The Dos and Don’ts in Derivatives Trading | European Blockchain Convention

[Music] thank you so much for that warm warm introduction it is um my pleasure to be here to introduce this panel and to have a talk about derivatives all things derivatives and especially especially happy to be in this beautiful city so B venidos um I'm a co-founder of immersive Finance we Support options Traders and volatility uh funds uh on the risk management side and U I have an fx options background 25 years so I love everything derivatives and options and it is my pleasure now uh to introduce our panel but I I I think it's best if we all give a small introduction about ourselves uh and the companies you to start start hello everyone um I'm HRI K uh co-founder at Tex where a new uh crypto options exchange um basically creating a hopefully a compelling alternative to to darit um and what also sets us apart is that um we uh partner actually with other spot exchanges uh where we make it very easy for their customer bases to uh to integrate with us um and in Q4 will will kick off that strategy with our first partner bitf thank you hello everyone my name is anesti saradis I'm the co-founder of Center markets it's an OTC structured product desk that is trading options in Bitcoin ethereum in the top 100 tokens anything from basic vanilla to structure products and before that I used to trade Commodities in large sizes for a decade uh hosting a panel right after lunch may not yield the immediate audience right but at least two derivatives Warriors are here so my name is Greg I managed a Global Micro fund for 15 years before calling it today and starting the company in crypto to do uh Euro stable coin we are the biggest and the old stable coin around that pushed regulations uh from the southern part of Europe into the whole Euro Zone hello uh good afternoon bonjour uh my name is jear bonu um I'm a kind of derivative veteran started uh in commodity derivatives in the in the '90s uh in a large investment Banks and uh started a management company in uh London in 2007 uh managing a number of commodity derivative funds and we pivoted to effectively digital Commodities AKA crypto in um four years ago four and a half years ago and effectively we are a systematic long short uh liquid uh hedge fund thank you very much and I think that we cannot start this panel discussion without talking about the big news from last week so we had the sack approving op options on bitcoin ETFs spot ETFs and um from Black Rock so I have a question what is what do you think is the significance of this approval from the SEC anest you want start yes uh this is some big news that everybody has been waiting for I believe that uh by allowing uh Bitcoin options on the ETFs uh suddenly the flow in derivatives Market overall will pick up by a lot mostly because the ETF Traders themselves Who start utilizing options Trader strategies for yield or risk management but more importantly because many crypto native funds have now an extra source to run arbitr strategies with so I believe that down the road the volatility between the Bitcoin ETFs and the CME will end up normalizing across all Lo changes as most Traders will try to be running that Arbitrage Jamar yeah I mean in terms of uh um validation it's phenomenal right we we saw the impact of the ETF on Delta One Flat price action uh and to have the same validation in terms of the largest deepest Capital Market in the world the USA of an option product uh it's phenomenal although I mean obviously there were already some option Market there's a CME option contract that does exist and uh there are some uh on the other side of the fence so to speak on the unregulated side there already a very buoyant U option Market but to have this us regulator imprint on that option contract is is a massive validator fantastic anybody else um I I I have to say that that definitely means that uh implied volatility will be became already an asset class of itself and when people say crypto is volatile volle well guess what Bitcoin uh last few years became less volatile than some of the traditional equities uh even before say events like Nvidia earnings release or something implied volatility on bitcoin was lower trading low that means there are institutional Capital that is offering this volatility on the market and we need credible uh platforms exchanges where that can be bought and sold so that comes to another question uh the legitimacy and the quality of the collateral that is used to to input these traits and to settle the traits we'll address them a little bit later but this is definitely important Milestone meaning that not just the crypto becoming institutionalized but the derivative on crypto implied volatility is also becoming institutional grade product maybe one quick addition to that point so to frame it in 2021 Bitcoin was a was a 100% Vol asset now it sort of mean reverts around 50 % Vol uh sometimes on the on the slow Saturday you can pick up Bitcoin Vol for 30% and so now probably as we've seen with the um with the previous um ETF introductions and uh and and the ability to sell future term structure probably you'll see a lot of covered call overriding further suppressing that ball um and that in turn will actually then unlock a lot more demand for using options uh to express directional views or hedging and so a big part of actually options um growth is is not just that piece of Education or certain institutions entering the space it's also just frankly that the cost of carry of options is really um structurally uh going down over the last uh few years but I have a question so do you see enough adoption of the derivatives Market do you think you know are we where we' like to be now uh did you expect to see because you all have been in the space now for a while so would you have expected a you know much faster pace of growth at this point so sorry um I mean in my view I mean let's take a bit of a step back right what's the size today of derivative Market in uh crypto um if you look at traditional markets equities um and commodities in particular the derivative Market is a big multiple of the underlying uh spot market right in in crypto it is not it's actually smaller so if you think of the