The Impact of Crypto Derivatives on Crypto Spot Markets

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ErisX is preparing for a season of product acceleration this fall. One might call it a harvest of initiatives planted this summer. In the coming weeks we will roll out exciting enhancements to our products and services, many with a focus on our retail members. These will complement our low cost cryptocurrency spot and U.S. based futures offerings, giving our Members more options for what, where, and how they trade!

Our team has deep experience in commodity derivatives and, by operating a spot and futures market on one platform, we are in a unique position to understand the relationship between both markets. Below is an explanation of why we believe derivatives trading will continue to be important for the growth of the crypto spot market and talk about challenges specific to crypto futures. Our readers also get a sneak peek at a new cash-settled futures product we are introducing later this month: Bounded Futures. Read On!

Economic Impact of Derivatives

According to the Commodity Futures Trading Commission (CFTC), futures trading began in 1859 when the Chicago Board of Trade was granted a charter to list futures products on wheat, corn and oats. Since then, products may have advanced, underlying instruments have expanded and markets are more technical; the introduction of futures has historically been a catalyst for growth in the market for a commodity.

Derivatives draw new and more diverse participants into the market, such as professional trading firms and market makers. The sophistication and diversity of players tends to make the market more efficient and brings natural-growth. This is in part a consequence of the technology and risk management capabilities of sophisticated firms who can quote more depth and tighter spreads. Exchange traded and cleared derivatives often become an important — and potentially the primary — source of price discovery. A good example is the COMEX gold futures vs the LBMA spot market. Both are significant, and which sets the price for gold has been a subject of debate and research.

Over the past 17 years, global equity futures have grown at nearly 2x the rate of cash equities (ie “spot”). Much of this growth has come recently, demonstrating and accelerating interest in derivatives (Source: World Federation of Exchanges; SIFMA Includes Listed and OTC equity futures).

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There are additional benefits that derivatives bring to the overall economy. According to a 2014 Milken Institute study titled “Deriving the Economic Impact of Derivatives,” “through risk mitigation, derivatives positively impacted U.S. economic growth during and after the 2008 financial crisis… derivatives expanded U.S. real GDP between 2003 and 2012 by 1.1 percent ($149.5 billion).”

With this in mind, the crypto futures markets are in very early stages (the first futures contract on Bitcoin didn’t launch until late 2017). As ErisX is the only U.S. based exchange that enables individual investors to access crypto spot and derivatives directly on a single platform, we invite you to participate in the very early days of this exciting and emerging market!

Regulation

To launch a futures market in the United States, ErisX was required to secure Designated Contract Market (DCM) and Derivatives Clearing Organization (DCO) licenses which fall under the jurisdiction of the CFTC. Regulated markets enable traders to explore the crypto markets without taking on the risk encountered at offshore or decentralized exchanges. We provide oversight, accountability, and transparency. For more information about the roles and responsibilities of a DCM and DCO, as well as our obligation to keep Member funds secure, we invite you to read this post.

It is important to note that our spot market is not regulated by the CFTC. We do, however, apply CFTC core principles to our spot markets and operate them under state and federal licensing requirements; such as the New York Virtual Currency “Bitlicense”, and FinCEN guidelines. ErisX is currently licensed in 50 states and territories and has applications pending in Nevada, Virginia, and the U.S. Virgin Islands. We are also proud to be one of only 12 firms participating in a pilot program in the state of Hawaii that enables us to offer services there, too.

Physically Delivered vs Cash Settled

Futures contracts that trade and clear on a CFTC regulated DCM and DCO are well understood products in the United States. Our Members that want to buy/sell the actual cryptocurrency can do so on a fully regulated exchange and settle via a fully regulated clearinghouse. This gives them the benefit of market oversight and surveillance that comes with such markets, and elimination of settlement risk.

There are two different ways a futures contract can be settled: physically delivered or cash settled. Physically delivered futures contracts allow position holders to receive or deliver the underlying cryptocurrency and reduce the inherent risk of slippage that may be present in cash settled contracts. ErisX allows its members to sell futures contracts and use their Bitcoin or Ether holdings as collateral or buy Bitcoin and Ether and have it physically delivered.

Physically settled contracts offer additional benefits, for example for “industrial” users of cryptocurrencies. Miners are able to lock in prices for current and expected inventory and deliver in the future. Ethereum DApp users that require ETH to pay gas fees, for example, can lock prices and take delivery in the future.

While we initially launched with physically delivered contracts, we understand the market’s need for a variety of settlement options.

Our Bounded Futures contracts coming soon are for market participants who want exposure to the asset price but don’t want to take delivery of the actual cryptocurrency. Bounded Futures are cash-collateralized with boundaries protecting position holders from large price movements in the underlying cryptocurrency. Bounded Futures retain the integrity as fully-funded contracts but may require less cash collateral compared to other U.S. crypto futures contracts. And best of all, the upper and lower bounds let Members limit their max potential loss. These are risk management tools that may be attractive to those who are tired of getting “REKT” on other markets. Please email info@erisx.com if you would like to learn more about Bounded Futures.

Challenges Unlike Traditional Markets

Unlike traditional commodities, cryptocurrencies may be subject to events such as a forking of the blockchain that can lead to the creation of new assets. This is where our background in the established capital markets has prepared us.

In designing derivatives contracts, or listing assets on our spot market, we have developed policies and procedures to anticipate and manage such potential events. In doing so, we aim to limit subjectivity and discretion to the greatest extent possible, while allowing sufficient flexibility to deal with the peculiarities of each specific situation. We aim to give our customers as much clarity and certainty as we can, ensure that we have clear internal controls and clear designation of authority.

The cryptocurrency market is new and we welcome everyone with all levels of experience to explore trading responsibly without sacrificing security, transparency or reliability. Whether you open an account and make a simple buy of bitcoin in two clicks, or you wish to trade the basis across spot and futures, we have you covered with a variety of products.

The team at ErisX has the benefit of experience gained through decades of practice in the established derivatives markets, to understand the unique risks and challenges of the crypto markets. We also benefit from the knowledge of many products and trading strategies that exist in other markets that will translate well to crypto. As market operators, our goal is to create opportunity for participants, while reducing risks. We strongly believe that derivatives will accelerate growth in the crypto market. In the coming weeks we will be introducing new products and features such as the cash settled Bounded Futures contract to help our Members take part in these nascent markets. We hope you will stay tuned.

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