Bitcoin has long been known for its violent swings in price. But the volatility isn’t just driven by tweets from Elon Musk or warnings from Chinese regulators: It’s also fed by a massive derivatives industry that has boomed on the back of voracious demand for leverage and speculative tools in cryptocurrency markets. In some ways it’s a tale as old as Wall Street, but now in a new digital wrapper. For instance, when Bitcoin plunged as much as 30% in a day in May, leveraged-up positions in futures and options were wiped out, with the expected consequence of amplifying the sell-off as they had boosted the rally earlier.
1. How big is the crypto derivatives market?
It’s pretty massive. In one 24-hour period ending July 16, for instance, Binance, the largest crypto exchange, recorded $48 billion of derivative volume, more than triple the activity in spot trades, Coinmarketcap data show. For context, CME Group Inc. saw an average $104 billion worth of energy contracts change hands every day in April. At the peak of the crypto euphoria in April, outstanding Bitcoin futures reached as high as $28 billion and have since plunged to $12 billion, Bybt data show. In June, more crypto derivatives were traded than actual coins, the first time that had happened in 2021, according to data tracker CryptoCompare.
2. What are they used for?
Old-timey derivatives like futures and options were invented long ago to give traders ways to hedge their positions, that is, to make side bets that would lessen the pain if the market turns against them. Of course, they have long been put to more speculative purposes, often as ways to add leverage to trades — and sometimes with spectacularly destructive effects, as was seen in the 2008 financial crisis. Hedging happens in crypto, too, especially by those with an economic stake such as miners, but it’s safe to say “to the moon” is largely the name of the game when it comes to crypto derivatives trading. That’s evident from the fact that most of the time on the top exchanges — especially before the recent drawdown — bullish positions exceed bearish ones. Major crypto exchanges like Binance where much of this derivative trading takes place have loudly advertised the ability to gear up positions by more than 100 times.