Crypto Derivatives Risk – The Essential Toolkit

In the rapidly changing world of crypto derivatives, staying ahead requires an understanding of market trends, product and technology innovations, and the ability to navigate unique risks. In this Talos webinar focusing on crypto derivatives risk and tooling, Kyle Downey, Head of Portfolio Management Systems at Talos, and Neelabh Dixit, Head of Product Strategy, outlined developments in the crypto market and showcased how the new integrated Talos Portfolio Management System (PMS) can help to navigate these challenges.

Summary

A look back at 2024

2024 marked a pivotal year for crypto derivatives. Highlights included:

• Significant institutional activity bringing new volumes into the market, particularly following the highly anticipated bitcoin ETF launch, with CME futures and options showing significant upticks. 
• Record-breaking volumes were seen in March and November, with the biggest quantum growth seen in crypto options and CME derivatives

Recent market evolution

Post FTX, we’ve seen some developments that reflect a sensitivity to counterparty risk but whose uptake remains in its early stages.

• Off-exchange settlement: Custodians are facilitating tri-party agreements to enhance security and efficiency.
• Prime brokerage growth: Increasing reliance on prime brokers, e.g., for credit intermediation on exchanges and lending, reflects a maturing of institutional market infrastructure.

Challenges of crypto derivatives trading

Despite the promising growth, crypto derivatives trading is still maturing and presents multiple challenges:

• Fragmented liquidity means that traders must build systems that can tap into and aggregate liquidity across multiple venues
• Counterparty risk increases with each additional trading venue used, introducing an optimization problem versus liquidity
• Disparate margining systems across exchanges introduces complexity to margin calculations and risk modeling
• Disparate instruments. e.g., with different settlement mechanisms, introduce additional complexity to understanding P&L and risk

The role of technology and tooling

A PMS is the backbone of a trader’s toolkit, helping the trader to understand their risk for informed trading decisions. The latest Talos PMS provides:

• A unified view of balances across the 60+ trading venues, OTC desks and custodians that Talos is connected to, including equity balances on derivatives exchanges
• P&L calculations of a portfolio across spot, futures, perps and options; at different points in time and across different time intervals
• Risk calculations i.e., full range of Greeks at the portfolio and instrument levels
• Counterparty exposures across a variety of venues to help manage risk of capital loss 
• Operational capabilities including tools for managing settlement of OTC credit and initiating transfers from custodians

Looking ahead: It’s just the beginning

The potential for growth in crypto derivatives remains substantial, especially when compared with its equivalent in traditional financial markets. Innovations to look out for include:

• Prime brokerage services are likely to emerge, fostering greater sophistication in trading strategies.
• Structured products will develop in response to more complex institutional needs.
• Standardization  could emerge in the areas of collateral acceptance and margining standards

What next for the Talos PMS?

Some of the pain points we’ve discussed with client and are looking to address include:

• Accounting for new instrument types such as those related to yield-bearing DeFi activities, e.g., staking
• Notifications are important to help clients manage risk, e.g., in response liquidation risk triggers
• Unified margin management across exchanges with different margining protocols 
• New OTC dealer tools that would allow an OTC desk to seamlessly offer, replicate and/or hedge various payoffs, while transacting with different instrument types across different venues

Conclusion

As the crypto derivatives market continues to rapidly evolve, Talos invites interested firms to collaborate with us as design partners, helping to shape the development of a robust next-generation PMS. 

_{‍Talos Disclaimer: Talos offers software-as-a-service products that provide connectivity tools for institutional clients. Talos does not provide clients with any pre-negotiated arrangements with liquidity providers or other parties. Clients are required to independently negotiate arrangements with liquidity providers and other parties bilaterally. Talos is not party to any of these arrangements. Services and venues may not be available in all jurisdictions.}