Jointly produced by Tongzhengtong Research Institute × FENBUSHI DIGITAL

Jointly produced by Tongzhengtong Research Institute × FENBUSHI DIGITAL

Consultants: Bo Shen; Rin; Chloe

In the 1730s, the first recorded financial bubble in human history—"Tulip Mania"—came into being a contract for buying a certain amount of tulips at a specific price at a specific time in the future. The prototype of financial derivatives.

Summary

Derivatives are the product of diversification and transfer of market economic risks. In order to solve the problems of insufficient liquidity and high risk of default in forward transactions, 82 businessmen in Chicago founded the Chicago Board of Trade in 1848, and futures in the modern sense came into being.

The instability of the international financial market gave birth to financial derivatives. A financial derivative is a financial contract whose value is based on the performance of one or more underlying assets or indices, such as interest rates, exchange rates, commodities, credit, and stocks. Financial derivatives are intertemporal, linked, and leveraged, with high risks and high returns coexisting. In addition, financial derivatives have the functions of hedging and speculative arbitrage.

Financial derivatives have a wide variety and a large number, and the market value has gone through a process of rapid expansion and gradual decline. At present, Europe and the United States occupy a dominant position in traditional financial derivatives transactions, and the scale of OTC derivatives transactions far exceeds that of on-exchange transactions.

The current token derivatives mainly include: futures contracts, perpetual contracts and option contracts, and some token trading platforms also classify spot leveraged transactions as token derivatives.

The current market situation is that token derivatives are mostly based on mainstream tokens with large market value, high market popularity, and strong liquidity. However, most tokens have high volatility and strong risk asset attributes. In addition, derivatives have leverage and are easier to scale up. volatility. With the development of the market, there is a high probability that futures contracts will become necessary token derivatives on trading platforms, and perpetual contracts are gradually becoming popular. Trading platforms operate transnationally and lack a unified regulatory framework.

Risk Warning: Regulatory Policies, Market Trends

Table of contents

1 Financial Derivatives: Products of Risk Hedging

1.1 Pandora's box slowly opened

1.2 Dance on the tip of the knife

2 Financial derivatives: various types, dominated by Europe and the United States

2.1 There are more and more financial derivatives

2.2 Over-the-counter transactions, dominated by European and American regions

3. Token derivatives debut

3.1 The "Four Heavenly Kings" in Token Derivatives

3.3 Prospects: Dragon Slaying Warriors have just grown up

In the 1730s, the first recorded financial bubble in human history—"Tulip Mania"—came into being a contract for buying a certain amount of tulips at a specific price at a specific time in the future. The prototype of financial derivatives.

1.1 Pandora's box slowly opened

Derivatives are the product of diversification and transfer of market economic risks. In the 12th century, Flemish traders used a "De Faire" document to carry out forward transactions of commodities in the market. The document mainly records the transaction content between buyers and sellers within a specific time in the future. In the rice market in Japan in the 17th century, in order to reduce the impact of uncontrollable factors on the price of rice, the owners of rice objects often chose to sell the notes of rice storage warehouses in order to lock in future income. In 1730, the Japanese government officially recognized this market as " Rice Expected Transactions" market. In order to solve the problems of insufficient liquidity and high risk of default in forward transactions, 82 businessmen in Chicago founded the Chicago Board of Trade (CBOT) in 1848, and futures in the modern sense came into being. In 1865, CBOT launched the first standardized agreement and formulated a margin system (Margin), and forward trading officially developed into modern futures trading.

The instability of the international financial market gave birth to financial derivatives (Derivatives, also known as financial derivatives). The Bretton Woods system collapsed in the 1970s, and the instability of the international monetary system increased. In order to reduce the exchange rate risk in international trade and investment activities, the Chicago Mercantile Exchange (CME) issued the first exchange rate in 1972. Foreign exchange futures contracts, financial futures enter the futures market, and financial derivatives are produced. Subsequently, new financial derivatives such as interest rate futures, treasury bill futures, index futures, currency swap contracts and option contracts were born one after another.

