Why Cryptocurrency Needs Derivatives?

SINGAPORE - EntSun -- Bitcoin. Almost everyone has heard of this digital currency aka cryptocurrency. In recent months, the price of Bitcoin has plummeted - and rebounded - leading investors on an uncomfortable "roller coaster ride." Other "alternative coins", or altcoins, have faired the same, if not worse, up and down price valuation.The newness and great uncertainty of the cryptocurrency market has given rise to a paper market tied to the intangible cryptocurrency market: the crypto derivatives market.

The development of this market is no surprise given the recent volatility cryptocurrency has experienced this past year.  Cryptocurrency, while a cyber asset mostly traded on the over-the-counter market (as opposed to exchanges) are subject to the same market forces, including severe downturns, as any other asset. The rapid decline of cryptocurrency, most notably Bitcoin, last Fall, gave investors a reason to fear direct investment in the cryptocurrency - and a reason to design a way to protect themselves from sharp, unexpected downturns.

Derivatives offer this solution as they provide the ability to hedge in volatile markets. "Derivatives contracts serve as investors and allow them to profit from price fluctuations without having to own the underlying cryptocurrency and incur all the risks associated with it" (M: LXDX, Cody Solomon, November 28, 2018). In other words, derivatives offer a way to "lose less" if your price prediction turns out to be incorrect. They offer insurance against price fluctuation losses (hedging your bets) (M:LXDX). This option has calmed the nerves of weary investors - both individual and institutional- and by doing so, has bolstered the validity of cryptocurrency as an investable asset.

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Enhancing their attractiveness is the variety of derivatives available for speculators to chose from: futures, swaps, options and warrants. Whether the investor believes that the price of the cryptocurrency will go up or down, there is a derivative to purchase to cover this prediction. Investors can buy a specific derivative as a sole investment; however, most typically, derivatives are purchased in tandem with and to offset losses from the main investment. For example, an investor in Bitcoin can purchase a derivative that minimizes losses should Bitcoin experience a decline in price. In this way, the investor has "hedged his bets" by covering his losses if his prediction that Bitcoin will increase in value turns out to be wrong.

Amid all the criticism and uncertainty of the cryptocurrency market, perhaps the greatest advantage derivatives can offer is to attract investors by offering more stability and protection. The world's largest derivatives exchange is Bitmex. The largest derivatives exchange in the Chinese market is Okex. Cryptocurrency contact trading is a huge blue sea. More and more new players are joining the field, such as PLOUTOZ Blockchain Community Derivatives Market (http://plo.one), a platform which recently started online. Their slogan is Every digital currency can be hedged. An very interesting idea. In fact, I agree that any digital asset should have a hedging mechanism to ensure the rationality of their prices and the stability of market sentiment.

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Derivatives encourage investors who would otherwise be too fearful, to invest, and this is especially true for the "unproven" cryptocurrency market (M:LXDX). Some also feel that crypto derivatives  elevate the legitimacy of the underlying cryptocurrency market by offering a more accepted "paper market" which makes the cryptocurrency more relatable. Others fear that the rise of the cryptocurrency derivative market will invite regulators to legislate crypto in general, which some view as a good thing as tighter regulation will attract more investors. More investors drive the volume of trading activity which in turn calms volatility (Blockonomi: What Are Derivatives? And How Do They Relate to Cryptocurrency?, March 17, 2018).

Overall, crypto can benefit from derivatives by stabilizing the cryptocurrency. Since one of the biggest criticisms of crypto is its volatility, offering a way to offset volatility will attract more investors, driving up volume which in turn creates greater stability and attracts more investors. In sort, then, derivatives may be the solution the crypto market has been looking for and has needed to create its own long term sustainability.