Journey of crypto to mimic um a more mature traditional asset you're going to see a situation where you need an inversion of that volume right you need to have Dy Market as a way to leverage um with paper uh the uh size of the underlying market so I think there's a lot of room to move from I think the options the the options market for instance in crypto is probably 60 billion uh um a month um which is Tiny compared to the cash Market in crypto and and tiniest compared to the option Market in traditional Finance so to have those venues um U the off exchange venue the CME now the ETF it kind of gives some more depth into the uh infrastructure to scale uh that and because it now addresses different constituents of the market crypto native will go to derit uh a mixed Crowd Goes to CME and then the US crowd it could go to the options in uh ETF you you mapping the the infrastructure is mapping much better for future growth the the needs of the market but coming back to that sorry so in my opinion um this is a two-sided answer can liquidity in the options across all crypto get much better absolutely is it good enough compared to where the market is currently I also think absolutely for two different reasons number one there is lack of regulatory Clarity the majority of the players in the developed uh countries and markets like the US and the Europe cannot access Bitcoin denominated options or crypto denominated options so you have that Arbitrage on CME that is closing two hours a day it doesn't really work at the same time one thing that many people uh forgetting crypto is that out of the $2 trillion let's say half is uh altcoins more than 60% of those tokens are still locked in sfts so the reality is that you have locked tokens that you need to utilize cash flow outside the token with the risk of the token rallying against your dollars and being margin called in multiples and this is something that is actually preventing uh the market on the alss for picking up simply because out of that one trillion Less Than 3 400 billion are actually liquid to be traded against derivatives uh I can give you even a number so when the front month volatility of Bitcoin will reach sort of gold level then you can say it it's enough now we just starting fantastic on that same note we talked about what would it take to really really bring financial institutions to the space what is it lacking do you see you know because I think that financial institutions I would say are only tipping in with ETFs maybe with with options so what is it that we lacking I think um if you look at the institutional adoption we have near 100% adoption of um proprietary Traders so people who trade their own money and usually those specialize in Market making and so crypto is already extremely mature in this use case of let's call it High Velocity Trading look at binance if you look at volume to open interest it's it's barely drops below two right so it's basically a lot of retail using um perpetuals as kind of the zero DTE options and market makers taking the other side of that it's fantastic flow for them it's incredibly Capital efficient um and they can um buy and sell um innumerable times each day and so every large Market maker uh inad fire is basically um already in crypto or um or about to um I think where you see much less adoption is in in lower velocity types of trading um think of like a Bren Howard style hedge fund that would use um derivatives uh Futures and options to express like complex views maybe related to also micro conditions um and because the problem there is that when you go to trades that have um longer durations of holding right you're still um often locking up a lot of collateral um um on exchanges and for a lot of Institutions they're absolutely still not happy with the the counterparty risk that involves um so so shall we talk a little bit about the collateral shall we or can I just finish just finish on the what will be the killer use case for options to scale I think if you look again at the traditional markets sorry to go back in time but there's two things is hedging and yield right so um you can hedge with u with uh with the options and I think this new instrument is going to allow some people who cannot hedge today to hedge and then even more crucially you can create yield uh I mean the biggest use of traditional Finance in option is to sell uh upside to increase yield right look at the bond market Bill gross spent his career selling uh all he could of upside calls on bonds so in Commodities you can do that so all these people who have now bought the ETF they'll be able to create a yield by selling belong the ETF sell sell the call and because it's the same stock I think it's going to happen in a more agile manner than if you have to buy your ETF and sell the CME or sell thereit so it's all about Capital what what ties up also these two big use cases will be Capital optimization because um the Brokers now in the US will be able to cross your margin on um the ETF option and the CME option that's something that cannot happen today on on uh of exchange uh like there AIT markets they're not they're a little bit insulated from Capital optimization um so those two use cases plus that Capital optimization is a good springboard for for growth I think and to finalize a little bit of the thought I think we kind of try to overrun whenever you say what does it take to bring the large institutions before we even try and get there we need to figure out what does it take to actually educate the crypto native Market on utilizing derivatives you know how do we need to train the Bitcoin miners to figure out how to hedge how can we teach the foundations the importance of risk management you know both on the Bitcoin ethereum level but also on the native token the financial institution will not come unless you have regulatory Clarity like people sometimes fail to understand that if I'm an80 billion fund on my PPM I already explain in extreme detail what I can trade and what I cannot trade so if as a us as Government you cannot Define what is an Alco and what is not I will never take the risk of putting $50 million of a small Al position because it will geop partise the legality of my full $60 billion fund so