Bitcoin’s newest trading product offers direct exposure to its volatility, and BlockTower Capital is the first to dive in

Quick Take

  • Hong Kong-based trading firm GSR just executed its first bitcoin variance swap trade with BlockTower Capital
  • Different from perpetual swaps and other popular derivatives products in the market, GSR’s derivatives offering gives investors more exposure to price volatility than its directional movement

Bitcoin’s volatility has long been thought of as one of the major factors that keep big money managers from investing, but a new esoteric financial product could help traders hedge against the cryptocurrency’s price swings. 

Hong Kong-based trading firm GSR revealed to The Block that the first trade of its bitcoin variance swap has been executed with cryptocurrency hedge fund BlockTower Capital — the latest development in the booming derivatives market for digital currencies. 

According to GSR co-founder Richard Rosenblum, the variance swap serves a similar purpose as vanilla swaps or futures in that it provides a way for corporations or traders to hedge against wild price swings in a commodity or speculate on the magnitude of a given price swing.

However, there are also some key differences between a variance swap and other financial products, Rosenblum noted. Most notably, a variance swap offers more direct exposure to volatility, rather than exposure on an asset’s directional price. On one side of the trade, one party is long volatility, whilst the other party is short. Rosenblum declined to disclose whether is firm was long or short vol. 

“It is very difficult to express a view on volatility using futures,” he said. For hedge funds like BlockTower, such an instrument could be useful to hedge against losses. A fund can bet on higher volatility to hedge price swings that could impact their returns. 

It could also be useful for exchanges, which are in the business of volatility. When prices swing widely, exchanges typically see more assets trade hands between clients. To hedge against periods of low volatility, an exchange could purchase a swap that bets on muted markets. 

“We are trying to help native players have access to tools that help them stay solvent during boom and bust cycles,” Rosenblum said. 

A number of derivatives marketplaces have sprung up in the cryptocurrency market over the past year, including Bakkt, ErisX, Seed CX, and trueDigital, which are all looking to offer futures or swaps tied to bitcoin. Elsewhere in Asia, crypt0-native exchanges — such as Binance and Bitfinex –have their eyes set on breaking into the derivatives market for so-called perpetual swaps, which offer a synthetic way to trade bitcoin. 

“This is one of the fastest-growing segments of the market,” Richard Rosenblum, a former oil trader at Goldman Sachs, noted. “Same way there was a lot of lending during the bear market, we are seeing a surge in derivatives.”

“It is only a matter of time, maybe a year, that we see a $3 billion trading day in cryptocurrency derivatives,” Rosenblum added. 

GSR sits in a different corner of the market, offering so-called structured products. Structured products, like the ones found on Wall Street’s trading desks, are created by non-exchange entities, typically banks. They are also blamed for market blow-ups like the one that precipitated the 2008 financial crisis.

As for what’s next, Rosenblum predicts the rest of 2019 will see the emergence of additional derivative products, including ones aimed at helping mining firms hedge against changes in bitcoin’s difficulty rate.