A battle between the worlds of traditional finance and crypto currencies is heating up as mainstream exchange operators like CME Group start to grab a larger share of the US$100bn-per-day crypto derivatives market.
CME, one of the largest derivatives exchanges in traditional financial markets, has seen average daily volumes in its bitcoin futures contracts almost triple over the past year to US$4.5bn amid growing interest from institutional investors. Other mainstream platforms like Eurex are steadily gaining ground too, while LCH, owned by IFR's parent LSEG, has plans to ramp up its involvement in the market.
These exchange and clearing giants believe they have an edge in attracting business from conventional investment managers that might otherwise be wary of entering the Wild West of crypto trading, in which companies have been prone to sudden and spectacular collapses. All offer highly regulated infrastructure with a proven track record in more established asset classes like fixed income and equities, drawing a contrast to specialist crypto exchanges operating in more lightly regulated jurisdictions.
That pitch is also appealing to crypto-native trading firms looking to increase their credibility with mainstream investment managers, enabling them to do more business. Specialist crypto exchanges, meanwhile, are responding in kind by applying for licences from European regulators and other jurisdictions that they believe can improve their credentials with traditional financial institutions.
“Institutional client demand for crypto derivatives is definitely there, but it’s historically been quite challenging for end-users to get safe access to this asset class given that a number of institutions have folded," said Deepak Mehra, head of digital assets for markets at Citigroup. “As mature derivatives market players like CME, Eurex and LCH become more involved in the market, they’ll likely see the most success over the long term as they will enable institutions to safely engage with crypto derivatives."
Derivatives have become an integral part of crypto markets, accounting for more than 70% of trading, according to specialist data provider CCData, with average daily volumes of US$102bn in September. Derivatives have also become the main gateway for mainstream investors keen to get involved in digital assets without having to contend with the incomplete and inconsistent regulatory framework surrounding spot crypto transactions.
A conventional problem
The problem for conventional money managers is that the bulk of crypto derivatives volumes occur on lightly regulated, crypto-native exchanges that focus on digital assets and grew up outside the conventional financial system. Sam Bankman-Fried's FTX has come to embody the risks of trading on these venues after what was then one of the largest crypto exchanges in the world imploded in 2022 amid revelations of massive fraud.
Binance is the biggest venue in crypto derivatives with a 41% share market share, according to CCData, and monthly crypto derivatives volumes of US$1.25trn in September. However, most of these volumes come from retail investors and high frequency traders trading so-called perpetual futures – a contract that can be held indefinitely to speculate on crypto price movements.
Most institutional investors, by contrast, favour non-perpetual futures or options. They only contribute around 3% of the monthly US$3trn in crypto derivatives trading volume aggregated across both crypto-native and traditional financial platforms, industry experts estimate, in a sign of how little institutional involvement there is at present.
Deribit is the most prominent crypto-native exchange among institutional investors, which make up 80% of its client base. The exchange handles about US$100bn of crypto derivatives each month, two-thirds of which stem from crypto options. Luuk Strijers, Deribit’s chief executive, said the firm sees itself as "being closer to Eurex or CME" rather than other crypto-native firms like Binance because of its focus on options.
Nonetheless, there are some clear differences in the way it operates that appeal to crypto specialists – and may unsettle traditional investors. Deribit requires traders to post less collateral against their positions than CME or Eurex. And, unlike its mainstream rivals, Deribit accepts crypto currency as collateral for margin calls – a definite plus for cash-strapped crypto traders.
Regulation rules
Overall it is regulation – or lack thereof – that is the biggest barrier for exchanges like Deribit to break into the traditional financial world. Deribit is headquartered in Dubai and regulated through the country’s Virtual Asset Regulatory Authority, meaning it doesn’t face the same level of regulatory scrutiny as CME or Eurex in the US and Europe. Many traditional financial institutions won't trade on its platform as a result and instead are heading to venues they're more familiar with, such as CME.
Rob Strebel, global head of relationship management at trading firm DRW, which includes crypto subsidiary Cumberland, said CME has a roughly 10% market share in listed crypto options, which he said counts as a significant move over the past few years.
"In part, I think this reflects an increase in institutional investors participating in this space," Strebel said. "While everyone’s decision-making process can be different, many factors can be at play here – a preference for a centrally cleared model, jurisdictional limitations or something as topical as time to market since many institutions are already integrated with the CME for other trading activities."
CME traded around 125,000 crypto options and non-perpetual futures contracts combined in August, averaging almost US$6bn in notional traded per day – the exchange’s best month of trading since it launched crypto products in 2017.
“More clients are looking to trade crypto derivatives on a regulated exchange ... such as CME Group,” said Giovanni Vicioso, CME's global head of crypto currency products.
Gaining traction
Germany's Eurex has also been gaining traction, with 105,000 bitcoin derivatives contracts and 3,800 ether contracts traded since launching last year, the equivalent of around US$4bn in notional traded per month, said Zubin Ramdarshan, head of equity and index product design at Eurex.
As well as institutional investors, CME and Eurex are attracting more crypto-native traders to their venues as these firms bet that joining these exchanges will bestow a greater degree of legitimacy on them in the eyes of conventional financial institutions.
“When a crypto-native trading firm like us on-boards with exchanges like CME and Eurex, it gives institutional investors confidence in us as a counterparty as we’re trading within the same environment and infrastructure they’re used to, which ultimately gives us a stamp of approval,” said Jake Ostrovskis, OTC trader at crypto derivatives market-maker Wintermute.
For its part, Deribit has recently filed for authorisation under Europe's MiFID rules and is making a similar application in Brazil in an acknowledgement of the direction of travel in these markets.
“Investment banks like Goldman Sachs, Citigroup, JP Morgan, UBS and their clients don’t typically trade on new venues like Deribit, so the more regulated we become, the more ready we are to welcome institutional investors,” said Deribit’s Strijers. “Over time, our market share may decrease to 50% as other exchanges ... gain ground but it’ll hopefully be 50% of a much bigger market given the higher level of trust everyone has.”
