They noted that the introduction of options on the IBIT ETF might increase the "paper" supply of Bitcoin, as institutional investors can gain exposure to Bitcoin without having to purchase it directly. "Options on spot bitcoin ETFs could also mean that the 'paper' supply of bitcoin will increase, as institutional investors can get exposure to bitcoin buying or selling without having to invest through the spot market, and being long without actually buying bitcoin or being short selling without having to buy bitcoin in the first place," CryptoQuant analysts added.
They pointed to a significant trend in the futures market, where the "paper Bitcoin" supply surged from 279,000 to 549,000 BTC during the 2022 bear market. This increase in open interest indicates a growing preference for Bitcoin derivatives over the physical asset, as investors sought to short Bitcoin without directly participating in the spot market.
Bitcoin perpetual futures open interest increased significantly during the 2022 bear market. Image: CryptoQuant.
Derivatives trader Gordon Grant discussed the implications of this trend, drawing parallels with the gold market. He highlighted that while "paper" trading constitutes a substantial portion of total trading volumes, there remains a necessity for physical demand that underpins this supply. "We see that while paper gold trading makes up a significant chunk of the total average daily volumes, so does spot, and while it is true that open interest can burgeon in the paper space, somewhere along the line, paper supply would necessitate paper demand which implicates a physical underpinning," he added.
Grant emphasized that as bitcoin integrates into traditional finance, its use as collateral becomes more complex. Unlike traditional assets, bitcoin isn't as readily accepted as collateral for derivatives contracts. "What is relatively new to bitcoin as we move to traditional financial products is that the digital asset is not easily used as collateral to gain leverage, which is the effective creation of paper contracts backed by bitcoin," he explained.
Grant then said that, as a result, participants will use U.S. dollars rather than Bitcoin for paper contracts. This indicates a preference or necessity for dollar-denominated transactions, likely due to the liquidity and acceptance of dollars in traditional markets. "As such, the necessity for participation in IBIT options will be dollars, not bitcoin itself," he said.
He further explained that the overall market for bitcoin products is expanding. The share of bitcoin derivatives is increasing within that market. "we could see a 'growing pie and growing pie share' phenomenon whereby the overall size of the bitcoin products pie, in terms of average daily volumes, encompassing spot, futures/linear derivatives, and options/nonlinear derivatives, continues to grow in either dollar or bitcoin equivalent units, and the pie-share of bitcoin derivatives also continues to grow," he said.
Grant also mentioned that the price of options could be affected by the new IBIT options product and how it will influence implied volatility. He expressed concerns about a potential volatility squeeze, citing past heightened retail demand for options. "The real question for me is how bitcoin options markets, in terms of the price of optionality as measured by implied volatility, will digest a new source of activity and participatory interest. I wonder about a risk of a potential volatility squeeze in bitcoin options if there is, at some point, frenzied retail-driven demand for bitcoin options, as we saw in the past with GameStop and Ethereum during the EIP 1559 upgrade," Grant added.
Disclaimer: The Block is an independent media outlet that delivers news, research, and data. As of November 2023, Foresight Ventures is a majority investor of The Block. Foresight Ventures invests in other companies in the crypto space. Crypto exchange Bitget is an anchor LP for Foresight Ventures. The Block continues to operate independently to deliver objective, impactful, and timely information about the crypto industry. Here are our current financial disclosures.
© 2024 The Block. All Rights Reserved. This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.