A financial derivative is a financial contract whose value is based on the performance of one or more underlying assets or indices, such as interest rates, exchange rates, commodities, credit, and stocks. The International Swaps and Derivatives Association (ISDA) describes financial derivatives as: bilateral contracts designed to transfer risk for traders. When the contract expires, the amount a trader owes the other party is determined by the price of the underlying commodity, security or index.

1.2 Dance on the tip of the knife

Financial derivatives are intertemporal and linked. According to the definition of ISDA, the transaction of financial derivatives is based on the expectations of both parties about the future and has intertemporal characteristics. At the same time, the price of financial derivatives is easily affected by basic products or basic variables, and in most cases the two show a positive correlation.

Financial derivatives are leveraged, and high risk and high return coexist. Financial derivatives transactions adopt a margin system, that is, it is not necessary to pay the full contract value of funds during the transaction, and only need to pay a certain percentage of margin to conduct the full transaction. The margin system provides investors with opportunities to make big gains with a small amount, but high returns must be accompanied by high risks. When the margin is lower than a certain percentage during the transaction and the investor fails to increase the margin in time, the position will be forcibly closed. In addition, credit risk, liquidity risk, settlement risk, operational risk and legal risk also widely exist in the transaction of financial derivatives.

Financial derivatives also have the role of speculative arbitrage. Speculative arbitrage in the financial market is a trading behavior that takes advantage of the correct expectation of the direction of market changes to make a profit. The inherent characteristics of financial derivatives and market trading mechanisms (such as the margin system) provide a living space for speculative arbitrage, and the leverage attribute of financial derivatives further enhances the power of speculative arbitrage.

2.1 There are more and more financial derivatives

Due to the intensification of international financial risks, the continuous deepening of financial globalization and the advancement of information technology, financial derivatives have emerged in an endless stream, gradually forming a basic situation of wide variety and large quantity. In 1972, the Chicago Stock Exchange of the United States took the lead in launching futures contracts for six currencies. In 1973, stock futures appeared, and in 1975, mortgage bond futures appeared. According to the statistics of the Bank for International Settlements, by 1994, the international market had more than 1,200 types of basic financial derivatives, covering financial markets such as physical objects, currencies, stocks, and bonds, and more than 20,000 types of more complex financial derivatives were created based on this.

According to product forms, financial derivatives are mainly divided into four categories: forwards, futures, options and swaps.

The futures contract is a standardized contract formulated by the futures exchange, which has uniform regulations on the contract expiration date and the type, quantity and quality of the assets traded.

Option (Option) contract is a transaction of buying and selling rights, that is, the right to buy and sell assets of a specific type, quantity, and quality at a specific time and at a specific price. There are exchange standardized contracts and non-standardized contracts for option contracts.

Option (Option) contract is a transaction of buying and selling rights, that is, the right to buy and sell assets of a specific type, quantity, and quality at a specific time and at a specific price. There are exchange standardized contracts and non-standardized contracts for option contracts.

A swap (Swap) contract is a contract between a buyer and a seller to exchange a specific asset at a specific time in the future. That is, at a certain time in the future, buyers and sellers exchange assets that they think are of equal value.

Financial derivatives transactions can be divided into on-exchange transactions and over-the-counter transactions according to different trading venues. On-site trading (exchange trading), that is, the trading method in which buyers and sellers concentrate on the exchange for bidding transactions. The exchange is responsible for formulating standardized contracts for trade participants to choose, collecting margins, clearing and assuming performance guarantee responsibilities. The mobile phase of floor trading is higher. Over-the-counter transactions (counter transactions), that is, the transaction method in which buyers and sellers directly become counterparties. The parties to the transaction negotiate and agree on the content of the contract and are responsible for the liquidation. Over-the-counter transactions require higher credit levels of transaction participants.

2.2 Over-the-counter transactions, dominated by European and American regions

Although the scale of over-the-counter derivatives transactions has declined in recent years, its total volume still far exceeds that of on-exchange transactions. According to BIS, the notional amount of open interest in over-the-counter derivatives has experienced repeated fluctuations since reaching a peak value of 710 trillion U.S. dollars in the second half of 2013. $544 trillion, only slightly higher than the 2015-2017 average for the same period. In terms of on-exchange transactions, the open positions of exchange options and futures in 2018 were US$47.3 trillion and US$33.7 trillion, respectively, far below the scale of over-the-counter transactions.