unless there is full uh regulatory Clarity I think as an ecosystem we should focus on training the crypto native people on utilizing derivatives and that will bring the regulator on trying to actually better determine the value of these assets and then the larger trade five players will come and start playing so if I can paraphrase you you're saying that there is quite a lot of liquidity yet to be unlocked abolutely in within the crypto system itself ecosystem um both in terms of lur the old coin Market but also within all the funds which are holding all the tokens yeah so there's quite a lot of upside opportunity in terms of these players coming in that's one point of view yeah I have to mention that there is also a problem with the dollar stable coin collateral because the dollar stable coins are not a legal claim on the isure so besides just the regular implied volatility you trading you have a credit risk of the isser itself and then you've got a risk that that stable coin will not be settled into Fiat now the dollar settl is so congested and fed recently issued a warning to United Texas bank which served 70% of dollar settlement so the the until there is a Clarity in us like what is a dollar stable coin how is it regulated what how to calculate the credit risk associated with that stable Point definitely exchanges like CME will have a massive advantage over all other derivative exchanges in the form of institutional adoption because if you're running an institution you cannot risk your career trading the instrument which has all this internal risks inside to some point there are Euro stable coins and M regulation Europe which solves that right but they're not at the level of adoption the dollar stable coins are so but Mika Mika helped with that or yeah because it it it creates a legal claim on the iser so Euro stable coin you always know you can go to court and liquidate all the assets of the isare which are transparently segregated and audited with the dollar stable coins nobody owes you anything it's a good will of the isser to send you money but how good is that will if they cannot send the money because the bank may not be willing to send money in exchange for the cash or stable coins so that that that has been a problem for a while and all the market makers know in order to settle dollars into stable coins and back you sometime have to pray to pay huge premiums and it may not work tomorrow until there is legal Clarity in us do you agree with that hendrik um to some degree but I think um the the issue with stable coins is is much broader than like themselves as a product they have these massive Network effects uh if you look at tether um it's the main um stable coin used for settlement of derivatives and you know bance already tried to get sort of rid of T um and replace it with other stable coins and failed um and I think actually if if MAA is is is essentially pushing um de settling derivatives exchanges out of Europe it's just going to I think displace a lot of that um that execution just outside of Europe um and so there's also then uh with some of these stable coins tther and usdc also a network effect in in more and more like real life use cases and I think breaking those Network effects is is is very hard so I actually think that yeah yeah but we are talking about institutional grade risk management so if you're trading for State treat or like big standard chart or other you would not touch these instruments yeah I think I think though that a lot of these sort of institutional guys they seem to get more and more comfortable with stable coin liquidity and they're much more interested about like drisking lack of liquidity than drisking the stable coin in my experience so we maybe is interesting because we're talking about derivatives and yet we we ended up talking about stable coin so we see how there are so many components uh to understand but there are many players were very comfortable within that space and from what you I hear you more and more players are getting comfortable I either through regulation or through other mechanisms perhaps in terms of the trading but I want to come back to derivatives so a little bit and talk about the basis trade so maybe somebody can explain um um the basis trade maybe anesis you want to explain the basis trade in simple terms to everybody and why does it exist in crypto um you know and is there going to be a point where it's going to be stopped being profitable absolutely so essentially taking it a step back in the Commodities markets we have the price of spot and you also have the price of what you think would cost to buy or sell the commodity at some time in the future and that has been happening because since the old days people that were trading spot Commodities they were trading what's called forward contracts where they would lock the quantity of the trade but not the price and they were able to utilize the Futures curve in order to hedge retroactively at the price they wanted so the cash and carry trade on bitcoin is very simply the trade where you buy Spot and you go and sell a Futures Contract at whatever duration you want six to 12 months out and you're actually capping that price difference right now because everybody's bu is Bitcoin uh every forward price on the Futures Market is higher than the price of spot so essentially what does that mean if spot is trading at $50,000 and the September 2025 Futures Contract is trading at $55,000 that's 10% higher so the cas and car trade is where the trader buy spot at 50,000 sells the equivalent amount of the September Futures at 55,000 and at expiration you make that 10 % risk- free there is price risk- free there is always counterparty risk and this is something that I always like touching when somebody says it's risk free that refers only to price the largest risk in crypto is counterparty risk not price and then of course Market knows like silver Corner nickel corner I mean you name it once in a while every commodity goes haywire and sometimes this uh spread expands uh to to massive uh numbers absolutely so essentially this trade is risk-free as far as you are not willing to unwind it until it expires because during the duration of the trade the future might