Tracing the Evolution of Crypto Derivatives

Derivatives markets in centralized finance have long been a focus for regulated exchanges. Holding extraordinary value – the exact amount still up for debate – derivatives account for a large volume of contractual trading around the globe. 

According to the Bank for International Statements (BIS), the derivatives market held a total of around $600 trillion in outstanding contracts. While the gross market value of these contracts was far less, only around $12.4 trillion, this still demonstrates the extent to which derivatives are a core part of our modern financial ecosystem.

As derivatives contracts allow traders to invest in price movements of a market or asset without having to buy the actual asset, it lends itself well to volume. Already engaged in theoretical trading based on deriving value from contracts, this field is apt for expansion into the digital sphere.

Over recent years, blockchain companies have tried to bring a sustainable derivatives market to the Web3 sphere. As a digital platform with high accessibility, this was initially promising. However, after a few years of unstable exchanges, no regulation, and lacking opportunities, the market hasn’t evolved particularly far.

In this article, we’ll dive into the world of Web3 derivatives trading, touching on the key shortcomings of previous projects, outlining the reasons behind these failures, and commenting on platforms like Ithaca that could represent a new era in decentralized finance.

How Does the Web 3 Derivites Market Fall Short?

Despite the complete dominance of the derivatives market in traditional finance, this form of trading isn’t nearly as popular. However, just because it’s not as common doesn’t mean it doesn’t exist. On the contrary, there are massive crypto derivatives markets currently in action.

For example, in March of 2023, the crypto derivatives market rose for the third consecutive month. In that month, derivatives trading accounted for 74% of the $4 trillion crypto market volume. These increases came shortly after decentralized exchanges began to add derivative trading to their central portfolio of features for users to engage with.

Yet, while the foundations are there, there are several core reasons that the Web3 derivatives market still hasn’t quite found its footing.

• Lack of Regulated Digitals: In traditional financial spheres, digital derivatives vastly expand the convenience and accessibility of this form of trading. Digitization of assets facilitates rapid trading and underpins the success of this market. However, in decentralized markets, there is a lack of standardized digital representations of assets. Without a central standard, each decentralized exchange may offer something that others do not accept as ubiquitous.
• Lack of Collateral Options: In order to maximize efficiency when trading derivatives, trading institutions will use collateral. Collateral is often either securities or cash, which institutions can monitor each day to define investing agreements. DeFi platforms may either lack the technological advancements to effectively measure and offer collateral additions to their systems or be unable to design a system that can manage the added complexities of DeFi trading.
• Platform Fragmentation: Each decentralized exchange offers a distinct service, each of which operates independently of one another. As a system that’s made up of various siloed ecosystems, there is limited communication and interaction with external platforms. Without interoperability and transparency between platforms, the DeFi derivatives market will struggle when efficiently pricing and managing liquidity. 

While not an extensive list, these problems represent the core difficulties that the cryptocurrency market faces when attempting to expand further into derivatives. 

How Blockchain Companies Seek To Restructure the Crypto Derivatives Market

As an industry that centers itself as an alternative to traditional financial spheres, blockchain businesses have long been working on potential solutions to faults in their derivatives market. 

Over the last few months, one of the most striking innovations has been the development of Ithaca. Ithaca aims to build a blockchain-based, permissionless, cross-chain infrastructure that will significantly improve the interoperability of ecosystems while enabling optimal risk sharing. 

For the derivatives market, these developments come with a range of potential solutions:

• Standardization: As an on-chain infrastructure that can state the digital representation of value, Ithaca will help to standardize digitalized assets. This is one of the core functions of derivatives, with this improvement vastly improving the overall experience for traders involved in this space.
• Collateral Optimization: Ithaca offers a collateral optimization and liquidation engine. By incorporating these functions into the underlying infrastructure of the platform, Ithaca will optimize collateral usage in blockchain derivative trading, boosting capital efficiency.
• Interoperability: As one of the core pillars of development, Ithaca plans to enhance the interoperability of blockchain ecosystems, offering cross-chain bridging capabilities that will allow different platforms to communicate with one another and streamline derivatives management. 

Although Ithaca is not the only company in the world of blockchain that’s developing an enhanced ecosystem to facilitate trading, its long-term plans for expansion and current architectural components make it one of the most prominent in the space. 

Final Thoughts

While the world of Web3 derivatives trading has had peaks and troughs, the future is looking up for this industry. As new technology, protocols, and systems launch, traders in this market are getting closer to an experience that closely resembles centralized finance – without the downsides that TradFi includes. 

Brands like Ithaca attempt to offer a comprehensive solution that addresses the core challenges currently faced in the Web3 derivatives market. By systematically solving the issues that have held this industry back, the blockchain world will be able to restructure the market to bring more traders on board and offer a more holistic trading ecosystem.

As these changes come into effect, the future may be bright for crypto derivatives trading.

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