Cryptocurrency derivatives have largely traded in a dual market structure for much of their existence. This hosts “native” platforms such as Binance, Deribit and FTX alongside the traditional exchanges, the most notable of which being the CME Group.
To date market share is dominated by the native markets and a plurality of venues for futures trading (and to a lesser extent options trading). These two worlds are, however, beginning to merge with significant implications for market structure and consolidation.
The merging of the two worlds is being led by crypto natives increasingly pushing into regulated markets through M&A seeking to acquire exchanges or venues with US-regulated licences for products such as derivatives.
Coinbase and FTXs’ acquisitions of FairX and LedgerX in recent months were the first moves in this respect. Both purchases have given the buyers operations with greater regulatory credentials and the ability to offer licenced crypto derivatives to compete in a fully-regulated environment with the likes of CME (which was able to launch its first bitcoin derivatives by virtue of its self-regulatory status).
This early M&A is regulatory. However, as the regulatory environment for crypto trading becomes clearer, consolidatory M&A is likely to follow. The inaugural Acuiti Crypto Derivatives Insight Report, a quarterly report based in part of a survey on Acuiti’s crypto derivatives Expert Network – a forum of senior executives in the market – found that there were expectations that exchange consolidation would increase over the next five years.
Crypto derivatives have followed a different path of market structure evolution to how traditional listed markets have developed. Exchange fragmentation is a defining feature of the crypto market structure, with firms’ trading strategies dominated by arbitrage between venues as much as between products.
The native exchanges have also evolved a market structure without a central clearing house developing significant innovations such as real-time margining and auto-close out of positions.
This market structure is enabling the plurality of exchanges for futures trading owing to the inherent monopoly enabled by central clearing in a non-fungible environment. This makes the path to a winner-takes-all endgame, as seen in other futures markets, less likely in crypto futures.
Regulation is likely to define how the consolidation plays out. Major jurisdictions, including the US, are currently developing extensive regulatory frameworks for crypto trading, which could boost the ability of native exchanges to further growth their institutional offering and make them attractive acquisition targets for the traditional exchanges.
How this affects the mix of institutional and retail market participants will be interesting to watch. These two investor types already mix more than often appreciated on native exchanges, which boast strong institutional participation – with Deribit, for example, home to over 90% of crypto options trading. But greater regulatory certainty should encourage new money to come in as well.
In that sort of environment, how should CME compete? One route is acquisition. The exchange has famously been a major consolidator of US derivatives markets. Regulatory clarity for native markets will provide the framework in which it can make similar moves in the crypto market. But valuations are sky high currently and regulation would likely reduce the fees that native exchanges can charge.
The exchange could also go down the product route to expand its retail coverage in the expectation of a more level playing field between native and traditional markets in the coming years – a move it is already making with the launch of smaller contracts.
Any one venue building a monopoly in futures seems unlikely for now though adding to the vibrancy of this nascent market. But once appropriate regulation is established in the core jurisdictions, all bets are off.
To download the inaugural Acuiti Crypto Derivatives Insight Report, visit: https://www.acuiti.io/crypto-derivatives-managers-insight-report-q2-22/
