Will on-chain Options be the next opportunity in encryption?

Original Title: Putting All Your Calls in One Basket Original Source: variant.fund

Original author: Rhythm BlockBeats

Source:

Reprint: Mars Finance

If the core value of cryptocurrency lies in providing new financial tracks, then it is puzzling that on-chain options have not yet become popular.

In the U.S. stock market alone, the daily trading volume of individual stock options is approximately $450 billion, accounting for about 0.7% of the total market capitalization of $68 trillion in the U.S. stock market. In contrast, the daily trading volume of cryptocurrency options is about $2 billion, which is only 0.06% of the approximately $3 trillion market cap of cryptocurrencies (which is 10 times lower compared to stocks). Although decentralized exchanges (DEX) currently account for over 20% of cryptocurrency spot trading volume, nearly all options trading is still conducted through centralized exchanges (CEX) like Deribit.

The differences between the traditional options market and the on-chain options market stem from early designs, constrained by the original infrastructure, which failed to meet two essential elements of a healthy market: protecting liquidity providers from adverse order flow and attracting high-quality order flow.

Today, the infrastructure needed to solve the former issue is already in place—liquidity providers can finally avoid being eaten away by arbitrageurs. The remaining challenge, which is the focus of this article, is the latter: how to develop an effective go-to-market strategy (GTM) to attract high-quality order flow. This article argues that on-chain options protocols can thrive by targeting two distinct sources of high-quality order flow: hedgers and retail investors.

The Trials and Tribulations of On-Chain Options

Similar to the situation in the spot market, the first on-chain options protocol draws on the dominant market design in traditional finance - the order book.

In the early days of Ethereum, trading activity was sparse, and gas fees were relatively low. As a result, an order book seemed to be a reasonable mechanism for options trading. The options order book can be traced back to EtherOpt in March 2016 (the first popular spot order book on Ethereum, EtherDelta, was launched a few months later). However, in reality, on-chain market making is very difficult; gas fees and network latency make it hard for market makers to provide accurate quotes and avoid losing trades.

To address these issues, the next generation options protocol utilizes Automated Market Makers (AMM). AMMs no longer rely on individuals for market trading but instead obtain prices from the internal token balances of the liquidity pool or external price oracles. In the former case, when traders buy or sell tokens in the liquidity pool (changing the internal balance of the pool), the price is updated; liquidity providers do not set the price themselves. In the latter case, when new oracle prices are published on-chain, the price is updated regularly. From 2019 to 2021, protocols such as Opyn, Hegic, Dopex, and Ribbon adopted this approach.

Unfortunately, AMM-based protocols have not significantly increased the adoption rate of on-chain options. The reason AMMs can save gas fees (i.e., prices are set by traders or lagging oracles rather than liquidity providers) is precisely because their characteristics make it easy for liquidity providers to suffer losses due to arbitrageurs (i.e., adverse selection).

However, what truly hinders the popularization of options trading may be that all early versions of options protocols (including those based on order books and automated market makers) require short positions to have sufficient collateral. In other words, selling call options must be hedged, and selling put options must have cash backing, which makes the capital efficiency of these protocols low and deprives retail investors of the key source of leverage they need. Without this leverage, when the incentive mechanisms disappear, retail demand also diminishes.

Sustainable options trading platform: Attract quality order flow and avoid bad order flow.

Let's start with the basics. A healthy market needs two things:

· The ability of liquidity providers to avoid “bad order flow” (i.e., to avoid unnecessary losses). “Bad order flow” refers to arbitrageurs earning almost risk-free profits at the expense of the liquidity providers' interests.

· Strong demand sources are aimed at providing “high-quality order flow” (which means making money). The so-called “high-quality order flow” refers to those traders who are price insensitive and earn profits for liquidity providers after paying the spread.

We review the history of on-chain options agreements and find that their past failures were due to the fact that both of the above conditions were not met:

· The technical infrastructure limitations of early options agreements have prevented liquidity providers from avoiding adverse order flow. The traditional method for liquidity providers to avoid adverse order flow is to update quotes on the order book for free and at high frequency, but the delays and costs of the order book protocol in 2016 made on-chain quote updates impossible. Migration to automated market makers (AMM) also failed to solve this issue, as their pricing mechanisms are relatively slow, putting liquidity providers at a disadvantage in competition with arbitrageurs.

