Crypto derivatives markets: Bitcoin vs. Ethereum

Derivatives play a crucial role in financial markets, providing essential tools for hedging, speculation, and price discovery. These instruments derive value from underlying assets, allowing market participants to manage risk and gain exposure to asset price movements without directly owning the assets. In the traditional financial market, derivatives are a massive category. The Bank for International Settlements (BIS) reported that the notional amount of over-the-counter (OTC) derivatives reached $667 trillion at the end of last year.

While the crypto derivatives market is significantly smaller than that, it has grown substantially in the past couple of years and has become an essential part of the broader market. Crypto derivatives have become indispensable tools for managing the inherent volatility and leveraging investment strategies. Bitcoin (BTC) and Ethereum (ETH) derivatives are the pillars of this relatively young market, despite many other derivatives products based on smaller cryptocurrencies.

The growing adoption of these derivatives shows their importance in enhancing market liquidity, enabling sophisticated trading strategies, and facilitating price discovery. In this report, CryptoSlate will explore the theoretical and practical differences between BTC and ETH and their respective futures, options, and perpetual futures markets.

As Bitcoin (BTC) and Ethereum (ETH) serve distinct primary purposes in the crypto market, significant differences exist in their market behavior, utility, and investor profiles.

The fundamental differences between Bitcoin and Ethereum have significant implications for their respective markets. Bitcoin’s primary use as a store of value results in relatively stable market behavior compared to Ethereum. While Bitcoin does experience volatility, its price movements are often influenced by macroeconomic factors, such as inflation rates and geopolitical events, similar to traditional safe-haven assets like gold.

Ethereum’s market behavior, however, is more complex due to its position in the DeFi ecosystem. Its performance is heavily influenced by the activity within its network, including the success and usage of various dApps and DeFi projects. It can lead to higher volatility than Bitcoin, as technological developments, network upgrades, and regulatory news can significantly impact Ethereum’s price. The rise of scaling solutions and Layer-2 networks further complicates its performance.

Liquidity is another critical difference between the BTC and ETH markets. Bitcoin generally enjoys higher liquidity. This means that large transactions can occur with less impact on the price, making them more attractive to institutional investors. While also highly liquid, Ethereum can experience more significant price swings due to its broader range of use cases and the varying demand for ETH in different applications.

These differences extend to their derivatives markets. BTC derivatives, including futures, options, and perpetual futures, tend to attract diverse investors, ranging from retail traders to large institutions. The primary motivation for trading BTC derivatives is often related to hedging against market volatility or speculating on Bitcoin’s price movements based on macroeconomic trends.

However, ETH derivatives attract participants interested in speculative trading and those deeply involved in the Ethereum ecosystem. These include developers, DeFi participants, and investors looking to hedge against the volatility of projects built on Ethereum. The fundamental differences between Bitcoin and Ethereum thus shape their respective derivatives markets in distinct ways. Bitcoin’s role as digital gold leads to a more straightforward market, with participants primarily focused on its price as a store of value. Ethereum’s multifaceted utility results in a more complex derivatives market influenced by technological innovations and the broader dApp ecosystem.

Futures contracts are financial derivatives that obligate the buyer to purchase, or the seller to sell, an asset at a predetermined price at a specified future date. They are instrumental in financial markets for hedging risk and speculation, allowing investors to gain exposure to asset price movements without directly owning the underlying asset. Futures contracts provide a mechanism for price discovery and liquidity, facilitating efficient market operations.

The BTC futures market is highly developed, with significant trading volumes and open interest. As of Jan. 1, 2023, the open interest for BTC futures stood at $17.20 billion. By June 20, 2023, this figure had nearly doubled to $33.30 billion, reflecting a substantial increase in market participation and interest. This growth illustrates retail and institutional investors’ strong demand for BTC futures.

In contrast, the ETH futures market, while also growing, is relatively smaller. On Jan. 1, 2023, the open interest for ETH futures was $6.99 billion. By June 20, 2023, it had risen to $15.10 billion. Although the ETH futures market is expanding rapidly, it remains less liquid than BTC futures.

BTC futures generally exhibit greater market depth and liquidity compared to ETH futures. The higher liquidity in BTC futures markets means that large trades can be executed with minimal impact on the market price, making it more attractive for institutional investors. ETH futures, while liquid, can experience more significant price movements due to the varying demand driven by its utility in the dApp and DeFi ecosystems.

Market sentiment and external factors have distinct impacts on BTC and ETH futures. BTC futures are influenced by macroeconomic trends, such as changes in inflation rates, geopolitical events, and regulatory developments. These factors can significantly affect Bitcoin’s perceived value as a store of value and hedge against traditional financial market volatility. ETH futures, on the other hand, are more sensitive to developments within the Ethereum network. Technological upgrades, such as the transition to proof-of-stake, the success of major dApps, and shifts in the DeFi landscape, can drive significant volatility in ETH futures markets. Additionally, regulatory news specific to smart contracts and decentralized applications can have a pronounced impact on Ethereum’s price and, therefore, its futures market.

