Payal Shah, CME Group
AT A GLANCE
- Recent events have sparked a migration of investors moving from crypto native platforms to futures
- A regulated futures marketplace provides continuity of risk transfer and price discovery for the crypto industry
The digital asset market skyrocketed in value and influence in late 2021. 2022 was, in stark contrast, defined by a series of market events underpinned by structural issues that quickly spread into nearly every area of the digital asset industry – and beyond.
The market turmoil of 2022 will be remembered with the collapse of Terra Luna and its stablecoin UST, and later the bankruptcy filings of Three Arrows Capital, Voyager, Celsius Network and BlockFi. And to cap the year, the failure of FTX, including the contagion that occurred as a result, has gone down as of one of the largest cases of fraud in the history of U.S. financial markets. In addition, over the year, bitcoin prices made consistent lower lows, resulting in a prolonged bear market sentiment.
Fast forward to 2023, we are now dealing with a series of significant market-moving events driving inflation to multi-decade highs. Perhaps most notably, the pace of interest rate hikes in the U.S. has dampened the bond portfolios of banks, wiping out capital buffers – earmarked by the recent banking failures of Signature, Silvergate and Silicon Valley Bank.
In the wake of the collapse of prominent crypto firms and contagion concerns, the starting point for cryptocurrency investment decisions should center on risk management…and then risk management again.
Liquidity and Price Discovery
Time and time again, with volatility in the underlying crypto markets, we see a migration of investors moving from more crypto native spot platforms to futures. We saw it on November 8, 2022, following the FTX collapse, when CME Group Cryptocurrency products were traded in record numbers. On March 13, 2023, with the failure of Silicon Valley Bank, CME Group Cryptocurrency futures once again proved their use case and saw their best trading day of the year, exceeding 90,500 contracts (representing more than $4.6 billion in notional traded).
Source: CME Group
The Value of a Regulated Marketplace
With uncertain and volatile markets, the ability to borrow and go short spot crypto has dried up. As such, futures have become the venue in which institutions can efficiently gain short exposure. This underscores the role that a regulated futures marketplace plays for the industry in terms of continuity of risk transfer and price discovery.
Turbulence in the broader crypto market has increased the use case for CME Group’s Cryptocurrency futures and options for a number of key reasons. First, our regulated product suite continues to offer deep liquidity and price discovery with growth in both volume and open interest.
Since the launch of Bitcoin futures just over five years ago in 2017, and Ether Futures in 2021, CME Group’s transparent rules, regulations and operational controls have helped to consistently allow customers to manage cryptocurrency risk against rapid price swings and other market-moving events.
Battle-tested functionality like dynamic circuit breakers are in place to monitor significant price movements, while also allowing price discovery to continue, even amid rapid price fluctuations.
Position limits protect customers against the risk of over-concentrated positions by a small number of participants. Cryptocurrency futures are cash-settled contracts and margins are set in line with the volatility and liquidity profile of the asset, affording market participants greater predictability regardless of price fluctuations.
As a regulated derivatives exchange, CME Group also maintains segregated customer accounts at both the clearing house and clearing firm levels. Futures Commission Merchants (FCMs) act as intermediaries and serve as a risk buffer between the customer and the exchange where the trade occurs. The clearinghouse becomes the buyer to every seller and the seller to every buyer and guarantees the clearing and settlement of transactions on the exchange.
Futures and Cash in Alignment
CME Group Cryptocurrency futures settle on the last Friday of every contract month to the Bitcoin Reference Rate or Ether-Dollar Reference Rate. Both are regulated benchmarks under European Benchmark Regulation and have expert oversight committees. The reference rates are published daily at 4 p.m. London time and are derived from bitcoin-dollar or ether-dollar transactions from six leading cryptocurrency spot exchanges.
As more participants start trading in both spot and derivative markets, we see the development of a highly interrelated ecosystem, bringing the price discovery that’s happening in futures in alignment with the cash markets. It could be said that recent events might actually accelerate the next wave of institutional crypto adoption, rather than impede it.
Read the full analysis at Crypto Finance