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Will Derivatives Affect the Crypto Markets in 2022?

Will Derivatives Affect the Crypto Markets in 2022

Yes, and they always have.

Everyone has seen stories of future contracts causing fluctuations in Bitcoin and Ether prices, especially when they cause sharp crashes. This won’t change soon.

In fact, the crypto industry has been affected a lot by leverage use, including resources from BitMEX and their May 2016 futures contracts.

However, the derivatives world is much larger than the average investor. It also includes institutional clients, market makers, mutual funds, and professional traders who can make use of its hedging advantages.

How?

Many large capital funds are already entering the Bitcoin market. For example, April 2020 saw Renaissance Technologies (hedge fund worth $130 billion) enter the Bitcoin futures pool, and through CME-listed instruments.

So what impact do those kinds of companies have on crypto? We’ll mention five of those below.

#1 – Miners Will Hedge Using Long-Term Contracts

Miners tend to switch their trading strategies as they become more professional. Instead of relying on short price swings to profit, they capitalize more on larger movements.

This leads to more demand for derivative instruments.

For example, miners can buy futures contracts that expire within three months, locking the sales price then. From there, regardless of market movements, a miner knows how much they get back prior.

Miners get similar results if they trade Bitcoin options contracts. As another example, a miner can sell a 2022 call option at $41,000 (assuming the current price is at $50,000). This will be enough to make up for profit losses if BTC drops to $43,000 or lower.

#2 – Crypto Movements Can Start to Correlate with Traditional Markets

At least in the short term.

As an asset, cryptocurrencies have become hedges against large-scale macroeconomic risks. Bitcoin is not an exclusive currency to that end.

However, cryptocurrencies may start to correlate with other major assets (such as commodities), and this did show briefly in 2021.

In fact, this may apply to government-issued assets too. Bitcoin values have been slowly reacting to the 10-year US Treasury Bill. Every time investors seek higher returns from fixed income instruments, that demand ends up reflecting on crypto asset prices.

But what about derivatives? Those are vital since many mutual funds cannot access cryptocurrencies directly. Instead, they rely on regulated futures contracts which grant them market access.

#3 – Investors Will Rely on Options Markets for Fixed Income

Currently, 80% of the Bitcoin and Ether options markets are held by the Deribit Derivatives Exchange – through FTX US and CME derivatives (which are US-regulated options) should eventually gain more market attention.

Why? Because institutional traders prefer those larger instruments, which do offer more stability (thus a sort of fixed income). They’re executed through strategies such as bull call spreads, covered calls, etc.

Also, institutional traders can combine buy/put options, setting a risk limit to options trades without risking liquidation.

Plus, many banks worldwide are keeping interest rates close to zero, or well below inflation. This forces investors to look for high return markets, even if that comes with higher risk.

#4 – Volatility Reduction

Crypto derivatives add volatility whenever an unpredicted price swing occurs. Those “forced liquidations” then become prediction tools for futures instrument movements.

Plus, they provide access to more leverage and move often done by retail investors.

However, institutional investors should be more prominent in Ether and Bitcoin derivatives, and thus will demand higher bid/ask prices. With that, a large multi-million dollar liquidation should have minimal impact on price motion.

Basically, with more professionals accessing crypto derivatives, we should see lower fluctuations in price tags. Over time, this should affect volatility, or at minimum reduce it.

#5 – Bitcoin Will Rely More on Collaterals for Traditional Finance

Crypto lending services are now accessible, a trend pioneered by a partnership between Nexo’s exchange and Fidelity Digital Assets. The service is only available to institutional investors.

The services are backed by Bitcoin cash loans that cannot be used in traditional money markets.

Those services make it easier for large companies (such as Block and Tesla) to add Bitcoin into their assets. It’ll be more usable as collateral for daily operations, allowing larger companies to increase the risk levels they take.

What do you think?

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