Options contracts are financial derivatives that provide the holder with the right, but not the obligation, to buy (call options) or sell (put options) an asset at a predetermined price before a specified expiration date. They play a crucial role in financial markets by offering hedging risk and speculative trading tools. Unlike futures contracts, which obligate the parties to execute the trade, options provide flexibility, allowing investors to manage risk with a predefined level of potential loss.

Call options grant the holder the right to purchase the underlying asset at a set price, enabling investors to profit from price increases. Put options, on the other hand, allow the holder to sell the asset at a specified price, benefiting from price declines. This flexibility makes options a valuable instrument for various trading strategies, including hedging against potential losses and speculating on price movements.

Bitcoin options have seen substantial growth. As of Jan. 1, 2023, the open interest in BTC options was $12.93 billion, which increased to $21.20 billion by June 20, 2023. This surge indicates a rising demand for BTC options among investors. The distribution of open interest between call and put options shows a preference for calls, with calls comprising 66.37% and puts 33.63%. On June 20, the 24-hour trading volume for BTC options further reflected this trend, with calls accounting for 63.69% and puts 36.31%.

While smaller in volume than Bitcoin, Ethereum options also exhibit significant growth. The open interest in ETH options rose from $6.45 billion on Jan. 1, 2023, to $9.58 billion by June 20, 2023. Like BTC, ETH options show a higher preference for call options, with calls making up 65.66% and puts 34.34% of the open interest. The 24-hour trading volume on June 20 mirrored this distribution, with calls at 65.55% and puts at 34.45%.

Implied volatility (IV) is a critical metric in options trading, reflecting the market’s expectations of future volatility. BTC options generally exhibit lower implied volatility compared to ETH options. This difference aligns with Bitcoin’s role as a store of value and Ethereum’s ecosystem driven by DeFi activities.

Perpetual futures contracts are a type of derivative that, unlike traditional futures, do not have an expiration date. These contracts allow traders to hold positions indefinitely, provided they can meet the margin requirements. Perpetual futures closely track the spot price of the underlying asset through a funding rate mechanism, which ensures that the contract price remains aligned with the spot market. Funding rates are periodic payments exchanged between long and short positions, incentivizing traders to keep the contract prices close to the underlying asset’s spot price.

The BTC perpetual futures market is highly active, with substantial trading volumes and liquidity. Funding rates play a critical role in these markets. As of June 20, 2023, the open interest-weighted funding rate for BTC perpetual futures was 0.0032%, and the volume-weighted funding rate was 0.0033%. These relatively low rates reflect Bitcoin’s established market position and the balance between long and short positions.

The ETH perpetual futures market, while also robust, exhibits higher funding rates. On June 20, 2023, the open interest-weighted funding rate for ETH perpetual futures was 0.0085%, and the volume-weighted funding rate was 0.0084%. These higher rates indicate greater volatility and a more intense trading environment influenced by the developments in the Ethereum market.

For BTC, low and stable funding rates indicate a mature market with balanced sentiment between long and short positions. For ETH, higher funding rates suggest more active speculation and rapid responses to network-related events. These rates impact traders’ strategies, influencing their decisions to hold long or short positions based on the expected cost of funding.

BTC perpetual futures attract a diverse range of participants, from institutional investors to retail traders. The market behavior tends to be more stable, reflecting Bitcoin’s role as a store of value and its lower volatility relative to other cryptocurrencies. Some speculate that the high derivatives volumes we’ve seen in the past few months were a result of a basis trade from investors holding ETFs and using futures to hedge their exposure.

The differences between BTC and ETH derivatives markets are their underlying asset characteristics and market behaviors. BTC derivatives benefit from higher liquidity, lower volatility, and broader acceptance as a financial asset, making them attractive to a wide range of investors. In contrast, ETH derivatives are influenced by the evolving Ethereum ecosystem, leading to higher volatility and a more complex market landscape.

Despite these differences, BTC and ETH derivatives markets show significant growth and increasing institutional participation. This trend reflects the broader acceptance and integration of cryptocurrencies into mainstream financial markets.

For Bitcoin, we can expect further growth in futures and options volumes as more institutional investors seek exposure to digital gold. The BTC market’s stability and maturity will likely attract more sophisticated financial products and deeper liquidity.

For Ethereum, ongoing developments within the network will likely drive some interest in ETH derivatives. However, the imminent launch of spot Ethereum ETFs in the US could significantly impact the market. Spot ETFs would provide a more accessible and regulated way for investors to gain exposure to ETH, potentially leading to a shift in trading behavior. Futures contracts might experience a decline in open interest and trading volumes as investors move towards spot ETFs for direct exposure to ETH. However, spot ETFs could boost the options and perpetual futures markets through basis trades looking to lock in prices akin to that seen in Bitcoin. Investors holding ETFs might use options and perpetual futures to hedge their positions, seeking protection against price volatility and enhancing their investment strategies. This shift could lead to increased trading volumes and open interest in ETH options and perpetual futures, reflecting a more sophisticated approach to risk management among ETF holders.

This is similar to how the launch of spot Bitcoin ETFs affected the BTC derivatives market. The significant increase in options volume and the rise in popularity of perpetual futures began after ETFs were launched, ushering in a new era for the derivatives market.