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Surging demand for derivatives is fueling Bitcoin’s resurgence

March 22, 2023 Updated Wed., March 22, 2023 at 12:28 p.m.

A collection of bitcoin, litecoin and ethereum tokens sit in this arranged photograph in Danbury, U.K., on Oct. 17, 2017.   (Bloomberg)
A collection of bitcoin, litecoin and ethereum tokens sit in this arranged photograph in Danbury, U.K., on Oct. 17, 2017.  (Bloomberg)
By Muyao Shen and Vildana Hajric Bloomberg

The forces that have reawakened crypto prices have aroused activity in the digital-assets derivatives market, too.

Open interest in Bitcoin options has skyrocketed, with the number of contracts rising to an all-time high in recent days, according to data from derivatives exchange Deribit.

Looked at another way, there’s also been an “astonishing increase” in Bitcoin open interest as measured in Bitcoin itself, according to Coinglass data compiled by Noelle Acheson, author of the “Crypto Is Macro Now” newsletter.

Meanwhile, options volumes have also risen, with some traders seeing that as a sign that new entrants might be stepping into the market.

All in all, derivative trading volumes currently account for more than 60% of the overall total – including spot – across crypto exchanges, according to CryptoCompare.

It’s all happening as the digital-assets market sees renewed interest amid the folding of a handful of banks in the traditional-finance space.

Bitcoin, the largest token, has gained roughly 70% so far this year to trade around $28,600 as of 12:37 p.m. in New York.

“The options market has absolutely exploded with demand and interest on these moves,” said Chris Newhouse, a crypto derivatives trader at crypto investment firm GSR.

“It really seems like other big players have started to step into the options markets.”

Crypto prices, coming off a banner start to the year, have surged anew in recent weeks amid turmoil in the U.S. and European financials sector, to which three U.S. banks have succumbed and which brought about the takeover of Credit Suisse by UBS over the weekend.

Digital-asset proponents say that their industry is a beneficiary as investors realize that tokens are out of the reach of governments and are far removed from any of the issues occurring with different lenders.

Options volume has picked up recently especially as traders expect high market volatility amid the banking crisis, said Luuk Strijers, chief commercial officer at Deribit.

“Talking to clients in November and December was all about protection and trust and security,” he said. “And now it’s about opportunity. People are coming back” to trade derivatives.

And there are signs that the new options participants are taking more bullish positions, said Acheson. Currently, there’s a lot of demand for calls.

“Traders are coming back into the market with sizable volumes – the combination of cheap options and possibly sharp price moves – which we are seeing – is a strong opportunity for any trader, not just crypto traders,” she said.

Derivatives products in crypto tend to be super popular with investors.

In recent months, some crypto firms have looked to build new derivatives exchanges to fill in a gap left by FTX, which imploded at the end of last year.

Meanwhile, the demise of some crypto lenders, including Genesis, have left some traders searching for other ways to leverage their positions. Genesis says its trading business continues to operate well.

“If you look to equity markets as a guide, the derivatives market is multiples larger than the spot market. It makes sense that this same trend would play out in crypto,” said Marc Weinstein, partner at Mechanism Capital, which invests in a few derivatives exchanges.

“As the infrastructure has improved, the size of derivatives both on- and off-chain is growing.”

Meanwhile, with the drop in both volume and liquidity, taking short positions on the spot market has become very difficult, according to David Martin, head of institutional coverage at digital-asset prime brokerage FalconX.

Derivatives have quickly become a popular market for institutional traders to go long and short, expressing their views on the market as well as hedging their portfolio.

Some investors were making an “artificial stablecoin” by taking a short position in the derivatives market while continuing to own Bitcoin, according to Antonio Juliano, founder and CEO of decentralized exchange dYdX.

“If you do that, you effectively have a stable asset that at least has a different risk profile than a stablecoin that has some dollars in the bank,” he said. “That’s a pretty good example of how derivatives have been used for hedging.”

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