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 start using digital asset derivatives for investment or hedging, said Usman Naeem, the Nasdaq-listed company’s global head of derivatives sales.
The institutions waking up to globally regulated crypto derivatives are typically asset managers who have a fiduciary duty to either 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 the activity, probably more than three-quarters, was in Asia,” Naeem said. “I think it’s going to rebalance a little bit and we’re going to see US and Europe-based, non-market maker institutions really getting into derivatives.”
Coinbase started life back in early 2012 as an on and off ramp for bitcoin and developed into an exchange that successfully captured a large part of the spot market, which at that time was in the United States. However, from 2017 onwards, innovations in crypto-like perpetual futures drove as much as 85% of volume and liquidity outside the US, mainly to the APAC region.
In response to this, in 2022 Coinbase acquired FairX, a derivatives platform registered with the Commodity Futures Trading Commission (CFTC), to offer US-regulated futures. It followed up with the Deribit purchase in May.
The rebalancing of the crypto derivatives market from Asia and places like Dubai, where perps are popular, will also see an adjustment in the type of strategy towards an approach more aligned with traditional finance, Naeem said. Traditional money managers don’t want to just buy $10 million or $20 million in bitcoin, he said. They are looking to scale up in a risk-managed way, and that involves using derivatives to hedge.
“As more long-term owners come in who are risk-managed, I think we’ll start to see a volatility service that more closely replicates what happens in traditional finance,” Naeem said. “Rather than just speculating after a 50% rally in bitcoin, they might be selling some upside to help finance downside insurance. These dynamics will cause a massive shift in volatility services, bringing more 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 earlier this month, which led to about $7 billion in liquidations in a very short period of time. Doesn’t the extreme volatility keep institutions on the sidelines?
Naeem pointed out that flash crashes are not exclusive to crypto and that the infrastructure of the digital asset industry was mostly working.
“The liquidations were there; the falls started as designed,” Naeem said. “Remember the dynamics of perpetual futures work very differently than either centrally cleared futures or spot, so they need tighter risk controls to liquidate positions. Also remember that everything happened in a window of 12 minutes or so.”
