The trade in derivatives was born soon after the advent of commodity exchanges. The main motivation behind their development was optimizing the risks related to possible changes in commodity prices. 

The most common derivative, futures, is a contract to buy a commodity in the future at a price that is settled at the current moment. It allows the buyer to insure against excessive price increases but deprives him of benefits should the prices fall.

In the second half of 2011, following the appearance of the first bitcoin exchanges, the trade in bitcoin derivatives began. It was pioneered by such companies as the New Zealand-based Bitcoinica, which offered its clients the option to bet for or against bitcoin price rises, and ICBIT.se, created by Russian programmers and allowing to trade bitcoin futures. Many of these companies lacked transparency and security and were therefore short-lived.

In 2013, bitcoin volatility stirred up an interest in bitcoin derivatives that were increasingly seen as a means of protection from the fits and starts of the bitcoin price and possibly of smoothing them. It was especially important for bitcoin miners: as mining passed from solitary enthusiasts to large firms, who sold bitcoins to cover their electricity costs, they felt a greater need to protect themselves from possible price declines. At this stage, the bitcoin community was joined by a number of people from the world of official finance such as George Samman, ex-New York exchange broker, who participated in the creation of BTC.sx in May 2013.

The fact that most legislators see bitcoins as a commodity, not a currency, allows many companies to stay in a ‘grey zone’ without provoking too much interest from the authorities: they need simply to conduct all trade in bitcoins, without involving fiat currencies. Nevertheless, a growing number of bitcoin derivative platforms is applying for registration in the belief that a regulated status would lend them additional support and attract investors.

Conditions of Bitcoin Derivatives

Leading bitcoin derivative companies include TeraExchange, OkCoin, BTC.sx and Coinarch. TeraExchange is the only bitcoin derivative company regulated in the U.S., having been licensed by the Commodity Futures Trading Commission (CFTC) to carry out bitcoin/USD swaps with a price that is settled beforehand. The swaps are short-term, usually two business days, and, when the time expires, the profit of one counterparty and the loss of the other are settled according to the difference between the contracted bitcoin price and the valuation price of the Tera Bitcoin Price Index at 5:00 pm EST.

OkCoin offers weekly, fortnightly, and monthly futures contracts in bitcoins and litecoins. Weekly contracts are settled on 4:00 pm, China Standard Time, the Friday following the date of the contract. Fortnightly contracts are settled on the second Friday and monthly ones on the last Friday of the month. The settlement price is calculated based on the average of the price index of the last hour before closing.

The most popular bitcoin derivative platform, BTC.sx, allows its customers to conduct margin trades, borrowing USD to enter a ‘long position’ (if the growth of bitcoin price is expected) or borrowing bitcoins to enter a ‘short position’ (if the decline of bitcoin price is expected). According to the company website, it offers 2:1, 5:1 or 10:1 leverage, and executes the trade directly at the market, thus guaranteeing all client profits and minimizing trading risks.

Coinarch offers two types of services, Booster and Maximizer. Booster is also a margins trade: the leverage allows to profit from the change of the price of bitcoin, and the option to close a position at any moment lowers potential risks. The automatic ‘stop loss’ feature means that a user would not lose more than their initial investment. Maximizer gives clients the chance to earn rates of interest on bitcoin investments. The user chooses the time interval and the bitcoin price at the end of the interval. If the bitcoin price is higher than expected, the client receives their interest. If it is lower, he buys bitcoins at the price they settled beforehand.

The Future of Bitcoin Derivatives

Daniel Gallancy, founder and CEO of New York-based SolidX Partners, believes that bringing together the world of regulated financial markets and the world of blockchain-based businesses is a very arduous task because the two systems are essentially incompatible. Still, it should be done. And bitcoin derivatives might play the decisive role: bringing the liquidity of regulated financial markets to the bitcoin world may “help mature the bitcoin market”.

According to Arthur Hayes, a co-founder and CEO of Hong Kong-based BitMEX and a former Citi Bank employee, 2015 will be “the year that people really start focusing on derivative products, and the volume in derivatives is going to grow exponentially compared to that of the spot market”.