Options Trading in Crypto Markets

Options trading in cryptocurrency markets on centralised exchanges (CEX) and decentralised exchanges (DEX) also face several challenges. Options are versatile financial instruments widely used across various asset classes for risk coverage or to capitalise on less likely events. However, their implementation in crypto markets, especially in decentralised settings, has encountered significant obstacles.

Challenges in Implementation

A primary issue with current crypto options platforms is their focus on the options pricing mechanism and its integration with margin requirements. Many platforms are experimenting with novel approaches to options trading, not just covered calls and volatility trades, yet they often overlook the crucial aspects of clearing and settlement. These foundational processes, akin to the unseen part of an iceberg, are critical for the stability and functionality of any financial trading system but are frequently absent or underdeveloped in the context of cryptocurrency options.

Virtual Market Makers

We also see some protocols that appear to be exchanges actually acting as virtual market makers, where they provide the other side of the trade and fund it via funding pools, or by adjusting the prices in their market to make sure further trades will offset prices, in the manner of a bookmaker or Enron. It is often hidden via a good front end and language that brings obfuscation talking about pricing theta. None of these address the harder and more central problems that underpin the establishment of a mature options platform.

In essence the absence of a mature and effective clearing and settlement system on-chain hampers the crypto market's success and wider adoption of options. This gap is a major factor preventing the emergence of a robust, decentralised options market.

Costs and Margin Challenges

Compared to traditional markets, the high capital cost associated with establishing positions in these derivatives is a deterrent. The lack of cross-margin capabilities in most platforms, including most CEX as well as Perp DEX, means that executing complex trades or spread positions becomes prohibitively expensive, often negating the potential profits of such trades. While some platforms propose solutions or future implementations of cross-margin, these claims lack clarity and feasibility. Others claim cross-margin capability but don't offset initial margin requirements only moving minor components like P&L. Even these small benefits make these platforms market leaders in the current space, showing the demand for any capital efficiency.

The high cost of margin in these platforms also inhibits the development of more complex products, particularly options, as slight adjustments in implied volatility do not offset the opportunity cost for market makers. Consequently, traditional options markets struggle to establish themselves in the existing margin model. Platforms like Deribit do offer more advanced capabilities than most but face challenges such as offshore operations and unclear default processes. Deribit is the closest system to what we propose could be run transparently on-chain with Crypto Valley Exchange.

In summary, the current landscape of options trading in the cryptocurrency market is constrained by a focus on front-end pricing mechanisms at the expense of crucial clearing and settlement processes, high capital requirements, and the lack of efficient cross-margin capabilities. These factors collectively hinder the development of a diverse and functional options market within the crypto domain.