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A sophisticated approach to crypto derivatives

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The steps into crypto being made by traditional financial firms are not only driven by the so-called fear of missing out, but these moves can also be seen as a bid to improve profitability and make investments go further. Also, as trading platforms decrease in number, trust will be critical to success in the space.

The steps into crypto being made by traditional financial firms are not only driven by the so-called fear of missing out, but these moves can also be seen as a bid to improve profitability and make investments go further. Also, as trading platforms decrease in number, trust will be critical to success in the space.

“It takes a lot of effort for the strategies employed by traditional trading firms to be profitable. Every dollar made has a certain dollar cost to generate profit. This ratio is much higher in the traditional space than in the crypto arena,” explains Luuk Strijers, chief commercial officer (CCO) at Deribit.

Further, certain approaches which are no longer competitive in traditional markets still function in crypto meaning they can be more profitable with fewer dollars invested.
Strijers also believes developing a crypto focus can help retain talent: “Crypto gets significant market attention and therefore if trading firms do not have a digital team or focus, they run the risk of staff leaving and launching new ventures themselves.”

These traditional financial firms are well-versed in the way markets operate and although the move into crypto and digital assets may be new, the way they trade and interact with these assets can largely echo their existing processes.

Access to a platform which provides a familiar experience is therefore key. From its perspective, Deribit focuses on crypto derivatives, it’s highly suited to sophisticated investors. “The platform is in line with what these clients would expect. It’s similar to a traditional institutional platform which facilitates trading crypto and digital assets instead of stock options,” Strijers outlines.

Due to the complexity of the assets being offered, Deribit has been purposely selective in the currencies and services it makes available to clients. Strijers says: “Although we have fewer services and our company is a lot smaller than those of our peers, we are lean and mean. This makes us agile and nimble. We can adjust faster and act quickly because we don’t have many layers of management to go through.”

Expanding solutions

This has allowed the firm to build unique solutions. One of these is related to portfolio margining. The aim of this is to help reduce the margin requirements of a portfolio. It uses a risk-based model that determines margin requirements based on price moves and implied volatility by valuing a specific portfolio over a range of underlying price and volatility moves. “We offer a customized approach and monitor all of the scenarios in real-time. Going forward people are going to need capital efficiency – because investors do not want to over-capitalise their account if it can be done more efficiently,” comment Strijers. He believes this service will be elemental to Deribit’s success in the near future: “This is one of the most advanced margining solutions available and we intend to continue improving it to the benefit of our clients.”

Keeping up with clients’ needs and requirements is one of the biggest challenges the firm faces, however Strijers notes that as it expands its services, Deribit needs to also safeguard market quality: “Our aim is to safeguard for future liquidity as well. If a client opens an option position today, the client needs to feel secure that it will be possible to close this position multiple months from now as well. This is only possible by having enough market makers committed to quote 24/7 as well as technical services like market maker protection and high order throughput.”

He further highlights how Deribit is also focused on growing from a capacity perspective to handle further growth. This is because the firm performs all risk checks internally: “We don’t have clearing brokers involved; We guarantee every trade which means that we have to risk-check every order and as a result, we can’t be as fast as some other platforms, because they rely on Goldman Sachs and ABN AMRO to guarantee the trade. We do this ourselves and it takes a little bit of time. Therefore, in order to grow, we need to expand capacity-wise.”

Sophisticated strategies

Another development Deribit is planning is offering cross-collateral capabilities. “This would make capital even more efficient than it is already. We currently have portfolio margining within currencies but not across currencies, which is what we are building,” says Strijers. This would make Deribit attractive to large capital-intensive firms.

Combination or strategy orders like call spreads, calendar speads etc are another solution expected to be available on the Deribit platform which means the large institutional investors can executemore complex trades. Through this solution, they can implement various sophisticated options strategies which will allow them to have multiple positions in play at the same time.

Strijers explains: “Once this is launched, it will allow investors to benefit from options in the fullest way possible. These strategies can currently be deployed by executing each leg separatelybut this could create so-called leg risk as the market might have moved before client was able to execute the second leg, , causingthe payoff tobe different to what was initially calculated.

“This is a world in which seconds are extremely valuable and therefore executing the trades simultaneously can be a big game changer.”

Reputation matters

These additions and new services are being developed to serve client needs. This is also done in an effort to maintain the trust investors have shown the platform.
Deribit has a strong track record in the space and is doing everything in its power to protect it. Strijers emphasises the important role trust plays in the industry: “Trust is an intangible thing but we have aimed to build it among clients by safeguarding future liquidity and also solving any mistakes made quickly.

“We compensate people immediately if any error is made by us and this has contributed to our good reputation. Blockchain entitles people and platforms to transfer assets real time. So, we think the real-time, availability of assets is an important component of the platform. I believe the list of operational, healthy platforms will decrease simply because people won’t trust a lot of them going forward. And that’s when reputation matters.”

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