Coinbase (COIN), the cryptocurrency exchange that bought the largest cryptocurrency 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 investments or hedging, said Usman Naeem, global head of derivatives sales at the listed company. Nasdaq.
Institutions that are realizing globally regulated crypto derivatives are typically asset managers, who have a fiduciary duty to speculate or carry out strategies beyond simply providing liquidity, which is the purview of market makers, Naeem said in an interview with CoinDesk. They most likely come from the United States and Europe and are a fundamentally different type of company.
“In hindsight, the vast majority of the activity, probably more than three-quarters, was in Asia,” Naeem said. “I think that’s going to rebalance a little bit and we’re going to see non-market-making institutions based in the United States and Europe really getting into derivatives.”
Coinbase began life in early 2012 as an on-ramp and off-ramp for bitcoin. and evolved into an exchange, successfully capturing much of the spot market, which at the time was in the US. But starting in 2017, innovations in crypto such as perpetual futures drove up to 85% of volume and liquidity outside the US, primarily to the APAC region.
In response to this, Coinbase acquired FairX in 2022, a derivatives platform registered with the Commodity Futures Trading Commission (CFTC), to offer regulated futures in the United States. He followed up with the purchase of Deribit in May.
The rebalancing of the crypto derivatives market in Asia and places like Dubai, where criminals 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 just want to buy $10 or $20 million worth of bitcoin, he said. They are looking to expand their business by managing risk, and that involves using derivatives to hedge.
“As more long-term holders come in with risk management, I think we’re going to start to see a volatility service that more replicates what’s happening in traditional finance,” Naeem said. “Instead of just speculating on a 50% rally in bitcoin, perhaps they will sell some upside to help fund insurance for the downside. This dynamic 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 cryptocurrency flash crash earlier this month, which caused around $7 billion in liquidations, in a very short time? Doesn’t such extreme volatility keep institutions on the sidelines?
Naeem noted that flash crashes are not unique to cryptocurrencies and that, for the most part, the digital asset industry’s infrastructure worked.
“The liquidations were there; the cascades were activated as designed,” Naeem said. “You have to keep in mind that the dynamics of perpetual futures work very differently than centrally cleared futures or spot futures, so they need stricter risk controls to unwind positions. You also have to keep in mind that everything happened in a span of about 12 minutes.”
