Cryptocurrency Derivatives Markets Are Booming, New Study Shows

In recent years, the market for bitcoin derivatives (contractual side-bets on the future price of cryptocurrencies) has grown. On a busy day, these futures trade for over $100 billion, which is comparable to the daily amount traded on the New York Stock Exchange. Furthermore, there is evidence that activity in these markets may have an impact on the value of cryptocurrencies.

These are just a few of the findings of a groundbreaking study [pdf] presented by Carnegie Mellon University CyLab researchers at this week's The Web Conference in Ljubljana, Slovenia.

"On average, the traded volume in cryptocurrency derivatives markets outnumbers the traded volume in ordinary crypto spot markets by a factor of five," says Kyle Soska, a Ph.D. student in Electrical and Computer Engineering at CyLab and the study's principal author.

The researchers conducted a thorough examination of BitMEX, a derivatives exchange that debuted in 2014 and went on to become one of the most successful in terms of volume traded. The researchers were able to put together the first complete look into the vast amounts of activity that occur in these types of exchanges by analysing publicly available data from BitMEX.

The researchers created and distributed a public website as part of their research that gives a live record of BitMEX and real-time access to their analysis platform for other scholars, economists, and interested parties.

"Derivative markets are essential because their behaviour effects the price dynamics of cryptocurrencies themselves," says Nicolas Christin, a professor at the Institute for Software Research (ISR) and the Department of Engineering and Public Policy at CyLab (EPP).

This is similar to a chicken-and-egg situation, according to Christin. People could utilise derivative markets to hedge against certain price fluctuations, he argues, but high-leverage derivative markets may produce instability cycles: turbulent cryptocurrency prices lead to more derivative market liquidations, which leads to more volatile cryptocurrency prices.

An examination of the archived conversations in BitMEX's site-wide chat room reveals a broad group of dealers. Most notably, Korean texts — the vast majority of which likely originated in Korea, which has only one time zone — were almost time-invariant. In other words, whereas one may expect activity to occur during "daytime" hours, the chat analysis reveals that a high number of Korean traders were active 24 hours a day, seven days a week.

"There's a saying that says, 'Money never sleeps,'" Christin says. "... However, Wall Street trades primarily between the hours of 9:30 a.m. and 4:00 p.m. We have data in these cryptocurrency derivatives markets that shows people trading at the same time every minute of the day."

Trading cryptocurrency futures on BitMEX and other exchanges is a high-risk, high-reward proposition. For starters, traders can employ "leverage," which means they can place a much larger bet — and hence commit to a lot larger position — than they can cover with the funds in their account. This can result in massive winnings, but it can also result in immediate losses.

The fact that, unlike traditional currency markets, trading on cryptocurrency derivatives platforms only requires a valid email account, some cash, and a few minutes of time adds to the danger.

"Our data shows that very tiny investments in these markets — likely owned by people with little experience — are being liquidated disproportionately," Soska explains. "Our findings suggest a typical scenario in a relatively new and booming market: that really sophisticated people show up and have a big advantage over novices," the researchers write.

In the future, Christin believes that cryptocurrency derivative markets will outnumber traditional markets, affecting not only those involved in the crypto world, but also those who are not.

"Whether we like it or not, these markets are becoming more mainstream," Christin explains. "Even if you aren't personally interested in cryptocurrencies, your financial advisor or a firm trading on your behalf may be."

Researchers from three separate colleges at Carnegie Mellon University collaborated on this study: the College of Engineering, the School of Computer Science, and the Tepper School of Business.