The market value of financial derivatives has gone through a process of rapid expansion and gradual decline. According to BIS, the market value of over-the-counter financial derivatives soared from 2.56 trillion U.S. dollars to 34.94 trillion U.S. dollars from June 1998 to December 2008. Affected by the economic crisis in 2008, the total market value began to decline year by year, reaching US$9.66 trillion in December 2018.

Europe and the United States occupy a dominant position in financial derivatives transactions. In the regional distribution of options and futures open interest on exchanges, North America has a clear advantage, accounting for more than 72% of the total for a long time, while Europe also remains stable at 23%. In the over-the-counter financial derivatives market, the UK has always maintained a leading position. According to BIS, in the total turnover of the OTC foreign exchange market, only Britain and the United States account for more than half of the market share, of which the United Kingdom leads with a 1/3 share.

3.1 The "Four Heavenly Kings" in Token Derivatives

The token market is an emerging market, characterized by high volatility, imperfect rules, and transnational services. Perhaps inspired by the diversification and risk transfer functions of traditional financial derivatives, token derivatives have gradually emerged in the token market.

The current token derivatives mainly include: futures contract, perpetual swap (Perpetual Swap) and option contract (Option), and some token trading platforms also classify spot leveraged trading (Margin Trading) as token derivatives.

Judging from the current token derivative products provided by the token trading platform, futures contracts have the momentum to become a must-have derivative on the trading platform, and perpetual contracts are spreading rapidly, while spot leveraged transactions and option contracts are relatively small, but options as One of the "Four Heavenly Kings" of traditional financial derivatives is expected to continue to develop in the field of token derivatives.

For futures contracts, traders can choose to buy or sell futures contracts by judging the price of the forward target to obtain income from the rise or fall of the token price. At present, the delivery time of the token futures contract is divided into "the current week, the next week, and the quarter". When it expires, it will be automatically delivered (it can also be advanced), and a certain multiple of leverage can be added. Futures contracts can be used to hedge against expected market risks, and can also function as hedging and arbitrage. However, most platforms currently support futures leverage of up to 100 times. In a volatile market, the risk of liquidation is high.A perpetual contract is a futures contract that does not undergo final delivery. The current main form is Rolling Spot Futures. For more information about perpetual contracts, please refer to the previous article "Perpetual contracts: the ultimate form of token derivatives?

". A rolling contract is a futures contract that is settled on the same day and automatically extended. The profit and loss are settled every trading day, and the contract positions held by traders will be automatically extended at the end of the trading day. A rolling contract is effectively a combination of an auto-renewing spot contract and a daily currency swap. The operation of the perpetual contract is relatively simple, and there is no need to consider steps such as delivery and swap. The professional requirements for investors are relatively low, and it can provide a user experience close to that of the spot; , thereby increasing market activity; perpetual contracts are convenient for arbitrage and hedging, which is conducive to introducing institutional investors and improving the market pricing mechanism.

Options contracts give the holder the right, not the obligation, to buy or sell an asset at a specific price on a specific date in the future. At present, option contracts are relatively small in the token derivatives market, and only a few trading platforms such as LedgerX and Deribit provide BTC and ETH option contracts.

Spot leveraged trading refers to the form of trading by borrowing funds or underlying objects from the trading platform based on a certain amount of principal and based on the judgment of the market trend. Spot leveraged trading has similarities with margin financing and securities lending in traditional finance. They both satisfy traders' demands for small and big gains by increasing leverage, but at the same time traders also bear the risk of doubling their losses. In the traditional financial market, margin trading and securities lending are usually not classified as financial derivatives, but in the token market, some trading platforms also classify spot leveraged transactions as token derivatives (such as Huobi Global).

3.2 Token derivatives: rigid demand futures, improved perpetual

Token derivatives are mostly based on mainstream tokens with large market value, high market popularity, and strong liquidity. In the trading of token derivatives, mainstream tokens such as BTC, ETH, and EOS are generally used as the basic subject matter of token derivatives. The leverage multiples supported by different derivatives are also different. Spot leveraged transactions generally support 3-5 times; futures contracts support 10-50 times; the upper limit of leverage for perpetual contracts is mostly 100 times.

