The last two years were unique in the world of Bitcoin and digital assets on many fronts, but by far one of the biggest influences was the introduction of derivatives. This changed and impacted market structure massively, as both retail and institutions gained access to hedging instruments, but also leverage.
This is part of the maturation process, as big money institutions simply cannot enter this space and allocate any meaningful size without having tools to hedge risk. This includes futures to go short, options to insure downside, and also to put on increasingly complex trade strategies.
The trade-off to this is that retail discovered leverage, and sadly, firms and actors like FTX et al took advantage of that. The liquidations were large, the wipe-outs real, and who knows how much money was transferred from the brand new fresh traders to the experienced ones (hint: it is a lot…but this is the way).
But now that the FTX dust has settled, and Xmas is around the corner, we can take a look at underlying market structure and how it plays out in derivatives markets. There are three in particular that stood out to me that are ones to keep an eye on.
First is that ETH and BTC perpetual swap trading volume is basically 50/50 in dominance, converging over the last 2yrs. This tells me that those who are trading, have sufficient liquidity in both markets. BTC and ETH really are the only two assets with any semblance of a market behind them, which is a promising sign for both.
Perpetual swaps have clearly become the dominant trading instrument in this market. The purple curve shows the volume dominance of perps, accounting for some 95%+ of all futures volume. All the algos, and bot traders are rocking perps, primarily because they stick close to the spot price, and all the available data can be directly fed through quant models.
Open Interest dominance in pink is slightly lower at around 75% to 80%. This gap means that some 25% or so of open interest is applied to expiring futures with little trade volume. These are hedging positions, placed with a known expiry, and likely rolled over month after month. Another sign of market maturity.
The last observation is that there is still around $2.5B in excess ETH call option open interest (green), in what appears to be a post-Merge hangover trade. I don’t expect it to completely unwind, but I do expect a good chunk to close out as the December expiry comes up.
I suspect these markets will remain pretty quiet through to years end, but this also means lower liquidity, and thus one should probably maintain a mildly bearish short-term outlook. There isn’t going to be much of a trade volume cushion below us, so small distribution pressures could keep prices depressed over Xmas.
On the long term view, this is a good view that these markets are growing up. Most of the leverage from 2021 is gone, but much of the infrastructure remains. These assets will rise again, and hopefully we see more of the hedging, and less of the leverage…but something tells me it will all come back…just the same.