The Key to Turning Crypto Into a Trillion Dollar Industry is Trust

The interest in crypto-derivatives has gained substantial momentum among investors and traders since the introduction of the Chicago Board Options Exchange (CBOE) and the Chicago Mercantile Exchange (CME) in late 2017. Crypto derivatives trading volume soared by 58 percent as compared to the prior month. The monthly volume reached $712bn in August, sufficient to surpass the previous high of $602bn registered in May 2020. Huobi, OKEx, BitMEX, and Binance registered a volume of $208 billion, $190 billion, $72 billion, and $184 billion, respectively.

Derivatives are valuable risk-management instruments for hedge funds, family offices, wealth funds, traders, etc. Futures, options, derivatives, and swaps are used by institutional investors and traders to hedge risk by deterring adverse price volatility from significant losses to their positions. I sat down with Thor Chan, CEO at AAX exchange, to discuss institutional investors’ growing interest in crypto-derivatives and what is making the market move.

Ishan Pandey: Hi Thor, welcome to our “Behind the Startup” series. Why are we seeing an increased interest from institutional investors in crypto-derivatives and asset management services?

Thor Chan: Interest in digital assets from institutional participants in finance has been rising for some time now. In 2019, around the time Facebook proposed Libra, regulators in key jurisdictions spoke out, asked questions, or issued guidance; we saw high-profile custody providers enter the space, and starting with smaller family offices all the way up to high-profile hedge fund managers, more institutional investors have been taking up positions in digital assets markets. The focus on derivatives, I would say, is not so much because of an increased interest in derivatives as such - institutional investors are well aware of the opportunities in such markets - but rather the industry has been maturing. Today’s infrastructure is better than before, gradually opening up the markets to more capital heavy and therefore, cautious market participants.

Ishan Pandey: Why do institutional investors prefer crypto-derivatives markets over the spot markets. Are institutional investors preferring bitcoin as a potential hedge against inflation?

Thor Chan: Derivatives trading is now inextricably part of what exposure to digital assets looks like. Crypto assets, for some, are more like collectibles; for others, commodities, a resource, or a form of money. For most institutional participants, Bitcoin and other digital assets are interesting for their price movements, rather than utility. Sophisticated derivatives suit such investor profiles. While we have seen some high-profile investors, such as Paul Tudor, take on Bitcoin as a hedge against inflation, right now, the play is more short-term with investors looking for ways to spread their opportunities and risk during these very unpredictable times.

Ishan Pandey: Are features like staking, margin, options, saving products, etc., something that interests institutional investors?

Thor Chan: Simply holding a coin, such as Ethereum, and placing it in custody, is one thing. Trading options and perpetual - provided there is enough liquidity - is also within the range. But for big profile institutions to start engaging in staking products or even savings, I believe there is more work to be done across the industry in terms of market infrastructure, transparency, compliance and legal protections, before we can expect any big movements.

Ishan Pandey: What portfolio and hedging strategy would you give a millennial who is just recovering from the 2020 coronavirus crisis?

Thor Chan: I think all millennials should learn about portfolio diversification and get a better sense of how various markets move and behave under different market conditions. The rise in crypto makes sense and is worth exploring for those who believe digital living will continue to proliferate. But there is no reason to abandon stocks or commodities such as gold. Speculative trading happens everywhere, and during the pandemic, Bitcoin behaved as the Nasdaq as much as the Nasdaq behaved like Bitcoin. Still, over the long-term, we should see the markets become less correlated again return. Diversification remains key to a healthy portfolio, and such diversification should be across asset classes.

Ishan Pandey: Is Institutional interest in Ethereum increasing lately due to it being the poster boy of DeFi?

Thor Chan: Ethereum serves as an index for the development of decentralized applications just as bitcoin serves as an indicator of the digital assets market’s overall health at this stage. Along with Bitcoin, Ethereum has proven its longevity while further down the ranking, the risks may go beyond what institutional investors are willing to take on. Ethereum is a safer choice in that regard, but as DeFi continues to develop, over the coming months, I believe we will see some seismic shifts happen that may lead to more take up of other altcoins.

Ishan Pandey: How big a concern is the KuCoin hack for investors, and what are the key takeaways from it?

Thor Chan: Compared to a few years ago, the state of security in crypto has improved a lot. But cybersecurity, in general, is always in flux, and it’s a constant battle, requiring exchanges to keep upgrading their systems and conducting security tests. This is important to keep client funds and data safe as well as instill investor confidence. The key to turning the crypto industry from a billion-dollar industry into a trillion-dollar one is trust.

Ishan Pandey: Are we witnessing a rise in High-Frequency Trading in the crypto markets? Further, for HFT firms, what type of exchange infrastructure is more scalable, resilient, and secure?

Thor Chan: Absolutely. Our adoption of the London Stock Exchange Group’s LSEG Technology matching engine was specifically because we anticipated that crypto markets would follow a similar trajectory as have traditional markets. We have recently partnered with Quadency in response to users who want to use automated trading bots on our markets. We are also working hard on our FIX connectivity - our matching engine has such capabilities. We are now finalizing the work around the risk management systems before we open this up to our users. This will be of particular interest to institutional traders that require ultra-low latency.

Ishan Pandey: As a trader, what are your overall views on the liquidity, volatility, and harmonics in the Bitcoin and Ethereum market?

Thor Chan: Liquidity for Bitcoin and Ethereum is in a good state overall, with plenty of options for block traders and high-net-worth investors to enter and exit the market. Of course, whales and miners exert quite some influence over the price of major crypto assets, but as more capital flows into the market, such dynamics should become less pronounced. It’s much more important to improve fiat on and off-ramps at this stage, not just in terms of the number of currencies supported but also in trade size and speed of exchange. We are now focused on getting more liquidity on our Bitcoin and Ethereum derivatives markets - this will be important to attract more institutional investors to our platform. The demand for derivatives is high, and few exchanges so far are really able to cater to the needs of institutional investors.