Most of the targets in the token market have high volatility and strong risk asset attributes. In addition, derivatives have leverage characteristics, which makes it easier to amplify volatility. Compared with the initial stage, the scale of the token market has grown greatly, reaching a peak of more than 828.1 billion US dollars. However, it is still an emerging market relatively speaking, and its scale and maturity are far behind the traditional financial system. At present, the token market has not yet produced a mature valuation and pricing system, and there are often huge differences in the value of token assets and dramatic price fluctuations. In 2018, there was a round of continuous decline in the token market. The total market value was as low as 100.7 billion U.S. dollars, and the largest drop was 87.8%. The previous increase was as high as 268 times from the beginning of 2017 to the high point of 2018, and the volatility was much higher than that of traditional market. Under high volatility and high leverage, the token derivatives market is more risky, and it is more prone to liquidation and liquidation.

There is a high probability that futures contracts will become a must-have token derivative on trading platforms, and perpetual contracts are gradually gaining popularity. Token derivatives have the functions of hedging market risks and intertemporal arbitrage. When the token market fluctuates violently, derivatives transactions tend to be active. Compared with spot transactions, token derivatives transactions have a higher demand and frequency of swaps, which can help trading platforms obtain stable and considerable revenue. After more than 170 years of development of traditional financial derivatives, there are relatively mature products and technologies that can be used as a reference for token derivatives trading platforms, and the design threshold for token derivatives is relatively low.

Token derivatives transactions are mainly for individual investors. At this stage, due to regulatory policies, market size and implementation conditions, the proportion of institutional investors in the token and its derivatives market is relatively low, and small and medium investors occupy a major position in the market. A Saramin survey report mentioned that among the 941 Korean respondents, 31.3% invested in tokens, and the average investment amount was only US$5,300. From the development process of the stock market, it can be found that as the market gradually matures, the proportion of institutional investors will gradually increase, and finally occupy a dominant position, but this will be a long process. It can be expected that the current investor structure will continue for a period of time, and how to meet the needs of ordinary investors and institutional investors is the main issue that service organizations in the token market must consider at this stage.

Trading platforms operate transnationally and lack a unified regulatory framework. The token is issued based on the blockchain, and generally has a peer-to-peer payment function. It is naturally cross-regional, and investors can choose platforms from different countries (regions) for transactions. Therefore, many platforms that provide trading and other services have chosen offshore financial centers as their registration places, which are open to investors from all over the world. However, the laws and regulations of various countries are very different, and disputes are relatively difficult to resolve. In the traditional offshore market, the participants are mainly institutional investors, with strong risk control capabilities and strength, and the risk of default is relatively controllable. However, the average asset size of investors in the token market is relatively low, and their investment capabilities are relatively insufficient. They are relatively more likely to default in an offshore environment, and the corresponding recovery is more difficult under the current conditions.

3.3 Prospects: Dragon Slaying Warriors have just grown up

May the warrior who slays the dragon not turn into a dragon. Although the original intention of financial derivatives is to diversify and transfer risks, the highly leveraged and speculative attributes of derivatives are bound to cause market shocks on a certain scale. There has always been an argument in the industry that "financial derivatives promote the outbreak of the financial crisis". In the same way, token derivatives are also evolved to hedge token market risks, and they also have the basic attributes of traditional financial derivatives. With the development and maturity of the market, token derivatives will become more and more influential.

Due to some reasons, some nouns in this article are not very accurate, mainly such as: general certificate, digital certificate, digital currency, currency, token, crowdsale, etc. If readers have any questions, they can call or write to discuss together.

Note:

Due to some reasons, some nouns in this article are not very accurate, mainly such as: general certificate, digital certificate, digital currency, currency, token, crowdsale, etc. If readers have any questions, they can call or write to discuss together.

This article was originally created by TokenRoll Research Institute (ID: TokenRoll). Unauthorized reprinting is prohibited.