Originally developed as the foundation for cryptocurrencies like Bitcoin, blockchain technology is now a key, if not exclusive, element of a wide range of industries.
The blockchain technology has developed far beyond its beginnings in banking and cryptocurrency. Despite declining from last year’s record high, annual funding to blockchain companies has almost doubled from 2017 to 2020. The market sizing tool from CB Insights assesses that blockchain spending will amount to nearly $16B annually by 2023.
Blockchain’s popularity helped demonstrate the technology’s potential for finance, but entrepreneurs are now convinced that it can be used to revolutionize many more fields. Blockchains operate on a decentralized platform that does not require any central supervision, so they are resistant to fraud. A transparent, verified record of transaction data has a plethora of potential uses, and the list is almost infinite.
As a result, crypto banking has experienced tremendous growth in recent years. The market for derivatives and bonds can also be revolutionized by the incorporation of crypto banking.
Here in this article, we will introduce the fascinating world of bonds and derivatives and why crypto banks are making waves in this ever-changing market.
Futures, options, and other contracts involving an asset’s value are what constitute financial derivatives.
With regard to crypto banking and especially the futures of Bitcoin and altcoins, financial derivatives are a hot topic. Derivatives are some of the oldest types of contracts on the market and are worth mentioning.
It is thought that derivatives were first used in medieval times to facilitate trades between traders who traveled throughout Europe and participated in periodical fairs. These fairs were a form of early market in the Middle Ages.
Derivatives have evolved into one of the most widely used financial instruments as a result of their development. Derivatives exist today as securities whose value is based upon an underlying asset or benchmark.
It is possible to enter into an asset sale or purchase contract between two or more parties that want to acquire or sell a certain asset in the future for a specified price. So the price of the benchmark that the contract uses to calculate its value will decide the amount of money that the contract will be worth in the long run.
Currency (or cryptocurrency), commodities, bonds, stocks, indexes, and interest rates are usually the underlying assets in derivatives. Trading derivatives can either be done on exchanges or directly with customers (C2C), which has its own regulatory framework and trading methods. The majority of traders use both methods, however.
The first crypto derivatives appeared on the market in 2011, but they were limited to futures contracts based on the bitcoin price (BTC). As the number of crypto derivatives increased, exchanges began offering additional products that investors could buy to protect themselves from market swings and profit from price changes, and by 2020 the market for crypto derivatives had reached record levels. By May 2020, the crypto spot market traded approximately $200 billion every day, while the crypto derivatives market traded approximately $320 billion – approximately 60% more than the spot market.
As institutional investors increasingly hedge their holdings in large-cap cryptos like Bitcoin, many experts think that the volume advantage that crypto derivatives presently have over crypto spot trading will only increase in importance.
In spite of the growing popularity of crypto-based derivatives, which shows the industry’s gradual maturation, these financial products generally still conform to the traditional regulatory framework that legacy banks and credit unions have created.
Due to this, the potential of crypto banking to transform the way the traditional derivative market itself works is one of the most exciting synergies of crypto banking and the global derivatives market.
Since derivatives can be pegged virtually to any real-world asset, in traditional financial markets, such as the traditional stock market, the number of derivative products is essentially limitless, since we are only talking about cryptocurrency derivatives so far. The evolution of on-chain synthetic assets exhibiting real-world performance has, however, resulted in a rapid expansion of the number of derivatives available on crypto banking derivatives trading platforms.
By definition, synthetic assets are bundles of assets – typically derivatives like options, futures, and swaps – that mimic the characteristics of another asset as they are aggregated. By purchasing two option contracts for a particular stock, rather than purchasing the stock directly, an investor would achieve the same net balance as if they were directly holding the stock. In contrast, Crypto banks with blockchain-enabled synthetic assets are unique digital tokens that represent assets traded on traditional financial markets such as derivatives and other tradable assets.
It’s not uncommon for these synthetic assets to have several advantages over their traditional counterparts:
- Blockchain technology enables free, permission-less creation and distribution of value. Users can create their own synthetic assets without external approval or centralized control. An increasing number of platforms provide services with which users can create and trade synthetic assets without having any coding experience. Centralized exchanges sell synthetic assets, which are tokens that adhere to the rules of the marketplaces in which they are traded. Crypto banks have the potential to cut out the middlemen that are required in order to create and trade new financial products. Even while these innovations have the potential to change how we think about what is feasible in the financial services sector, certain decentralized derivatives (and their DEX host platforms) may be in regulatory grey areas and therefore be riskier investments.
- Transparency and efficiency: Another advantage of crypto banks lies in their transparent and immutable storage of data, which allows them to provide real-time information to market participants. On the blockchain ledger, everyone can view circulating assets, custody chains, and smart contracts, so manual external records are not needed. Traders can make better-informed decisions based on real-time records, thereby reducing the risks associated with trading. As another benefit, crypto banks normally require little maintenance compared to many of the existing IT systems underlying markets for derivative instruments. In contrast to these traditional systems, automated crypto banks can validate and execute transactions, store data, and safeguard network functions simultaneously. A crypto bank’s automated trading documentation can also reduce asset prices and minimize risks associated with human error. Crypto bank experts believe these factors will eventually result in more efficient and cost-effective crypto bank systems taking over the aging network infrastructures supporting the traditional derivatives market.
- In many cases, the creation and enforcement of derivative contracts are closely tied to a small number of hedge funds, commercial banks, and other institutions. Synthetic assets created through crypto banks are easier to trade and transfer than their conventional counterparts due to their distributed, immutable design. As for platforms that run synthetic assets, unlike conventional derivatives markets, they use smart contract-based price discovery protocols such as decentralized oracles to source data from markets operating 24/7, which allows investors to access longer trading periods without the restrictions of time zones.
The advantages of an established derivatives market extend beyond the benefits individuals receive from their portfolios. Cryptocurrencies are developed as a complete financial product for retail and institutional investors that meet both their needs. Further advancing the use and acceptance of cryptocurrencies, the derivatives market continues to grow. Additionally, As the go-to venue for financial products, we can challenge conventional methods and products. The long-term success of investors depends on the development of their wealth.
In recent years, several blockchain projects have made significant strides towards accelerating this transition. Synthetix enables the creation of new assets by placing digital currencies into pools. The pools are represented as contracts in Ethereum, so participants can also earn dividends. Similarly, UMA enables the creation of new assets by placing cryptocurrency in the pools, which are Ethereum smart contracts that act as certificates for dividends. In light of the improvement of decentralized exchanges (DEXs) and the current market share they take from centralized platforms, many crypto banking experts believe financial instruments will migrate to decentralized markets in the near future.
As a result, crypto banking will allow the inclusion of the majority, if not the whole, of what is presently available in conventional financial markets into the ecosystem in a manner that will improve market efficiency and transparency. By providing market liquidity and investment options, the global derivatives market also helps investors hedge their risks. By incorporating crypto banking technology into the development of new financial instruments and the migration of existing products to decentralized, global platforms, financial institutions offering derivatives can benefit from increased market transparency and efficiency at the same time.
Therefore, as the infrastructure supporting this interconnected web of decentralized finance platforms continues to mature, it is expected that these crypto banking spaces will merge with the legacy financial services sectors to form a more efficient financial ecosystem with massive additional features.