go significantly higher than the spot or vice versa so as far as you're bucking it by 100% oneon-one and you don't lift it till the end you are okay when it gets funky is when people try to trade around the trade and this is when you usually see people blowing up but but be careful oil trade it negative I have a question for jear and that what do you think je Mar about the basis trade would it last forever so I've traded a commodity basis trade for 20 years and uh it can surprise you it can flip from contango to bation we talk about contango here when the back of the curve is higher tomorrow is higher the price than today but the reality is that it can Spike the front can Spike because it's a shortage of the short-term spot and then you got back then you don't make money on the on the on that Bas trade so it's a nice trade but it's transient it's not going to give you if you a fun for instance okay there are years where you can make money on the Bas trade and years you won't make any money right you have to find something else so you have to be aware that it's a very um volatile uh pattern in in in structure and I would say trying to think about crypto it is possible that the Advent of the ETF and the option ETF could could compress the basis trade because they going to if they do what I said earlier they do structured paper on on on ETF right if they if 5% of the ETF holders on Bitcoin today start doing structur trades like a reverse convertible I mean you name it right and then basically selling ball you're going to have a crush push push down the the business trade so I'll be interested to see how the business trade looks like in 12 months I wonder add something very I think important uh for the Bitcoin specifically it's the only Cash and Carry trade you can do in Commodities where you can actually post the underlying commodity as collateral because if you want to do the cast and carry trade in oil you can buy the physical oil let's say your BP you can sell you can sell the forward 12 months out in the US it cost a dollar a month to store a barrel of oil so as far as the the 12mon forward is trading higher than $12 you have that risk-free premium the problem is that if the market goes against you you need dollars to back the Futures heads while Bitcoin is the only commodity where essentially I can buy the physical and post it on the exchange as collateral against the trade and minimize the margin C interesting one more thing about the basis trade is also I think we've covered the mechanics here very well but you also have to sort of figure out the starting point as to why is um why is uh a perpetual or a future usually trading at a premium right because if you look at Bitcoin as a financial commodity um risk Premia of counterparty uh aside um there's actually not really like um a notice a meaningful cost of carry and so um there's actually structural reasons why it's actually upward sloping in um in regulated markets like CME like Bitcoin Futures were really used as a way of Market access and there was more Demand on the buy side and sell side and so that pushes up that curve but actually again get things like ETFs right it actually lowers that that use case of having basically Bitcoin Futures as a substitution for uh owning spot and on the um the side of like all the the retail exchanges like uh binance uh bybit Etc um it's really the fact that this retail guys have usually more demand for buy side leverage and sell side leverage the price then stabilizes above index and and usually funding rates are paying uh the people who sell perpetuals um but that's really like um something that lasts as long as also that retail crowd does not get more educated about how costly it actually is for them to to carry these uh these contracts over time and you start to see like uh stable coin projects like etina stepping in there and providing a lot of cide liquidity then you have things like staking yields which actually add a sort of like a a positive char to the trade which again also uh both of these factors should again then start actually putting pressure on the curve so if I think you look out five years from now you expect these yields really to compress over time and so if you're a retail Trader I would say it's it's still a very good trade to put on yourself at home with a bit of Bitcoin sell a per keep the the risk relatively limited but there's like a very healthy risk premium there that you know is there still for structural reasons but I think it's going to disappear over time well we a lot to talk about basis trade here um but in essence it could be picking up some sort of inefficiency in the market which eventually will disappear so it is an opportunity at the stage where we are now actually in crypto for many reasons um but I want to move back now to talk about regulated versus unregulated exchanges who's winning the battle Yeah because as you know all the exchanges in crypto started on the native side on the crypto native the kind of what do they do they break and then ask for forgiveness um where are we because there are quite a few exchanges coming on uh which are trying to become regulated following the rules within MAA within everything around so what are your thoughts on that well um in my opinion you know obviously the there is no uh same in saying that der RIT is right now the largest Exchange in crypto and there are many new exchanges that are coming actually we need competition in the space you need more than one exchange especially if the market is so big the regulated versus unregulated also is not also 100% accurate because when we mean unregulated we mean not regulated in the US and Europe because all these exchanges are regulated somewhere right um I believe that um as of now there is a tie simply because the crypto native exchanges are winning on volumes but they have a massive hardle in being able to access us and Europe while the trade fire exchanges have the access to us and Europe but then you cannot deliver the spot you cannot actually trade 247 so there is kind of a tie and whoever tries to cap the Gap in between the two will be the winner you also have many new exchanges that are actually coming with a Clean Plate and I would bet on those as