Crypto Options: Challenges and Opportunities for Startups

Oct 30, 2023  •  Written by Ocular Team

Despite macroeconomic conditions, the derivatives market, particularly crypto options, is experiencing significant growth. As of September 27, 2023, the volume share of options in overall crypto derivatives hit a new high of 3%. However, when compared to the traditional market, where option notional volume is generally 30% of total derivatives in the US, it becomes evident that crypto options are still in an early stage. 

To understand why the options market are facing hurdles in their growth, let's break down the three primary factors they're up against.

  1. Regulatory Uncertainty

One of the primary challenges for the crypto options market is the lack of clear compliance and regulations. Volatilities in crypto are much higher than in other markets, making crypto options trading potentially more lucrative. There are also arbitrage opportunities to access different platforms for tokens due to the inefficient market. However, institutions find it hard to enter and optimize the markets.

Unlike the traditional market, general crypto regulations are still either non-existent or under early development. This is what hinders large institutions from entering the space due to compliance risk management concerns. The AML/KYC standards in option trading also lack uniformity, while service providers are not as sophisticated as traditional finance.

Spot ETF is a great example as institutions prefer to apply ETFs instead of buying spots from current crypto exchanges. This demonstrates how important regulatory compliance is for institutional investors.

  1. Counterparty Risks

The concentration of liquidity on centralized platforms poses significant counterparty risks. With a few large centralized exchanges and market makers which may or may not be regulated dominating the trading volume, the risk of platform vulnerabilities is evident, especially in even small cap options. This challenge has catalyzed the birth of DeFi solutions like GRVT, which leverages both off-chain efficiency and on-chain smart contract and ZK technology to handle high volumes while mitigating counterparty risks. 

GRVT offers an institutional-grade self-custody derivatives trading platform, eliminating counterparty risk by utilizing smart-contract-enabled bilateral pools for on-chain margin management. This platform provides complete asset control for enhanced security. GRVT also provides a more comprehensive trading system, e.g., delta neutral margin calculation. It is important now for DeFi to understand institutional language to attract institutional users.

  1. Lack of Standards in Pricing Models

The limited liquidity of linear products in the crypto options market presents challenges for traders in hedging price risks. With large market makers (MMs) and exchanges dominating the market, crypto option pricing is very opaque. We feel this could be gradually solved through the increase in volume and market efficiency. However, it is also important for a market standard of pricing methodology to be developed. 

In the traditional market, IHS Markit (acquired by S&P for 444bn) was known for providing independent data and developing pricing standards for derivatives, foreign exchange, and loans.

Given the large volume concentration on BTC and ETH options today due to the above-mentioned reasons together with difficulty in pricing, the development of an industry standard for pricing discovery will be beneficial to expand the trading beyond existing tokens to altcoins. 

So, are there any opportunities for startups in general?

Ocular recognizes the immense growth potential of the crypto options market. As the market is still in its early stages, attracting institutional participation is key. Startups focusing on setting up better service standards for options pricing, risk management, and compliance stand at the forefront of opportunities in this expanding space.  We would love to speak to platforms that are working on setting up better service standards for options pricing, risk management, and compliance for institutional investors.

Disclaimer: This information is for educational purposes only and should not be taken as investment advice. Always do your own research and seek professional advice before making any investment decisions.