Cash Settled vs Deliverable Derivatives

There are two main types of derivative markets available to institutional investors: cash settled and deliverable. The cash settled market functions almost exactly as it sounds. At the time of maturity, the difference between the current price and the contract price is settled via an exchange of cash. The most notable exchange to be cash settled is the CME (Chicago Mercatile Exchange). The deliverable market is more commonly thought of in the commodity space, as the physical asset is delivered to the buyer at the time of maturity. ICE (Intercontinental Exchange) partnered with Bakkt and operates in this manner.

The differences seem quite straight forward; so why would an institutional market participant choose one over the other? In almost all cases, hedge funds and large funds operate under a trading mandate. This mandate will specify what types of securities that the fund can trade or purchase. Given custodial problems that can arise for hedge funds and other institutional players (among other compliance issues), the cash settled market at the CME is a venue in which they can speculate or get exposure to the Bitcoin asset, without ever having to own the asset. On the contrary, many OTC (over the counter) trading desks and market makers may have built up inventory (Bitcoin) and already store the asset. These participants are more likely to trade on the ICE exchange where the cryptocurrency is physically delivered at maturity.

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