CAIA Blog:  A New Way To Trade Bitcoin And Hedge Risk - September 21, 2021

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Since 1998, the global OTC derivatives market has grown rapidly, from a notional value of $80 billion to over $600 trillion in 2020, which is nearly 7 times global GDP. The public is well acquainted with these financial instruments as an effective way to hedge risks and optimize returns by transforming the performance of underlying assets.

Despite the importance and size of the global derivatives market, there has been little change to the actual structure of products, as most of them either split pooled assets or pooled cash flows. Structured products are made up of several financial assets and are therefore not reliant on one of them individually, but on their combined performance. In general, structured products consist of two components, the first one ensuring the protection of the principal capital and the second one, riskier, allowing the product to maximize its return. Mortgage-backed securities are the best-known example where multiple assets or cash flows are pooled together, tranched and sold as different securities with various investor-desired risk-return characteristics i.e., a pension fund gets safer financial instruments than the original underlying, while investors with a greater return appetite get a riskier product with bigger potential returns.

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