· The requirement for full collateral has eliminated the option function (leverage) that retail investors value, and leverage is a key source of quality order flow. Without other on-chain option usage solutions, quality order flow cannot be discussed.

Therefore, if we want to build an on-chain options protocol in 2025, we must ensure that both of these challenges are addressed.

In recent years, numerous changes indicate that we can now build infrastructure that allows liquidity providers to avoid bad order flow. The rise of infrastructure specific to certain applications (or industries) has significantly improved market design for liquidity providers across various financial application areas. Among the most important are: speed bumps for delayed execution orders; priority sorting for order posting only; cancellation of orders and price oracle updates; extremely low Gas fees; and anti-censorship mechanisms in high-frequency trading.

With the help of large-scale innovation, we can now build applications that meet the demand for good order flow. For example, improvements in consensus mechanisms and zero-knowledge proofs have lowered the cost of block space enough to enable the implementation of complex margin engines on-chain, thereby eliminating the need for full collateral.

Resolving the issue of poor order flow is primarily a technical problem, and in many respects, it is a “relatively easy” problem. Indeed, building this infrastructure is technically complex, but that is not the real challenge. Even if the new infrastructure can support protocols that attract good spillover traffic, it does not mean that good order flow will appear out of nowhere. On the contrary, the core issue of this article, and also its focus, is: assuming we now have the infrastructure that supports good order flow, what kind of go-to-market strategy (GTM) should the project adopt to attract this demand? If we can answer this question, we have hope of building a sustainable on-chain options protocol.

Price-insensitive demand characteristics (good order flow)

As mentioned above, good order flow refers to demand that is insensitive to price. Generally speaking, demand for options that is insensitive to price is mainly composed of two core customer categories: ( hedgers and ) retail customers. These two types of customers have different objectives, and therefore their use of options also differs.

A hedger refers to those institutions or businesses that believe reducing risk is sufficiently valuable and are willing to pay an amount higher than the market value.

Options are very attractive to hedgers because they allow them to precisely control downside risk by choosing the exact price level at which to stop losses (strike price). This differs from futures, where the hedging approach is either/or; futures protect your position in all cases but do not allow you to specify the price at which the protection takes effect.

Currently, hedgers account for the vast majority of demand for cryptocurrency options, and we expect this mainly comes from miners, who are among the first “on-chain institutions.” This can be seen from the dominant trading volume of Bitcoin and Ethereum options, as well as the fact that mining/verification activities on these chains are more institutionalized than on others. Hedging is crucial for miners because their income is denominated in volatile crypto assets, while many of their expenses—such as wages, hardware, and hosting—are denominated in fiat currency.

Retail investors refer to individual speculators who aim for profit but lack relative experience—they typically trade based on intuition, belief, or experience rather than models and algorithms. They generally prefer a simple and user-friendly trading experience, and their driving motivation is the desire to get rich quickly, rather than a rational consideration of risk and return.

As mentioned above, the reason retail investors have always favored options is due to their leverage. The explosive growth of zero-day options (0DTE) in retail trading confirms this — 0DTE is widely regarded as a speculative leveraged trading tool. In May 2025, 0DTE accounted for over 61% of the trading volume in S&P 500 index options, with most of the volume coming from retail users (particularly on the Robinhood platform).

Although options are very popular in the financial trading sector, retail investors' acceptance of cryptocurrency options is actually zero. This is because there is a better cryptocurrency tool available for retail investors to leverage for long and short trading, which is currently not available in the financial trading sector: perpetual contracts (perps).

As we see in hedging trades, the greatest advantage of options lies in their degree of refinement. Options traders can consider going long/short, time, and strike prices, which makes options more flexible than spot, perpetual contracts, or futures trading.

