In 2017, many traders and investors flocked to cryptocurrencies because they were attracted by the kind of returns not available in the less-volatile traditional markets. However, volatility inevitably comes with risks as well as opportunities.
But crypto offers many opportunities that go far beyond traditional instruments. Programmable tokens and smart contracts create the potential to automate trading and investment vehicles, making them easier to understand and more accessible to retail users of all risk appetites.
The race to innovate in centralized finance
Derivatives trading platform FTX was the first centralized exchange to pioneer the use of leveraged tokens, enabling users to gain margin exposure without the hassle of managing margin, liquidation or collateral. Leveraged tokens are derived from the exchange’s perpetual swap contracts and operate as tradeable ERC-20 tokens that can be withdrawn and traded.
They rebalance every day and can also be redeemed based on the user’s trading activity. These are higher-risk instruments suitable for traders looking for more exposure to volatility.
If imitation is the sincerest form of flattery, then FTX can take comfort from the fact that Binance was relatively late jumping on the leveraged token bandwagon. After initially listing FTX’s leveraged tokens, Binance suddenly u-turned and removed them, citing user confusion as the reason. Only weeks later, the exchange giant announced it was launching its own version of leveraged tokens.
However, FTX has been determined to continue providing innovative trading solutions to crypto users. One such example is its MOVE contracts, which are basically an options straddle strategy with centralized liquidity for speculating on Bitcoin’s (BTC) volatility.
Rather than managing two options contracts with the same strike price and expiration, known as a straddle, MOVE contracts allow users to access a more sophisticated type of investment with a more user-friendly and understandable format.
Synthetic assets and other derivatives flourish in DeFi
Due to its immaturity and experimental nature, decentralized finance applications have experienced several notable setbacks in 2020, including the bZx and Balancer exploits. Nevertheless, the value locked in DeFi has soared and is set to touch the $7-billion mark soon.
Much of this popularity can be attributed to the fast pace of innovation, as the fertile ecosystem layers on more sophisticated products beyond lending pools, insurance instruments and stablecoin-issuing decentralized autonomous organizations.
Aave is one example of an application that has moved up the rankings to rival the popularity of MakerDAO. The main reason is the opportunity for flash loans that involve borrowing and repaying a loan in a single blockchain transaction. Their demand has been fueling the practice of yield farming — running funds through a series of DeFi applications in an attempt to extract maximum returns.
Some of the current limitations of derivatives products on DeFi platforms are worth noting, however. Ethereum congestion and gas fees could pose a threat to the continuing expansion of DeFi DApps, while the network continues to grapple with the complexities of the Ethereum 2.0 upgrade. Furthermore, Vitalik Buterin himself has warned traders about the risks of yield farming.
Nevertheless, for professional traders, the volatility of crypto paired with an increasingly impressive suite of trading products is enticing, to say the least. As more analysis firms and traders conduct their due diligence of the booming derivatives market, expect the deluge of products to continue parallel to growing interest.
Simplifying investments for the risk-averse
For the more risk-averse average Joe investor, passive investment is usually the optimal risk-adjusted method for investing in the crypto space long-term. Using strategies like dollar-cost averaging into Bitcoin and Ether (ETH), users can gain exposure to an asymmetric call option on the future of money.
However, piling into a single crypto asset risks maximizing the drawdowns during price crashes, such as March’s “Black Thursday.” Attempts to offset this risk have led centralized finance and DeFi innovators to develop more passive investment vehicles.
Unfortunately, there is no crypto exchange-traded fund yet, but the vanilla option for a broader market exposure of large-cap altcoins is index funds. Similar to major stock index funds, crypto index funds encompass a basket of crypto assets aggregated into a single investment vehicle. They are independently weighted based on investor preferences and the fund’s design and can range from baskets of the leading 10 assets to the top 200 by market capitalization.
Some centralized finance index funds have been stealthily gaining traction in a way that’s somehow escaped the attention of the crypto media. Adrian Pollard, a co-founder of bitHolla — a producer of white-label crypto exchange software — pointed out:
“Many have been so focused and concerned about Bitcoin’s price volatility not noticing a secret stash quietly piling up at Grayscale, which now manages the largest crypto investment vehicle around.”
Funds that include more assets, particularly lower cap altcoins, grant investors more potential upside should anything resembling the mania of 2017 repeat. However, they also mean more exposure to drawdowns, as lower cap altcoins still tend to fare poorly during sharp downswings in larger-cap crypto assets.
Tokens as a fund
The caveat with Grayscale is that it’s only available to accredited investors, which is somewhat antithetical to the notion of crypto becoming a more inclusive financial system. That’s where “tokens as a fund” of different shapes and sizes enter the picture.
A tokenized fund is essentially an ERC-20 token on the Ethereum network that mirrors the price of an index fund using oracle price feeds and other technical components.
Coinbase’s Index Fund, which covers Coinbase’s listed basket of assets, is an optimal method for retail investors to gain index exposure, and since Coinbase is also the largest fiat-to-crypto gateway in the United States, its index would be easy to access for many.
The retail-friendly funds remove the accredited investor hurdle, making them more appealing to retail investors who want broader exposure and less volatility. To manage volatility spikes, index funds are ideal passive options for investors who are hesitant to dive all in on BTC, ETH or a handful of large-cap altcoins.
Now that the stock market is beginning to resemble crypto with its absurd bankruptcy stock runs, crypto doesn’t seem so much like the Wild West of finance anymore. Retail traders now have broader exposure to more risk-averse instruments available, and the progressively bigger pro-trading crowd can enter a market thriving with long-overdue derivatives innovation.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.