Crypto Options - A Fast-Growing Market

Deribit is the largest market when it comes to crypto options and futures. 85% of crypto options open interest is held at Deribit and 40% of the (dated) futures OI (which is explained by the fact that market makers need to hedge all options exposure using futures). Around 80% of volumes and OI are generated by institutions that are attracted by liquidity, the wide range of custodians, low latency matching and Deribit’s reputation & track record. To safeguard being the institutional preferred destination, Deribit has invested in many things like a spot and Derivatives license in Dubai, audited financials, SOC2 and ISO 27001 attestation, the highest security standards resulting in AAA rating on CER.live and the growing list of external custodians like Copper Clearloop, Cobo, FalconX, and Fireblocks. Deribit intends to expand the global regulatory coverage and the first step is to seek a MiFID license.

Please find in this article a peek into the world of crypto options, who trades them, the market and expectations for the future.

Who Trades Options?

Compared to Delta one products like futures or spot, options allow for more varied and more specific views on the price of an asset to be expressed, as well as views on volatility. Views on price or volatility can be expressed for a single asset or relative to another asset, for example trading BTC vs ETH.

This flexibility makes options useful to a variety of market participants, including:

• Speculators like sophisticated traders and hedge funds
• Investors with buy-and-hold strategies like asset managers & funds funds
• Miners (and other entities that generate income in crypto)
• Market makers

Speculators

Any liquid asset that moves as much as Bitcoin, or other cryptocurrencies, is of course going to attract speculators of all sizes, from individual retail traders through to large institutional trading firms. Options allow speculators to be very specific about where their risk is, and under what circumstances they will make a profit. Rather than the simple up/down of buying/selling an asset, it is possible for a trader to, for example, choose a specific price range in which they will make a profit.

This image shows one such example structure, called a ‘condor’:

This type of position can be executed with put options, call options, or a combination of both.

Buy and hold investors
Crypto has many long-term holders, many of which are happy to simply hold through all the ups and downs. For those that like to trade around their core holdings though, put options offer a way to protect against severe downside risks, while still getting to participate in the upside. Selling call options allow holders to collect a premium to potentially increase their holdings, though they give up the upside beyond the strike chosen.

Miners
Unless they have access to free electricity, Bitcoin miners will have a minimum price at which they need to sell the Bitcoin they receive in order to make a profit. As the price of bitcoin is quite volatile, some miners will use derivatives to hedge their expected future income. Futures can be used, however shorting a future surrenders the possible upside, so buying put options may be a more attractive choice. This could also be partially or fully funded by selling out-of-the-money calls. Similar strategies are deployed by other entities that generate income in crypto like exchanges or foundations that own a lot of tokens.

Market makers
As well as the obvious opportunities for option market makers, Delta-one product market makers may find options useful for hedging risk.

Option Market Growth

Options have been a popular product in traditional markets for many years, but even there, they have seen a dramatic increase in volume since 2020.

This chart shows the options volume (number of contracts) in the US equity sector for the last 20 years. Over 11.2 billion contracts were traded in 2023.

Source: fia.org

The number of option contracts traded is several times higher than the number of futures contracts traded, as shown in the below chart, which shows the number of futures contracts traded in the US equity sector for the last 20 years. Over 1.3 billion contracts were traded in 2023.

Source: fia.org

The markets for options on cryptocurrencies such as Bitcoin and Ether have also shown strong growth in the last few years.

For context, Deribit, the first mover on crypto options, launched in 2016. The following two charts show the notional volume of BTC and ETH options since 2020.

Source: TheBlock.co

However, the crypto option market is still a much smaller percentage of the total crypto derivatives market compared to traditional markets.

The following chart shows the crypto option volume as a percentage of the total crypto derivatives market.

Source: Laevitas.ch

As can be seen, options currently make up just under 3% of the crypto derivatives market. Perpetual swaps (a type of futures contract that does not have an expiry date) are a delta one product, and currently take up the majority of crypto derivatives volume.

Although this percentage is still low, it has been increasing at a remarkably steady pace for several years. If the crypto option markets are ever to get to a comparative size to their traditional finance equivalents, there is clearly still a lot of room for growth.

A minority of retail crypto traders have already added options to their trading toolbox, and with more educational resources now available, this number continues to grow. However, the majority of crypto option volume is still institutional. This includes crypto native companies, and traditional finance companies who are bringing their experience of trading options in traditional markets over to the crypto space. Deribit is currently around 85% of the crypto options market, and around 80% of the volume on the Deribit platform involves institutional clients.

A Maturing Crypto Market

In previous years many traditional financial institutions would be extremely wary of the crypto space in general due to the lack of regulation, and lack of even basic KYC at many venues. It is only recently that regulatory routes have opened up enabling crypto exchanges to structure themselves in a way more familiar to these institutions.

Auditors are now better able to work with crypto companies, and there are now paths available for exchanges to become regulated. Dubai is hoping to become a hub for crypto exchanges, and in April 2024 Deribit announced that they were the first derivatives exchange to receive a Virtual Asset Service Provider (VASP) licence from Dubai’s Virtual Asset Regulatory Authority (VARA) for VA Exchange Services.

There are some centralised crypto venues that continue down the unregulated, no/low KYC path, and many DeFi apps allow anyone with a crypto wallet to interact anonymously and make transactions, including trading options. Indeed many crypto natives may prefer this approach. For those that prefer a more traditional approach though, and the safer, high-performance environment that comes with it, there are now viable choices for gaining access to the volatile crypto markets.

There are also several custody solutions now available. Custodians such as Copper, Cobo, Fireblocks, and FalconX allow the user’s funds to be stored with the custody provider rather than the exchange, but still be used for trading on the exchange

Crypto ETFs

In January 2024 the first US-based spot Bitcoin ETFs were launched. For some, this legitimised Bitcoin as something that could be invested in, with it being suggested that many would start allocating a percentage of their investment and pension accounts into these ETFs. Whether this view ends up playing out over the longer term remains to be seen, but the inflows so far have been strong.

Spot ETH ETFs are also on the way at some point this summer. There is no set date for those yet, but regardless of the timing, the launch of both the BTC and ETH products shows that at least the larger cryptocurrencies are slowly being integrated into the traditional finance system.

Looking Ahead

The crypto option market is still relatively young but has come a long way since the first bitcoin option was traded on Deribit in 2016.

At the moment the crypto option market is mainly vanilla options, but as the market matures, options will also be used to create more structured products. These allow traders to invest in structures that use options, without having to go into the option markets directly themselves. We have already seen Defi option vaults attempt this type of product, with varying success, and there are companies that already offer structured products OTC. It’s only a matter of time though until more of these find their way onto exchanges themselves.

When comparing relative sizes to more traditional markets, there is clearly still plenty of room for the trend of growth in the crypto options market to continue. And while Deribit’s market share of over 80% is likely to decrease in future, the continued growth of the market overall will mean Deribit is well positioned to remain the go-to venue for crypto options.

About the Author

Article authored by Luuk Strijers, CEO at Deribit