Article Highlights
- Why on-chain options are not more popular despite their core value in providing new financial rails.
- How on-chain options protocols can effectively target hedgers and retail investors.
- What challenges did early on-chain options protocols face, and how can they be overcome?
- How modern infrastructure can protect liquidity providers from adverse order flow.
- What go-to-market (GTM) strategies can attract premium order flow?
Introduction
If the core value proposition of cryptocurrencies lies in providing novel financial rails, then the lack of widespread adoption of on-chain options is puzzling. In the U.S. equity market alone, the daily trading volume of single-stock options is approximately $450 billion, accounting for roughly 0.7% of the $68 trillion U.S. equity market’s total market capitalization. In contrast, crypto options see a daily trading volume of around $2 billion, representing only 0.06% of the roughly $3 trillion crypto market capitalization (relatively 10x lower than equities). Although decentralized exchanges (DEXs) now facilitate over 20% of crypto spot trading volume, nearly all options trading still occurs through centralized exchanges (CEXs) like Deribit.
Early Challenges in On-Chain Options
The disparity between traditional and on-chain options markets stems from early designs, constrained by rudimentary infrastructure, that failed to satisfy two essential elements of a healthy market: protecting liquidity providers from adverse order flow and attracting premium order flow. Today, the infrastructure needed to address the former is largely in place – liquidity providers can finally avoid being picked apart by arbitrageurs. The remaining challenge, which is the focus of this article, is the latter: how to craft an effective go-to-market (GTM) strategy to attract premium order flow. This article argues that on-chain options protocols can thrive by targeting distinct sources of premium order flow: hedgers and retail investors.
How to Build a Sustainable On-Chain Options Protocol
One of the first steps involves understanding the price-insensitive demand characteristics, which can be classified as “good order flow.” Generally, price-insensitive demand for options primarily consists of two core client segments: (1) hedgers and (2) retail customers. These two client segments have different goals, and therefore utilize options in different ways. Hedgers are institutions or operating businesses that believe reducing risk is valuable enough that they are willing to pay more than fair market value. Hedging is critical for miners as their income is priced in volatile crypto assets, while many of their expenses—such as wages, hardware, hosting, etc.—are priced in fiat currencies.
As for retail customers, they are relatively unsophisticated individual speculators—typically trading on gut feel, beliefs, or experience rather than models and algorithms. They generally desire a simple and easy-to-use trading experience, and are driven by the desire to get rich quick rather than rational considerations of risk and reward. For on-chain options protocols to succeed, they must be able to cater to the needs of both hedgers and retail investors.
Go-to-Market Strategies
To achieve this, there are several go-to-market strategies that can be employed. For hedgers, the best go-to-market strategy is to target hedgers, such as miners who currently trade on centralized exchanges, and offer a product that gives them ownership of the protocol through tokens while minimizing changes to their existing custody setups. For retail customers, the best way to attract them is to provide them with novel products with a simplified user experience. On-chain options protocols can create vaults that allow retail users to trade on volatility, both up and down.
Conclusion
The conditions for the success of on-chain options are finally coming together. Infrastructure is maturing enough to support more capital-efficient solutions, and on-chain institutions now have a genuine reason to hedge directly on-chain. By building infrastructure that helps liquidity providers avoid adverse order flow, and building on-chain options protocols around two segments of price-insensitive users—hedgers seeking precise trades and retail traders looking for novel trading experiences—a sustainable market can ultimately be built. With these foundations, options can become a core part of the on-chain financial system in ways never before possible.
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