Hedge funds rush to bet on outcome of Ethereum ‘merger’

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The Ethereum blockchain’s imminent move to a new, greener system has sparked a trading frenzy by hedge funds racing to place bets ahead of one of the biggest events in the short history of cryptocurrencies.

Traders picked up options on ether tokens — the flagship cryptocurrency trade on Ethereum — betting on price volatility or hedging against sharp, sudden moves ahead of the “meltdown.”

The merger is a long-awaited event in the crypto industry and will change the way new transactions are verified on the Ethereum blockchain.

A handful of traders are betting that switching to a new system will reduce network power consumption by up to 99%, opening up ether tokens to traditional investors who have been wary of a network with power consumption until now. energy roughly equivalent to that of Finland.

“It’s been one of the most crowded exchanges in crypto history,” said James West, managing director of Globe Exchange, a crypto derivatives exchange.

Many trades were placed in the options market, where West said “a lot of smart money [is] buying,” with many expecting a successful switch to push up Ether prices.

The total number of options contracts outstanding on the Deribit exchange, which accounts for 97% of open interest on ether options on the exchanges, has risen from 1.2 million at the start of the year to more than 4 .6 million on Wednesday.

About 80% of these contracts are call options – a bet on a higher price in which an investor has the option to buy ether at a fixed price for a set period of time – while the rest are options. puts or bets on lower prices. This is a sign of “massive bullish sentiment”, according to Luuk Strijers, chief commercial officer of Deribit.

Some even think the merger could help ether supplant bitcoin as the world’s largest cryptocurrency. The total value of bitcoin in circulation is $390 billion, compared to less than $200 billion for ether, according to the FT Wilshire Digital Assets Dashboard.

“The mere anticipation of ether overtaking bitcoin” could become “self-fulfilling and unstoppable,” said Anders Kvamme Jensen, co-fund manager of the AKJ Digital Assets fund, who said the funds he invests in are betting on merging using options.

Line graph of percentage change over the past three months showing Ether outperforming rival bitcoin before the merger

Meanwhile, some investors have constructed option trades to try to take advantage of the potentially huge price volatility of the merger, whether that price movement is up or down, according to Strijers.

But such was the hype around the merger, other traders had strategies in place that bet that the price of ether would rise sharply before the event, but then sell off if the merger happened.

As a result, some bought shorter-term call options paying if Ether hit $2,500 and funded it by selling longer-term calls paying $3,000, according to Chief Investment Officer Ed Hindi. of the hedge fund Tyr Capital, which acts as a crypto options market maker.

However, this trade has so far not gone as expected. While the price of ether has risen from below $1,000 in June to $1,600 this week, it’s still a far cry from what short-term options would yield. Fearing that they will now be hit if ether rises sharply after the merger and triggers the options they sold, traders rushed to hedge their positions, according to Hindi.

The market was “far too bullish” before the merger, and “far too bearish beyond the merger,” he said.

Many investors already holding Ether have attempted to protect themselves from a sell-off if the merger does not materialize, for example if it is delayed or there are technical issues, also using futures contracts to bet that its price will drop. This type of trading, known as shorting, effectively protects them from price movements.

According to Kaiko Research, the so-called funding rate, a measure of the direction of traders’ collective futures positions, in ether is at its lowest level in over a year, averaging minus 0.6. %. This usually indicates that investors are focusing on short selling.

Traders are also hoping that this gamble of holding ether while shorting the futures could earn them some extra tokens, while protecting them from market volatility. Investors who hold Ether at the time of the merger are entitled to tokens that are still based on the old transaction processing system, known as proof of work.

While the merger is set to transition Ethereum to the more energy-efficient proof-of-stake model, some market participants who oppose the change will continue to operate on the old system – something known as “fork” – which means that these coins may contain part of their evaluate.

Jay Janer, founding partner of KPTL Arbitrage Management in the Cayman Islands, runs this trade because he thinks options trading has become too expensive. “If the fork happens, we’ll get the proof-of-work token for free,” he said.

Additional reporting by Philip Stafford

laurence.fletcher@ft.com

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