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What is The Potential Impact of Ethereum 2.0 on The Derivatives Market?


Ethereum is expected to deliver a system-wide upgrade that will significantly boost its compatibility, scalability, and security. This much-awaited upgrade called Ethereum 2.0 would introduce several protocol improvements, including economic changes impacting regular users. 

In the last five years, several minor changes were made. But Ethereum 2.0 is the network's largest update by far, which may take a few years to complete. The Ethereum 2.0 update is expected to go live by the end-2020, or by the beginning of 2021. 

This article discusses the impact of Ethereum 2.0 and its influence on ETH prices. It studies market sentiment and positioning leading up to this event, and explore some ways for traders to benefit from the event.

What is Ethereum 2.0?

Ethereum 2.0 is the latest major upgrade to the Ethereum network. Following the upgrade, one of the primary improvements will be Ethereum’s consensus mechanism. Ethereum 1.0 uses a consensus mechanism known as Proof of Work (PoW), where it requires miners to verify transactions and build new blocks using computational power.

On the other hand, Ethereum 2.0 will use a Proof of Stake (PoS) mechanism, where it uses validators to forge new blocks onto the blockchain. Validators will be rewarded with new tokens for maintaining the integrity of transactions on the network. To operate a validator node, participants must meet its primary requirement, a minimum of 32 ETH ‘staked’ under the proposed Ethereum 2.0 upgrade.

A Proof of Stake mechanism is less energy-intensive and requires fewer resources needed to operate the Ethereum network. Thereby increasing scalability and efficiency as a result.

How will it impact the market?

ETH 2.0 will attempt to move all users and assets to the new network while simultaneously maintaining existing operations - this has never been done before on such a large scale. 

This raises a big question, will the Ethereum 2.0 upgrade have any impact on the ETH price? 

There are a few different hypotheses on how the crypto markets could react. Below are explanations of the factors that could shape market reactions to the launch of Ethereum 2.0.

Potential supply shock?

One of the potential outcomes is a disruption to Ethereum’s supply of tokens. With the transition to PoS, investors will be more incentivized to keep and lock-up their Ether holdings to qualify for staking rewards. This will then reduce the supply of ETH tokens while demand continues to grow strong as large investors flood in seeking steady gains. 

Latest statistics have shown that the number of addresses containing 32 ETH has risen exponentially year-on-year. According to Glassnode, more than 123,229 Ethereum addresses hold 32 or more ETHs — grew by 15.5 percent from last year.

Source: Glassnode

Although a timeline for the planned switch is still undecided, investors have been aggressively stacking ETH in anticipation of the ETH 2.0 update.

Euphoric markets?

A supply shock could potentially drive a dramatic price surge and trigger unprecedented levels of retail FOMO.

Crypto markets last experienced a similar kind of euphoria in 2017, when Bitcoin’s massive rally to $20,000 uplifted altcoin markets as well. The same momentum is needed for FOMO to arise this time around.

Looking back, the 2017 market euphoria was curtailed partially due to the shortage of fiat on-ramps. With these platforms widely available today, nothing can prevent a retail-FOMO frenzy. 

Nowadays, most large exchanges provide services that make staking ETH more available to the retail market. As a result, this would further raise demand and reduce circulating supply.

Enhanced consumer viability?

Although the above implications could be speculative, a genuine demand could spark this supposed rally. With the upgrade offering a solution to Ethereum’s scaling problems, its use-cases will drastically increase.

As stated earlier, the update would take months, if not years, to be completely enforced. It would take some time to transfer existing dApps and developer workflows to a new network. As such, the effect of this upgrade may not be felt immediately.

It would, however, have a longer-term impact. Companies and developers would not jump on board hastily and commence full-scale operations on the new network. Instead, it will be a gradual process to validate and build confidence in a new system. As such, usage will eventually increase over time.

Everything considered, these catalysts may potentially have a positive impact that ETH holders had wished for.

Are derivatives traders positioned for this event?

With the upgrade expected to go live soon, speculators may have been positioned to take advantage of this event. Below we examine several market indicators that could potentially reveal traders’ sentiment surrounding ETH 2.0.

