There has been a consistent rise in the number of decentralized derivatives platforms in the past few months. I find that there are two reasons behind this that stand out. One is the regulatory scrutiny that centralised exchanges have come under, which has led some to stop offering derivatives products. The second is that users are looking for a transparent exchange that does not falsely liquidate their positions. Centralized exchanges have been challenged in the past for falsely liquidating traders’ positions in times of high volatility.

In this week’s Magnify, I will explore these reasons in detail. I will also look at some emerging platforms that have been doing well for margin, perpetual, options, and futures. And, I’d like to conclude by exploring the challenges that users face while using them. Let’s dive in.

The regulatory hurdles

Unfortunately for Binance, their name has come up several times in terms of regulations. In one of those instances, they had to remove their derivatives products from offering them to users in the EU amid rising pressure from the German, the Italian, and the Dutch government.

Bitmex agreed to pay a $100M civil monetary penalty, in October 2020, when it came under the scrutiny of the United States Commodities Futures Trading Commission (CFTC) and the Financial Crimes Enforcement Network (FinCEN).

This has deeply impacted derivatives trading in the United States, the EU, and some Asian countries as well.

As these exchanges were coming under scrutiny, traders were forced to look for alternatives. That is where decentralized derivatives platforms came in. Some of these platforms have done a good job in solving two major problems that traders face:

• Providing 100% non-custodial services
• Offering quick settlements at low fees

I found several exchanges that solve these problems for traders. Here’s an overview of some of their features and their past performance.

As far as the overall market goes, dYdX is the winner as it is one of the most liquid DEXs in the market currently. It offers margin trading on L1s with up to 5x leverage, and perpetual on L2s with up to 25x leverage.

Projects like Perpetual Protocol and Mango Markets offer 100% non-custodial services. The former offers low slippage and much faster trading thanks to xDAI. The latter charges no fees for interests. Both have performed quite well in the past few months.

Another new futures trading platform is GMX, which runs on Arbitrum and offers future trading at low swap fees and zero price impact trades.

For options, Hegic and Opyn are popular platforms that offer gas fee-free trading and free limit orders to their users respectively.

Why are these platforms getting so popular?

What else would you do in an extremely volatile market? Probably just look for ways to hedge against the market. The past few weeks’ stability in the crypto markets could also be a reason why there has been a sudden spike in derivatives contracts.

I remember this also happened in late 2017 when the Chicago Mercantile Exchange (CME) started to offer Bitcoin futures trading. That was the time when the crypto market had just concluded its bull run, and the introduction of futures contracts helped traders hedge their bets against the market.

But, there are other reasons behind their rise as well.

• I think that most of these platforms have already achieved their product-market fit while working in the background.
• Traders, in general, prefer the much-stable prices offered by the decentralized protocols because there is a significantly reduced influence by the exchange. The cheaper fees along with quick settlements are also a significant selling point for these platforms.
• The fourth reason could be the high amount of institutional investors that are now entering the space.
• Centralised exchanges have also been questioned on them manipulating the market and liquidating traders falsely during flash crashes and volatile market conditions.

However, these protocols do come with their own challenges. For instance, one of the biggest questions has been around the control of the underlying contracts especially in the instances of calculation of funding rates.

That aside, the rise of the overall derivative market itself is telling of potentially good times ahead for the overall market.

Where are we headed?

I believe that the emerging derivatives market is a positive sign for the crypto market in general. It goes to show that traders are now moving away from the basic trading of assets on exchanges and are adopting a more rational approach of hedging against different market movements by adopting derivatives. A maturing market and traders seem to be emerging.

The futures lead the derivatives market presently, accounting for as much as $2.07T of the total quarterly trading volume. This dwarfs the $133.22B trading volume for options in the first quarter of 2021.

Despite all of this, I find there is a bit of uncertainty around the growth of the derivatives market. I do think that recent activity suggests that the market is gradually maturing. But, we are yet to see how these platforms evolve in terms of not only the services/products they provide but also how many of them emerge in the larger ecosystem.

What do you think?

Like the above article 👆, I uncover one intricate topic each week and share my findings. I’m @mohakagr on Twitter.