However, there is one area, where stablecoins are stealing a march on bitcoin – settlement of crypto derivatives.
For the uninitiated, derivatives are financial products that derive their value from an underlying asset or a group of underlying assets. In the case of crypto derivatives, these underlying assets are cryptocurrencies or crypto-assets. The currency in which profit/ loss of a derivative contract is denominated is referred to as the settlement currency.
Derivatives are currently the most exciting area of crypto trading and have seen remarkable growth in the last 12 to 18 months. This growth is being led by new entrants which are shaking up several aspects of derivatives trading, including settlement currency. The incumbents, namely BitMex and Deribit have preferred BTC settled contracts. Deribit now also offers futures and options on ETH that are settled in ETH. However, the broader market is quickly moving towards stablecoin settlement.
New Derivatives Exchanges are Driving Stablecoin Settlement
Delta Exchange, which is a relatively new entrant in the crypto derivatives space, has been pioneering stablecoin settled futures. Delta launched its first USDC settled futures contract back in January 2019. Considering that USDC was fairly new then, the choice of USDC over the much more established USDT was a bold one. This bet on USD paid off as both volumes on Delta Exchange and USDC market cap grew rapidly in 2019. Encouraged by the response of traders, Delta Exchange went on to list USDC settled futures and perpetual swaps on several leading altcoins.
With the trader demand for stablecoin settled futures clearly established, other derivative exchanges have started to follow suit. The most notable among these is Binance. The exchange launched its futures trading platform in the 4th quarter of 2019 and has selected USDT as the quoting currency for the entire platform. Given Binance’s reach, this will give a big fillip to the market share of stablecoin settled derivatives.
Why Traders Prefer Stablecoin Settlement
Trader’s preference for stablecoin pairs has been clearly visible in spot markets. In fact, having USDT pairs on altcoins was one of the key reasons behind Binance’s strong growth in 2017. Even now, for most cryptocurrencies, the trading volume in USDT pairs is higher than that in BTC pairs.
Focusing on derivatives trading, stablecoin settlement is preferred by traders for primarily three reasons:
- Ease of understanding: Stablecoin settlement makes trading crypto futures quite similar to trading futures on stocks in traditional financial markets. A trader bets up on the $ price of a crypto-asset/ stocks and keeps USDT/ USD as collateral. If she is right (wrong), her USDT/ USD increases (decreases). Compare this to a BTC settled futures on BTC. A trader has to bet upon the price of bitcoin while keeping BTC as collateral. It requires some mental gymnastics to wrap your head around this.
- Protection of collateral against market moves: Let’s continue with the BTC-settled BTC futures example. Consider a trader that believes bitcoin price is about to go down and takes a short position in BTC futures. For this, she is required to keep some BTC as collateral. If the trader is proven right and bitcoin price actually goes down, the following happens: (a) she makes profit on her short futures position, but (b) the $ value of her BTC collateral also goes down. So, in this case, the trader ends up with lesser money in dollar-terms. She could have avoided this hit if she had the option of keeping collateral in a stablecoin.
- BTC price of altcoins is hard to predict: Bitcoin is quite volatile. The volatility in altcoin prices is even higher. This makes predicting prices of altcoins in BTC-terms incredibly difficult. Let’s explore this in detail. When the market is bullish, both BTC and altcoins go up in $-terms. However, in the early parts of a rally, BTC price tends to go up more than altcoin prices. This means that BTC prices of altcoins actually go down. Given these dynamics, traders find it easier to trade futures where prices are in USD or a USD-pegged stablecoin (e.g. USDC and USDT).
In mature asset classes, the sizes of derivatives trading is typically 4-5x of spot trading. The rapid growth of crypto derivatives suggests that the same relationship will likely get established for cryptocurrencies too. As crypto derivatives grow and mature, standardisation and a move towards established practices from traditional financial markets is natural. We believe stablecoin-settlement is part of this process. Introduction of more complex derivatives such as options and interest rate swaps is only likely to accelerate this trend. That said, it remains to be seen whether Delta Exchange can continue to innovate in stablecoin-settled derivatives and manage to stay ahead of its peers.
This article was originally posted on FX Empire
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