ETH Futures open interest remains strong on Binance

Source: Skew

Ethereum futures open interest on Binance has risen considerably since the beginning of 2020. Particularly since H2FY20, ETH open interest rose massively, expanding from less than $60 million to $200 million at its peak - an expansion of more than 3 fold. This coincides with a massive ETH rally that saw prices peaked at $480 in less than a month. The open interest upsurge in the second half of 2020 may suggest that traders have positioned long-term directional bets on Ethereum. 

Increasing Futures basis signals investors’ expectations

Market analysts often turn to the futures market to understand market expectations. Particularly, the futures basis is often used to study traders’ sentiment. The basis represents the difference between the underlying asset's spot and futures prices. 

In bull markets, futures prices trade higher than spot markets. As such, the futures basis tends to be positive.

By contrast in bear markets, futures prices often trade at a discount to spot markets. Therefore, the futures basis would turn negative.

As such, the futures basis is usually an indicator of market expectations surrounding the underlying asset's future direction.

Binance Futures ETH1225

Binance Futures ETH0326

Source: Binance Futures

In the last few months, we witnessed ETH’s close relationship with many DeFi protocols - both have seen tremendous gains in recent months. This is because many DeFi protocols were built on Ethereum’s network. As DeFi grew popular, the momentum has positively impacted Ethereum as well. 

However, since early September, many DeFi tokens have experienced a reversal of fortunes, dragging down Ethereum along. On average, most DeFi tokens are down by 60% to 80% from their peak. Despite that, ETH is still holding strong with futures basis turning positive in recent weeks. This suggests that investors are more bullish on Ethereum in the near-term and that the proposed upgrade could be a fundamental catalyst for Ethereum’s resilience.

The chart above shows how the ETH futures basis has mostly remained positive in the last 30 days, with occasional drops, especially in the middle of September.

Demand for Ethereum Options 

Source: Skew

Here we examine the distribution of open interest by expiration dates. We observed that options expiring in December hold the largest open interest with 481,500 open contracts. Meanwhile, the Mar-21 expiry open interest is 199,800 contracts, according to Skew, a market data platform. The concentration of activity in December and March contracts suggests that traders anticipate significant volatility in these periods and may be gearing up for ETH 2.0.

Source: Skew

Lastly, we examine ETH options open interest by strike price, showing the accumulation of positions at different prices. The graph above reveals considerable open interest concentrations on both ends. We can see accumulated positions around $600 and higher and around $200 and lower. This finding suggests that market participants are uncertain about Ethereum's future direction. The cluster on both ends may suggest that traders are positioned for volatility driven trades, where a price breakout beyond these thresholds could trigger a large move.

Looking at the growing demand for Ethereum futures and options, it seems to suggest that investors are still bullish on Ethereum with concentrated activity surrounding the expected launch date of ETH 2.0. Backed by other fundamental factors such as the fast-growing DeFi sector, the demand for Ethereum looks convincing.

How can you position your portfolio ahead of ETH 2.0?

Many products offer increased exposure to Ethereum should you believe that the event will bring volatility and trading opportunities. On Binance, users can select from various instruments such as Futures, Options, and Leveraged tokens.

If you want to position a trade ahead of this event, the best way would be futures contracts.

1. Coin-margined Futures

Investors are more likely to hold on to their Ether holdings, particularly in anticipation of ETH 2.0. Binance's COIN-margined futures are ideal for traders who tend to hold positions for a long period. Ethereum investors can increase their exposure via coin-margined futures contracts where the settlement of profits and losses are denominated in the respective underlying asset, i.e. ETH. Any profits will contribute to your long-term Ether stack. It is a perfect way to maximize your Ether portfolio over the long term. 

2. USDT-margined Futures

However, if you don't own any Ether and want to participate in the potential uptrend, USDT-margined contracts will be perfect. Retail investors who cannot afford to stake on the new network can gain leveraged exposure to Ethereum through USDT Futures contracts. Binance’s USDT futures contracts are perpetual, which means they do not have an expiration date. As such, these contracts are similar to spot markets. On Binance, users enjoy high liquidity and low fees, enabling them to trade in volatile markets efficiently and cost-effectively.

Final thoughts

More investors seem to be acquiring ETH exposure using derivatives in 2020. With YTD gains close to 200%, it is a further testament to investors’ interest. 

The upcoming Ethereum 2.0 upgrade and the rapid growth of the DeFi space have proved to be significant variables driving the bullish sentiment. With potentially more use cases, the narrative appears to be fundamentally sound.