A survey conducted by Coalition Greenwich has found that NDFs are being repurposed as a vehicle to support institutional buy-side interest in cryptocurrencies.
The research firm conducted 108 interviews across a spectrum of cryptocurrency users, augmented by targeted interviews of senior trading personnel at some of the largest cryptocurrency derivative market makers.
One of the key findings is that derivative products were naturally the first to be utilized to get exposure to the crypto market—namely futures and exchange-traded products (ETPs), but their own unique challenges have prevented wide adoption in the short term.
The obvious solution to this challenge is to use widely used derivative instruments that are well understood by most market participants. “We are keen to make markets in cryptocurrencies, but the current setup makes risk management and hedging challenging,” noted one major broker-dealer. The initial approach was the launch of cryptocurrency futures and ETFs, though both had drawbacks that were raised in our discussions with the market.
The high volatility of the underlying creates margining and netting issues for adopting futures and ETFs. While an excellent investment vehicle for retail, ETFs do not lend themselves easily to this purpose as the create/redeem process requires smooth access to the physical market, which does not solve the issue banks raised. Also, expecting to hedge ETF price-making activities smoothly back to back implies relying too heavily on other market participants to provide liquidity, especially during particularly volatile periods.
As to NDFs, given their OTC nature, NDFs are much easier to manage and the technology and risk management is well embedded into the current setup across all banks.
24Exchange is leading the movement toward Crypto NDFs. “24Exchange with its partner banks are pioneering adapting the NDF product for cryptocurrency. With a crypto derivatives exchange license from the Bermuda Monetary Authority, 24Exchange is in a strong position as a first mover and will be able to garner outsized market share in crypto NDF flows”, said Dmitri Galinov, CEO of 24Exchange.
While there is broad consensus around the focus on digital assets going forward, certain details are worth highlighting: Bank and broker participants expect a third of crypto volume in the coming years to be executed on fully decentralized exchanges, while the buy side thinks under 15% will be handled by non-SEC/CFTC venues. In contrast, fintech firms expect about half the volume to go through that channel.
