Coinbase Launches Derivatives Product in Crowded—and Depressed—Market
While Coinbase looks for new lines of revenue, rival crypto exchanges dominate derivatives trade
Coinbase COIN 4.30%▲ Global Inc. just launched a derivatives product, its latest attempt to move into a new field and offset weakness in its core spot-trading business. It has a lot of competition.
The largest U.S.-based crypto exchange acquired a U.S.-regulated derivatives exchange called FairX in February for $330 million, according to research firm PitchBook. This past week, it relaunched it with a focus on cryptocurrencies. Its first product is a “nano bitcoin” futures contract that will be offered through brokers while Coinbase awaits regulatory approval to offer them directly. Derivatives are financial instruments that are based on and allow traders to bet on the price of an underlying asset, like bitcoin.
Coinbase could use a new source of revenue. Its trading volume, which is all spot trading, was likely down by about 30% in the second quarter from the first, Oppenheimer analyst Owen Lau estimated. And its highly publicized launch of an NFT exchange hasn’t driven much activity.
Coinbase’s first few quarters as a public company were wildly profitable, but since the crypto selloff began in November, the company has struggled. In the first quarter of 2022, it reported a loss of $429.7 million, or $1.98 a share, and said users were fleeing.
Since its launch on Monday, the Coinbase futures product traded an average of 32,000 contracts a day, according to the company. “It’s a pretty solid launch,” said Boris Ilyevsky, the head of Coinbase Derivatives Exchange.
The derivatives market, though, is a crowded one. Rival crypto exchanges such as Binance, Bybit and OKX dominate the derivatives trade, and traditional exchanges like CME are in it as well.
Moreover, a class of crypto exchanges called decentralized exchanges are becoming larger players in the derivatives market. Decentralized exchanges, or DEXes, basically automate the functions of traditional exchanges and allow traders to invest without an intermediary.
Most of this activity is offshore, and largely unregulated.
Over the past few years, decentralized exchanges have steadily been increasing their share of the trading pie. Today, they account for about 55% of “on-chain” trading volume—the trading settled directly on a blockchain—compared with 45% for centralized exchanges, according to research firm Chainalysis.
The comparison isn’t absolute because centralized exchanges such as Coinbase and Binance handle most of their transaction volume internally, or “off chain.” And centralized exchanges are still larger than decentralized exchanges.
But the growth of decentralized exchanges does point to the degree of competition among the different trading venues, something likely to only increase in an environment where activity has been depressed by the selloff in bitcoin and other cryptocurrencies.
The differences between decentralized and centralized exchanges are mainly below the surface. Centralized crypto exchanges are essentially brokering trades, matching orders, and executing and settling the orders. They are the central intermediary, and if something goes wrong, they are the party responsible.
Decentralized exchanges aren’t actually brokering trades on behalf of their customers or facilitating the execution or settlement of the trades. All of those functions are handled through software automation. The liquidity to ensure trades get executed comes from the users, too, collected into large “liquidity pools.”
The arrangement also means that even the companies that created the exchanges don’t assume legal responsibility for them. The Uniswap terms of service include this line: “We are not responsible for any of these variables or risks, do not own or control the protocol, and cannot be held liable for any resulting losses that you experience.”
The biggest products for decentralized exchanges are derivatives, which comprise about two-thirds of their total volume, according to Antonio Juliano, the chief executive of dYdX Trading Inc., which created the second-largest derivatives exchange, dYdX.
The exchange is focused on derivatives mainly because it is the most popular trade in the crypto market, Mr. Juliano said, but he envisions a future where decentralized exchanges compete with centralized exchanges for any type of trading.
“We’re starting to think more about other types of products,” he said. “That kind of stuff takes time to build.”