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Crypto Derivatives: A Better Investment Than Buying Crypto Coins?

Jul 15, 2018, 10:50AM
4 min, 37 sec READ

The market for cryptocurrency derivatives is growing despite long-term weakness in the traditional cryptocurrency sector.

Derivatives are financial securities with prices that fluctuate based on the value of an underlying asset or group of assets. Traditionally, the underlying assets were commodities like soybeans or corn. If a farmer wants to sell his harvest at a specific time in the future, he can trade a derivative contract instead of the actual produce. 

With time and the growth of financial systems, derivatives became more complex and grew to include things like mortgages, weather, and of course, cryptocurrency.  

Cryptocurrency derivates entered mainstream consciousness with the launch of Bitcoin futures by both CBOE Global Markets and CME Group in December 2017. CBOE, also known as the Chicago Board Options Exchange, is America's largest options marketplace, and its foray into cryptocurrency-based derivatives was an important milestone in the financial industry. 

Today, Bitcoin futures are available on a variety of mainstream trading platforms, and the cryptocurrency derivative market has expanded to include a plethora of investment products.

Means to Invest in Crypto Derivatives

The market for cryptocurrency derivatives is growing despite long-term weakness in the traditional cryptocurrency sector. 

Following the launch of Bitcoin futures on CBOE and CME, several additional platforms have announced support for these new financial securities, and the range of derivative products available to consumers is also expanding. 

Back in March, Chris Concannon, the president of CBOE, revealed his organization's interest in possibly introducing derivatives based on other popular blockchain protocols such as Ether (ETH), Ripple (XRP), and Bitcoin Cash (BCH). On top of this, several organizations offer blockchain-based solutions for cryptocurrency derivative investors who want to invest in something other than Bitcoin. 

Cryptoderivatives.market is a decentralized platform that allows users to exchange ERC20-based derivatives without a middleman. However, platforms like this are not available to American investors because they do not comply with U.S financial regulations. Most American investors can access cryptocurrency derivatives through traditional discount brokerages such as E*Trade, TD Ameritrade, and Ally Financial. These brokerages use the XBT futures developed by CBOE. Higher net worth investors may work with more sophisticated brokerages like Goldman Sachs. 

Goldman Sachs is already working with Bitcoin futures clients and there is a possibility of expansion into a wider array of cryptocurrency-based products. David Solomon, the company’s COO stated,

We are clearing some futures around Bitcoin, talking about doing some other activities there, but it’s going very cautiously. We’re listening to our clients and trying to help our clients as they’re exploring those things too.

Funds & ETFs

U.S-based investors have access to the Greyscale Bitcoin Investment Trust (GBTC), a publicly-traded trust designed to directly track the performance of Bitcoin. 

Unlike other derivative products, GBTC operates in essentially the same way as a stock or ETF. Shares are titled in the investor's name, giving the asset a familiar structure for taxation and reporting. GBTC charges an annual management fee of two percent, and the fund generally trades at a large premium to the value of Bitcoin held in the trust. 

Right now, GBTC is worth almost double the value of Bitcoin held in its vaults.

Greyscale also operates several other cryptocurrency-base derivates, allowing investors to gain access to Bitcoin (BTC), Bitcoin Cash (BCH), Ethereum (ETH), Ethereum Classic (ETC), Litecoin (LTE), Ripple (XRP) and Zcash (ZEC). 

Pros and Cons of Crypto Derivatives

Cryptocurrency derivatives have numerous advantages over regular coins and tokens, but they also come with challenges and limitations. That is why it is important for investors to consider their unique situation and investment goals before putting money in any type of financial security.

The Pros

•    Derivatives allow investors to gain access to the cryptocurrency market without having to hold any crypto.

•    Cryptocurrency derivatives can streamline tax and reporting.

•    Cryptocurrency derivates allow investors to utilize more sophisticated trading strategies like short-selling and leveraged trading.

•    Cryptocurrency derivatives help bring cryptocurrency investing into the mainstream. The involvement of companies like Goldman Sachs and CBOE Inc. make the sector look more legitimate to institutional investors. 

•    Cryptocurrency derivatives may add liquidity and transparency to the market.

The Cons

•    Cryptocurrency derivate trading can be restrictive for some investors due to regulatory requirements. For example, many discount brokerages require a higher account value before enabling derivate trading. 

•    Cryptocurrency derivate trading is more complex than other forms of investing in the sector.

•    Some cryptocurrency derivates charge fees.

•    Cryptocurrency derivatives often trade at large premiums over the value of the underlying asset. 

•    Cryptocurrency derivatives may be exerting negative pressures on the market. This is because they make it easier for people to short sell assets, possibly driving down the market price. 

Conclusion 

As the cryptocurrency bear market continues, growing demand for cryptocurrency derivatives brings life to the struggling industry. These securities allow investors to utilize margin, employ sophisticated trading strategies, and profit no matter the direction of the market. But despite their many advantages, cryptocurrency derivatives, like all financial instruments, carry a risk that can’t be understated. 

As time goes on, investors can expect derivatives to make up an increasingly important portion of the total cryptocurrency industry. They are likely to expand in both scope as sophistication as more players enter the market. 

Disclaimer: information contained herein is provided without considering your personal circumstances, therefore should not be construed as financial advice, investment recommendation or an offer of, or solicitation for, any transactions in cryptocurrencies.