Crypto derivatives have been growing in popularity since the launch of bitcoin futures by the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) in December 2017. These two derivative platforms have gained significant traction among investors and traders. One of the main challenges for institutions and accredited investors to have exposure in the digital-asset market has been the availability of regulated platforms and exchanges.
The launch of the CBOE and CME derivative products led to a massive influx of these institutions and professional traders. It was also significant to note that the launch of the CBOE product coincided with the top of the 2017 bull market which saw the leading digital-asset bitcoin reach an all-time high of $20,000. The launch of these products offered investors and traders the opportunity to hedge positions, thus attenuating some risk.
The introduction of crypto derivative platforms show that the market is maturing, making it more comfortable for professional traders and drawing in new traders.
Derivatives play a crucial role in the global financial markets, we foresee these markets playing an even greater role in this new asset class. Traders can speculate on future prices of digital-assets without having to purchase the underlying asset itself.
This mechanism will also help potential investors that are unable to directly purchase the underlying asset. Due to the high volatility in the market, we foresee crypto derivatives being used as a risk-management system. Traders can use futures, perpetual swaps, and options to lock in prices and prevent massive downsides.
The crypto landscape has witnessed a Cambrian explosion of several derivative platforms such as CoinFlex, Huobi, Binance, Kraken, OKEx, FTX, Bitfinex, BitMex, Deribit, Bybit, and Bakkt (whose parent company is the Intercontinental Exchange Inc which also owns the New York Stock Exchange). These platforms and exchanges have one thing in common, they are all mostly regulated and centralized. Traders are required to go through KYC/AML, for professional investors and traders, this is exactly the type of security and insurance needed for confidence, for ‘degen traders’ and libertarians who make up the base of the crypto market, centralized, regulated platforms with KYC/AML are nonstarters.
The explosive growth of decentralized finance (Defi) started with the concept of liquidity mining, which has led to the growth of several other aspects of the markets. In summary, we are witnessing every aspect of the traditional finance market being brought into the decentralized finance market (from CeFi to Defi), we believe decentralized derivative platforms will be the next wave to attract significant capital into the digital-asset market. Statistics show that quarter after quarter, derivative volumes increase between 70%-100%. Decentralized derivative platforms such as Opyn, Hegic, Aco, Primitive, Opium, Synthetix, and FinNexus are all strong contenders for the leading application.
At SatsCapital, we have researched and analyzed various derivative platforms and have a firm belief that this market will only keep growing. It was based on this belief that the team invested in decentralized protocol Hegic in Q3. Hegic is a decentralized, censorship-resistant platform for American options, built on Ethereum. Hegic operates under the assumption that most options expire worthless and that over time, market makers will generate positive returns as a result.
It uses a pool model to provide liquidity to option buyers, liquidity providers lock up ETH or WBTC in a smart contract which is then used to provide fully collateralized options. Liquidity providers get rewarded for taking this risk. Traders have access to non-custodial on-chain call and put options. Hegic also provides the simplest and intuitive user interface.
The paramount distinguishing feature of Hegic is the pooled liquidity model, this means that the counterparty for the buyer is the smart contract vault, this enhances liquidity.
In phase 1, liquidity pools will be bootstrapped with the $12M IBCO raised, and liquidity providers will be incentivized with a program that pays 1.3M token daily, these rewards will be subject to a 6 months lockup. Aside trading calls and puts on Hegic, investors can also provide liquidity on the platform by depositing funds to the vault, this capital is utilized across board by traders and liquidity providers earn pro-rata premiums.
LPs do not have any direct control over the writing of individual option contracts, instead LPs gain yield passively. An advantage the Hegic model has is that buyers can choose the terms of the contracts at their discretion. Traders can set their option types, expiration dates, and strike prices. This model will continue to work perfectly provided the liquidity pool in the protocol is deep.
Hegic raised $12.2million during the Initial Bonding Curve Offering (IBCO), the protocol currently has a market capitalization of $17million with a trading volume of $350,000. Q3 showed us just how explosive new market trends such as AMMs and liquidity mining can go. We believe with the current clump-down of unregulated centralized derivative platforms, the next logical phase of adoption in the cryptocurrency space will be decentralized derivative platforms.
Derivative trading volumes across centralized crypto platforms and exchanges hit an all-time high (ATH) of $602 Billion in May, this will only increase as bitcoin approaches its prior all-time high of $ 20,000. The growth in the DeFi space will also continue to grow, the total value locked (TVL) in decentralized applications now sits at $11.24B. We estimate this amount to reach $70 –100B over the next 20 –24 months, with all these factors in mind, the potential growth of decentralized derivative trading applications such as Hegic could be explosive, we estimate the market capitalization of Hegic to be in the region of $100–150m over the next 10 –15months.
Disclaimer:
Investors must have the financial ability, sophistication and experience to bear risk of an investment. This article is intended for those with an in-depth understanding of the high risk nature of investments. This article is not to be considered as investment advice and tax advice. Talk to your accountant and your investment advisor. Do your own research before making any investment decision.
