Thursday links: Financial friction, perpetual futures, and ransom notes

Did derivatives sink crypto?

One theory for the current crypto malaise is that the recent introduction of exchange-listed derivatives and derivative-like alternatives — futures, options, ETFs, DATs — has increased the supply of bitcoin and ether, thereby depressing prices.  

It’s not a correct theory: ETFs don’t increase the supply of bitcoin any more than call options increase the supply of Apple shares.

But an academic paper suggests it could have a similar effect.

“We show that an otherwise redundant derivative can reduce the price distortion of the underlying security by relaxing its scarcity,” the authors write.

Bitcoin prides itself on its scarcity, so anything that reduces it would seem particularly impactful. 

The authors cite another study in support of their findings: “The price of the underlying stock tends to fall when (nonlinear) options on the stock are introduced.”

Still, this is not a case of increasing supply. Instead, the authors explain that derivatives lower prices by reducing frictions that make it harder for investors to get exposure to the underlying. 

Making something more difficult to buy raises its price, so it stands to reason that making it easier to buy should lower it.

It’s unclear to what degree, though. The paper has a lot of equations quantifying the effect, which is summed up by the arrow below: 

The solid red line represents the price of an underlying before the introduction of derivatives and the dotted red line is the price after.

But the models behind the graph assume that derivatives make markets more efficient by directly matching buyers with sellers — specifically, sellers who otherwise would not have been willing or able to sell. 

This is very theoretical.

In the case of bitcoin, futures may have unlocked new supply by allowing bitcoin miners to sell coins they haven’t yet mined. But that’s an edge case. In most cases, if someone buys a future contract, they’re probably buying it from a market maker, who will buy spot bitcoin to hedge.

In terms of supply and demand — and therefore price — that’s no different than if the buyer bought spot bitcoin directly.

So, no, derivatives have not increased the supply of crypto — Bitcoin’s 21-million cap remains intact.

But they have reduced friction in the crypto market, and that, in turn, has probably lowered crypto prices.

I’m guessing not by much, but still — we thought TradFi adoption would raise prices by creating new buyers. 

Instead, it lowered them by eliminating frictions.

Be careful what you wish for.

The use case of 24/7 trading

One way to understand the price-raising effect of friction is to consider silver. If investors’ only option was to buy physical bars or coins from a local shop (as was the case as recently as the 1970s), they’d pay significantly more for it. Silver from a shop costs more than silver from an exchange.

Investing in silver got much cheaper when futures were introduced in 1975, and then again when ETFs were introduced in 2006. 

Now, you can even buy it on weekends!

The crypto exchange Hyperliquid has reduced friction in commodities markets by offering perpetual futures (perps) on silver and gold that are always available to trade. 

This is genuinely useful, as Blockworks research analyst Shaunda Devens details in a recent report: “One of the most practical use cases for Hyperliquid 24/7 perps is pricing the COMEX Sunday reopening auction.”  

Silver futures stop trading when the COMEX closes at 5 p.m. ET on Fridays and reopens at 6 p.m. on Sundays. In between, the only place to continue speculating on silver is Hyperliquid. 

The trading is surprisingly efficient. Devens’ research finds that even when COMEX is closed, the bid-offer spreads on Hyperliquid’s commodity perps are tight (tighter than COMEX, even!) and liquidity is good (but not nearly as good as COMEX, of course).

As use cases go, weekend trading in silver is pretty niche. But the efficiency with which  Hyperliquid does this suggests that more price discovery for traditional financial assets could move to perps exchanges.

Hyperliquid is already doing $5 billion of notional volume a day in TradFi instruments like silver, which is a good start. And there could be much more to do; markets won’t be perfected until there are no more frictions to take away.

The mega-bull case for perps 

Arthur Hayes, who co-invented the crypto version of perpetual futures in 2016, thinks they’re now poised to conquer traditional finance.

“By the end of 2026,” he predicts, “price discovery for the largest US tech stocks and the key US indices will happen on perps markets serving retail.”

Given his phrasing — “price discovery” — I think he’s referring to trading while the exchanges are closed (which is most of the time), not all trading.

But either way, that’s just for starters. By 2029, Hayes expects that the most liquid US equity derivative “will be an equity perp traded on a crypto exchange.”

To put that in perspective: Just the primary S&P 500 futures contract can do over $1 trillion in notional trading volume on a busy day.

Hayes thinks perpetual futures will take that volume away from traditional futures simply because they’re a better product: “Being right trading options on a high-vol asset is less profitable than being right trading a highly leveraged perp.”

Also, perps are available 24/7. And they’re available to everyone, not just those with access to US exchanges.

Those would be some big frictions to remove.

An unfortunate payments use case for bitcoin

An anonymous tipster has demanded payment of one bitcoin in return for information they claim to have about the kidnapper of Nancy Guthrie, an 84-year-old who went missing in Tennessee last week. 

It’s a sad story. It also raises questions of how individuals like the tipster — and people in general — are thinking about cryptocurrency. Would the tipster have demanded 0.7 bitcoin at the start of the year, when bitcoin was 50% higher?  

In other words, is the tipster thinking in dollars — I want $68,000 for this information — and that just happened to equal 1 bitcoin when they made the demand? Or are they thinking in bitcoin — I want 1 bitcoin for this information — whatever that happens to work out to in dollars?

It must be the latter, right? It seems too coincidental that the dollar value of the tipster’s information just happened to equal exactly 1 whole bitcoin when they sent the note. 

If so, bitcoin may now be the unit of account for ransom-related transactions. 

Of course, it’s long been a means of payment: The actual kidnapper has reportedly demanded a ransom paid in bitcoin as well (although we don’t know if it’s also a suspiciously round number of them).

So now bitcoin just has to prove it’s a store of value, and it will have fulfilled all three prongs of moneyness and therefore become money.

In any case, it’s good to stay relevant.

— Byron Gilliam

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