While more combinations can bring higher precision, which is what hedgers expect, it also requires making more decisions, which often leaves retail investors feeling overwhelmed. In fact, the success of 0DTE options in the retail trading space can largely be attributed to the fact that 0DTE options improve the user experience of options by eliminating (or significantly simplifying) the time dimension (“zero days”), thereby providing a simple and easy-to-use leveraged tool for going long or short.

Options are not considered leverage tools in the cryptocurrency space because perpetual contracts (perps) have become very popular and are simpler and more convenient for leveraged long/short operations than 0DTE options. Perps eliminate the factors of time and strike price, allowing users to continuously perform leveraged long/short trades. In other words, perps achieve the same goal as options (providing leverage to retail investors) with a simpler user experience. Therefore, the additional value of options is greatly diminished.

However, retail investors in options and cryptocurrencies are not completely without hope. In addition to using leverage for simple long/short operations, retail investors also crave interesting and novel trading experiences. The refined characteristics of options mean they can provide entirely new trading experiences. One particularly powerful feature is that it allows participants to trade directly on volatility itself. Take the Bitcoin Volatility Index (BVOL) offered by FTX (now closed) as an example. BVOL tokenizes implied volatility, enabling traders to directly bet on the magnitude of Bitcoin price fluctuations (regardless of direction) without managing complex options positions. It packages trades that would typically require straddles or strangles into a tradable token, allowing retail users to easily and conveniently speculate on volatility.

Marketing strategy for price-insensitive demand (good order flow)

Now that we have identified the characteristics of price-insensitive demand, let's describe the GTM strategies that the protocol can use to attract good order flow to the on-chain options protocol for each characteristic.

We believe that the best marketing strategy to capture the flow of hedge funds is to target hedgers, such as miners currently trading on centralized exchanges, and provide a product that allows them to have ownership of the protocol through tokens, while minimizing changes to their existing custody setup.

This strategy is similar to Babylon's user acquisition approach. When Babylon was launched, there were already a large number of off-chain Bitcoin hedge funds, and miners (some of the largest Bitcoin holders) were likely able to leverage these funds to provide liquidity. Babylon primarily built trust through custodians and staking providers (especially in Asia) and catered to their existing needs; it did not require them to try using new wallets or key management systems, which often necessitate additional trust assumptions. The choice of miners to adopt Babylon indicates that they value the autonomy to choose custodial solutions (whether self-custody or selecting other custodians), to gain ownership through token incentives, or both. Otherwise, Babylon's growth would be difficult to explain.

Now is an excellent time to take advantage of this global trading platform (GTM). Coinbase recently acquired the leading centralized trading platform in the options trading sector, Deribit, which poses a risk for foreign miners who may be reluctant to keep large amounts of capital in U.S.-controlled entities. In addition, the improved feasibility of BitVM and the overall quality enhancement of the Bitcoin bridge are providing the necessary custodial assurances for building an attractive on-chain alternative.

Rather than trying to compete with criminals using their usual tricks, we believe the best way to attract retailers is to offer them innovative products with a simplified user experience.

As mentioned above, one of the most powerful features of options is the ability to directly observe volatility itself, without having to consider price trends. On-chain options protocols can construct a vault that allows retail users to engage in long and short volatility trading through a simple user experience.

Previous options vaults (such as those on Dopex and Ribbon) suffered losses due to inadequate pricing mechanisms, which made them susceptible to arbitrageurs. However, as we mentioned earlier, with recent innovations in specific infrastructure, we now have a clear reason to believe that you can build an options vault that is not troubled by these issues. Options chains or options aggregators can leverage these advantages to enhance the execution quality of long and short volatility options vaults while also promoting the liquidity of the order book and order flow.

Conclusion

The conditions for the success of on-chain options are gradually being met. The infrastructure is becoming increasingly mature, capable of supporting more efficient capital utilization schemes, and on-chain institutions truly have reasons to hedge directly on-chain.

By building infrastructure that helps liquidity providers avoid adverse order flow and constructing on-chain options protocols around two types of price-insensitive user groups—hedgers seeking precise trades and retail investors seeking a new trading experience—it can ultimately establish a sustainable market. With this foundation, options can become a core component of the on-chain financial system in ways never seen before.