Coinbase Sees TradFi Institutions Driving Crypto Derivatives Boom

Coinbase (COIN), the crypto exchange that bought the largest crypto options exchange, Deribit, for $2.9 billion earlier this year, expects a wave of traditional finance (TradFi) institutions to start using digital asset derivatives for investments or hedging, said Usman Naeem, global head of the Nasdaq-listed company’s derivative sales.

The institutions waking up to globally regulated crypto derivatives are typically asset managers, who have a fiduciary duty to either speculate or conduct strategies beyond simply providing liquidity, which is the realm of market makers, Naeem said in an interview with CoinDesk. They’re most likely to come from the U.S. and Europe and are a fundamentally different breed of firm.

“Looking back, the vast majority of activity, probably more than three quarters, was in Asia,” Naeem said. “I think that’s going to rebalance a bit and we’re going to see U.S. and Europe-based, non-market maker institutions really step into derivatives.”

Coinbase started life back in early 2012 as an on and off ramp for bitcoin BTC$110,176.96 and evolved into an exchange, successfully capturing much of the spot market, which at the time was in the U.S. But from 2017 onwards, innovations in crypto like perpetual futures drove as much as 85% of volume and liquidity outside the U.S., mainly to the APAC region.

In response to this, Coinbase in 2022 acquired FairX, a derivatives platform registered with the Commodity Futures Trading Commission (CFTC), to offer U.S.-regulated futures. It followed up with the Deribit purchase in May.

The rebalancing of the crypto derivatives market from Asia and places like Dubai, where perps are popular, will also see an adjustment in the type of strategy toward an approach more aligned with traditional finance, Naeem said. Traditional money managers don’t just want to buy $10 million or $20 million of bitcoin, he said. They are looking to scale up in a risk managed way, and that involves using derivatives to hedge.

“As more long-term holders come in who are risk managed, I think we’re going to start seeing a volatility service that replicates more what’s happening in traditional finance,” Naeem said. “Rather than just speculating for a 50% rally in bitcoin, maybe they sell some upside to help fund insurance for the downside. These dynamics will cause a massive shift in volatility services, which brings more liquidity and stability; a more reliable and understandable derivatives market.”

That’s all fine and well, but what about incidents like the crypto flash crash of earlier this month, which saw some $7 billion of liquidations, in very short order. Doesn’t volatility that extreme keep institutions on the sidelines?

Naeem pointed out that flash crashes are not exclusive to crypto, and that, for the most part, the digital asset industry’s infrastructure did work.

“The liquidations were there; the waterfalls kicked in as designed,” Naeem said. “Keep in mind the dynamics of perpetual futures work very differently to either centrally cleared futures or spot, so they need tighter risk controls to unwind positions. Also keep in mind everything happened in a window of 12 minutes or thereabouts.”