How to Leverage the Expected 2020 Crypto Derivatives Trading Boom

The 2019 crypto derivatives market saw a host of developments across the board as several trading avenues opened across the globe. Retail brokerage giants like BitMEX and OKEx commanded much of the trading volume throughout the year. However, the latter part of 2019 saw the emergence of new cryptocurrency derivatives exchanges looking to gain a share of the market. These new participants have to overcome a number of issues, especially related to unplanned liquidation problems. 

With margin collateral limits significantly smaller than with mainstream derivatives, a sudden price move — which is common for such a highly volatile industry, can see massive liquidation of a trader’s position faster than they can move capital out of the losing position.

Liquidity and price discovery mechanisms also plague the market as a significant portion of one exchange’s index price might be based on another platform. If there is a large liquidity variance between both services, any trading discrepancy in one platform can lead to a cascade of forced liquidations in the other as seen during the Bitstamp Bitcoin flash crash of May 2019, or the recent XRP wick on BitMEX, which enraged many traders. 

Limits of leverage for crypto derivatives trading also remains an issue with some jurisdictions working towards imposing strict guidelines for margin trading. In places like the U.K., regulators are reportedly considering a blanket ban on cryptocurrency derivatives, citing risks to retail investors.

With the Bitcoin (BTC) halving in mid-2020 expected to generate renewed hype in the broader crypto market, some analysts predict that both spot and derivatives crypto market will experience even greater trading volumes. Analysts are also pointing towards the emergence of crypto options trading as another avenue for renewed interest in virtual currency-based derivatives.

2020 the Year of Crypto Derivatives

In its 2019 crypto derivatives trading report, cryptocurrency analytics firm TokenInsight revealed a massive increase in the global virtual currency derivatives trading market. Some important takeaways from the report include:

  • Total crypto derivatives trading on exchanges topped $3 trillion in 2019 with an average daily trading volume of about $8.5 billion.
  • The market also rose from 10 percent of the spot trading market volume to one-fifth (20 percent).
  • Three major exchanges —BitMEX, OKEx, and Huobi DM cornered the majority of the crypto derivatives trading activity, accounting for over 85 percent of the total market trading volume.

They also reported that they expect the crypto derivatives market in 2020 will maintain similar growth trends experienced in Q3 2019. Trading volume for cryptocurrency derivatives in the second half of 2019 almost doubled the figures recorded for the first half of the year.

Looking ahead to 2020, TokenInsight’s predicted forecast is that the crypto derivatives market will outstrip the spot trading scene by as much as 100 percent. With the influx of more virtual currency derivatives instruments, some commentators are already tipping 2020 to be the year when the crypto derivatives scene takes center stage.

Evaluating Exchanges

With the positive sentiments surrounding the crypto derivatives scene, traders need to think carefully about the exchanges they chose for their crypto derivatives activities. Despite the abundance of options, the (still) largely unregulated nature of the retail cryptocurrency derivatives trading scene opens up possibilities for untrustworthy actors in the brokerage space.

Trading fees should form a major part of the consideration when deciding upon an exchange. Some platforms offer misleading information about their trading fees, hiding the true costs of trading within the fine print. These exchanges usually do so by highlighting their low maker/taker fees while not prominently displaying their spreads.

Instead traders should look for exchanges that display spreads and commission fees. Without these vital pieces of information, determining actual trading costs can be difficult.

Another important consideration is the amount of information provided by exchanges about their platform tools and how they relate to the market. Given the possibility for forced liquidations, responsible crypto derivatives exchanges should make it easy for retail traders to set up stop losses when entering a new position.

Making it easy to trigger stops is a major consideration. Select an exchange that operates similarly to traditional exchanges, where orders are rejected if their price is beyond +/- 10% of last price or +/- 15% mark price. Market order execution price should also be able to be capped by such range to avoid any unexpected slippage, in addition to order quantity limits on single orders, which prevent potential mistakes of large traders from wiping out the entire order book.  

With deposits and withdrawals being made in cryptocurrencies like Bitcoin plus the absence of fiat support, vast amounts of know your customer (KYC) details shouldn’t be required by the exchanges, having to provide identifying information when not required raises potential red flags tied to privacy concerns.

Multiple Trading Options Including Healthy Leverage

The ability to go long or short on any derivatives instrument plus the presence of healthy margin trading provisions is also another factor to be considered when choosing a crypto derivatives exchange. Limited trading options usually points to crypto derivatives exchanges that are intent on trading against their customers.

Such practices often lead to massive liquidations of customer positions while the platform maintains a healthy bottom-line.

Leverage limits for crypto derivatives trading continue to be a subject for debate within the cryptocurrency trading space. Critics say high leverage ratios open inexperienced traders to the potential for massive losses.

However, responsible crypto derivatives brokers help their customers manage the risks of margin trading by providing adequate protection. Crypto derivatives exchanges should offer risk limits to mitigate such occurrences. One such protective protocols some exchanges use is traders who wish to open larger positions must reduce their leverage ratio while paying a bigger margin sum.

2020 promises to be a busy year for crypto derivatives trading. Using these points listed above, retail traders may be able to choose the best platforms to help them take advantage of the opportunities coming throughout the year.

About the Author

By Jack Tao, CEO of Phemex, an ex-Morgan Stanley executive who with eight former colleagues have built a crypto derivatives trading platform that is on par with those experienced at big investment banks.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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