disrupt institutional market infrastructure.
Q. The Acuiti survey highlights key findings reflecting how crypto derivatives market participants expect or hope this space to evolve in the new future and along the lines market structure and evolution, regulatory infrastructure and derivatives market share. In your view, what is the most important takeaway from this survey and why?
A. What our inaugural quarterly Crypto Derivatives Management Insight Report really brings home is how different the market structure that is evolving in the crypto derivatives market is from the traditional futures and options world.
Take the most obvious difference of the number of exchanges offering the same products. In the traditional futures environment, there is an inherent winner takes all market structure, primarily down to the lack of fungibility between products at a clearing level. For several reasons, the crypto futures world is evolving in a multi-exchange environment. (I caveat that with the fact that options are different – there is clear concentration on Deribit, which has over 90% of market share today).
What is interesting today is how that multi-exchange environment in the futures market will develop. A majority of the Acuiti Crypto Derivatives Expert Network, which is surveyed to produce the quarterly report, expect consolidation in the number of exchanges over the next three years.
What that consolidation looks like will define the future of crypto derivatives trading for years to come. We have seen early M&A from Coinbase and FTX, which have both acquired regulated US-based futures markets over the last six month. These moves, however, are regulatory plays rather than consolidatory moves. Once the regulatory environment for crypto derivatives platforms becomes clearer consolidation is likely to follow.
Q. The survey asserts that sell-side intermediation could have the biggest positive non-regulatory impact on the crypto derivatives environment? Can you explain to our audience why this is the case?
A. Owing to the lack of a clear onshore regulatory framework, participation in crypto derivatives by the traditional sell-side has largely been limited to offering access and clearing to products traded on CME, Bakkt and, briefly, CBOE – the regulated onshore markets.
Perhaps most interesting angle with regards to sell-side intermediation today is how crypto native sell-side firms are evolving to fill the gap left by the traditional players, building their offerings around the unique crypto market structure, and how these innovations are impacting the “TradFi” market. For example, Copper, which offers among other things a crypto-native custody platform, recently did a deal with State Street to partner on an institutional digital asset custody offering.
Elsewhere, FTX, following its deal to acquire LedgerX, applied to the CFTC to offer cleared and margin products directly to investors without the involvement of an FCM to clear the trades. This non-intermediated model would potentially enable 24/7 trading in traditional futures products adopting the market structure of native crypto derivatives exchanges. It is a fascinating idea, although there are several viable challenges to it that are being voiced in some corners of the market.
Overall, these two examples are indicative of two trends – one is how innovations in digital assets are beginning to change traditional finance. The other is the need for regulators to urgently develop regulatory frameworks that will enable the traditional sell-side to offer more in this market. Bringing the native and traditional world together will optimise the growth potential of crypto derivatives trading.
Q. An increase in participation from the buy-side was cited as the second biggest development that would impact the trading crypto derivatives environment? This area is already growing even though many institutional sell-side firms are sitting on the fringes. What do you think will need to happen to push these traditionalists to take the plunge to support crypto derivatives?
A. This is very closely linked to the previous question. While there is strong demand from the traditional buy-side to trade crypto derivatives, and many are already active in the market, many are being held back from engaging by the lack of offerings from their preferred sell-side partners.
Q. Can you share how survey participants viewed how the high volatility environment of crypto evolving and how this expected evolution might impact the existing barriers or lines drawn between native crypto and institutional business?
A. Crypto currencies have been synonymous with volatility since they became mainstream around five years ago. However, almost two thirds of respondents thought that volatility would settle down either in the next few months or once digital currencies as a concept have matured.
That is already being born out – over the past three months bitcoin has been considerably less volatile than certain commodities and, indeed, than some benchmark stock indices.
While many are attracted to the volatility in crypto as it provides trading opportunities, the costs of margining will come down as volatility reduces. In addition, more traditional buy-side firms will become more comfortable with bitcoin as an investable asset class after a period of sustained lower volatility.
Q. You mention the debate on if exchanges should be licensed to offer custody services to institutional clients and that the view on this is split among your community members. Can you explain this debate in more detail and why there is such a divide on this issue?
A. As noted above, the native crypto players are evolving their offerings without the engagement of most of the traditional sell side. This creates a blank canvas for what various service providers can offer. Whereas in the traditional world there are clearly defined roles and boundaries, in the native market these roles and boundaries are being set and defined.
One area currently under debate is whether exchanges should be licenced to offer custody services. The survey of the expert network for the report found that around 60% thought that exchanges should not be able to offer custody citing concerns over security and market dominance.
Q. There is no doubt greater regulation and oversight is expected in the crypto space. Your survey participants noted platform regulation is the top area that needs development in terms of regulation. What specifically do firms want to be regulated and how?
A. Platform regulation was top of the list of areas that members of the expert network wanted to see put in place. This is key as it would allow greater participation from the traditional sell-side and buy-side but also provide regulatory clarity to the venues.
Regulation is in the interests of almost all parties but particularly for the traditional sell-side who are being disintermediated from the market currently and are also unable to provide balance sheet to the market.
An appropriate regulatory framework would allow both the native and traditional world to come together to build a market that draws upon the best of both the traditional and the new environments. Crypto currencies and the new technologies that they are bringing to the market promise innovations on a level not seen for decades. However, they need to grow and develop in an orderly and well-functioning market and that requires appropriate regulation.
*This interview is based on the Acuiti report – “Crypto Derivatives Managers’ Insight Report Q2 2022 – Acuiti