well if I if I may say for regulated and regulated it's like a meal I want my cheese and my pudding I want both because it it serves different purposes and different use cases and different client base if I have a fund in K Island and I'm trading with for LPS who are uh effectively um specialist if you wish or native uh to the market I I don't need regulated because you know the setup today allows us to do that if I want to grow and and have a pension fund in in my fund or my my business I won't regulate it so I think that a two-tier Market that is going to grow and this regulated uh framework is going to grow probably faster over the next few years but in addition I don't expect the unregulated market to completely disappear I mean it's a huge market and it fits a purpose and a lot of those who using it don't don't want the regulation so why would they move to the across the so it's it's Plus+ to me it's I want both yeah well let's just mention that black rock just amended their agreement custody with coin base to settle physical Bitcoins in 12 hours after the trade that just gives you a sense that there is no such thing as regulated exchange yet properly regulated one so keep to the point that not your keys not not your coins is probably the safest risk management uh argument for now I'm going to throw one last question uh before we wrap off the panel a controversial one but um a lot of the sickness comes as well from a counterparty risk against the exchanges have the native PBS are they managing to solve solve that problem so the prime Brokers you know do you think that there are solutions in place what are your thoughts well personally I believe that uh there are solutions in place but those W come from uh Clearing Houses or PBS I believe the custodians will come in between and offer that solution you have the go network with pitco you have clear loop with copper whereas essentially more and more people are actually trying to settle off Exchange in an escro type style accounts I see many reasons for why the large exchanges do not want this but at the same time I see many young exchanges trying to do everything they can in their power in order to generate volume so I believe that down the road we will see a hybrid of off exchange trading through custody in escro style accounts most traditional Prime Brokers and banks are not providing any haircut or any leverage for uh Bitcoin ETFs and others so we're still far from it so it's just it's just early days yeah I mean there are efforts to provide uh credit effectively what we talk about is credit PR Brokers there is but it's I call that Prime brokerage light the full fat Prime brokerage with credit is very difficult to find and the reason is is what said earlier it's the market has not learned to price crypto risk crypto counterparty risk it's not comfortable with it banks are certainly nowhere near and I think I would venture to say that this um ETF option might teach the prom broker who who are going to have to use it right teach them to price collateral um exposure risk on crypto asset on the regulated side and then they'll they'll cross it with CM so we're going to see some prime broker in the US doing uh optimizing CME uh to uh ETF option collateral and all that participates to them learning how to price crypto risk and I think we it's going to benefit all of the crypto industry that some traditional players will start to come and say okay okay I can live with that volatility after all yeah I think that kind of sums up a lot of the general thinking in this panel which is that you can you can hedge Market risk but you cannot really deal with non-market risk except for you know position sizing smaller or maybe just having General Capital buffers in place and I think that's just the same thing that underlies this whole Prime broker discussion is like to really get efficient for instance leverage uh cross exchange cross margin um the issue is just that every exchange is its own little clearing house right now and so um it's really like a network of counterparty risk that is keeping this this Prim brokerage Market um subscale right now well we are running out of time but I would like to leave on a positive note so if anybody can give me like 20 seconds of your thoughts about where are we going with derivatives in uh crypto well personally I'm very bull is Bitcoin and in under certain circumstances crypto uh I look at Bitcoin as modern digital gold I look at crypto as Tech startups where I believe that the broader macro environment has a lot to do with their success or not but overall I'm very optimistic and bullish for the near future well I I think e student alization started 2014 became noticeable 2017 accelerated 2021 22 23 so implied volatility of Bitcoin is going to the range of gold that's that's the target for the next years yeah I think the what what amazes me is that the infrastructure built over the last four five years has been amazing the volumes have not yet met the infrastructure that we have all collectively built or I see some nice uh progress in the US um uh towards that with the ETF uh flat price and option so I'm quite confident within five years we'll get to those multiples where the paper Market the only way to grow the crypto Market is by the paper market right it's not the the Bitcoin cash is not going to grow much much it's limited but the paper can make it 10x and I think you know derivatives derivatives yeah if we do a 10x in um seven years I'd be very happy yeah I think so to that I think especially what we talked about earlier like this emergence now of these overriding flows where you can sell upside calls uh and potentially you can also start doing in crypto then the pension fund trade of like selling upside calls buying downside puts is a great way to then like manage uh long uh underly exposure over time and so I think yeah the the future is like a larger penetration of options and and much more interesting volatility products that will then come out of a a mature options market so in other words the future is bright for derivatives yeah thank you very much uh for your time sorry we run out of time there we covered many topics at speed uh so please welcoming and thanking the panel thank you