Encryption Next Trend: On-chain Options

Source: variant.fund

Compiled by: Zhou, ChainCatcher

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

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

The differences between traditional options markets and on-chain options markets stem from early designs, constrained by the original infrastructure, failing to meet two 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 formulate 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 scarce and gas fees were relatively low. Therefore, an order book seemed like 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, as gas fees and network latency make it challenging for market makers to provide accurate quotes and avoid losing trades.

To address these issues, the next-generation options protocol adopts Automated Market Makers (AMM). AMMs no longer rely on individuals for market trading but instead obtain prices from the internal token balances of liquidity pools or external price oracles. In the former case, when traders buy and sell tokens in the liquidity pool (changing the internal balance of the pool), the price is updated; liquidity providers themselves do not set the price. In the latter case, when new oracle prices are published on-chain, the prices are updated periodically. From 2019 to 2021, protocols such as Opyn, Hegic, Dopex, and Ribbon have 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 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 popularity of options trading may be that all early versions of options protocols (including those based on order books and automated market makers) require that short positions must have sufficient collateral. In other words, selling call options must be hedged, and selling put options must have cash backing, which makes these protocols inefficient in terms of capital and deprives retail investors of the critical source of leverage they need. Without this leverage, when the incentive mechanisms disappear, the demand from retail investors also diminishes.

Sustainable Options Exchange: Attract high-quality order flow, avoid poor 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). The so-called “bad order flow” refers to the situation where arbitrageurs earn nearly risk-free profits at the expense of the interests of liquidity providers.
• Strong demand sources are aimed at providing “high-quality order flow” (which means making a profit). The so-called “high-quality order flow” refers to those traders who are insensitive to price and earn profits for liquidity providers after paying the spread.

We reviewed the history of on-chain options agreements and found 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 freely and frequently, but the delays and fees of the order book protocol in 2016 made on-chain updates of quotes impossible. Migration to automated market makers (AMM) also failed to resolve this issue, as their pricing mechanisms are relatively sluggish, putting liquidity providers at a disadvantage in competition with arbitrageurs.
• The requirement for full collateral has eliminated the options functionality (leverage) that retail investors value, and leverage is the key source of quality order flow. Without other on-chain options usage scenarios, quality order flow becomes a non-issue.

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

In recent years, various changes have indicated that we can now build infrastructure that allows liquidity providers to avoid adverse order flow. The rise of infrastructure for specific applications (or industries) has significantly improved the market design for liquidity providers across various financial application domains. The most important aspects include: speed bumps for delayed execution orders; priority for limit orders; order cancellations and price oracle updates; extremely low Gas fees; and anti-censorship mechanisms in high-frequency trading.

With scaled innovation, we can now build applications that meet the demands of good order flow. For example, improvements in consensus mechanisms and zero-knowledge proofs have made block space costs low enough to implement complex margin engines on-chain, thus eliminating the need for full collateral.

The issue of addressing poor order flow is primarily a technical problem, and in many ways, it is a “relatively easy” problem. Admittedly, building this infrastructure is technically complex, but that is not the real difficulty. Even if the new infrastructure can support protocols to attract good overflow traffic, it does not mean that good order flow will appear out of thin air. On the contrary, the core issue of this article, and its focus, is: assuming we now have the infrastructure to support 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, a good order flow refers to demand that is insensitive to price. Generally speaking, the demand for options that is insensitive to price mainly consists of two core types of customers: (1) hedgers and (2) retail clients. These two types of clients have different objectives, and therefore use options differently.

Hedge Fund

The so-called hedger refers to those institutions or businesses that believe it is worthwhile to reduce risk and are willing to pay an amount above the market value.

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

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

Retail

Retail investors refer to individual speculators who aim for profits but lack experience — they typically trade based on feelings, beliefs, or experience rather than models and algorithms. They generally want a trading experience that is simple and easy to use, and their driving need is to get rich quickly rather than to rationally consider risks and returns.

As mentioned above, the reason why retail investors have historically favored options lies in their leverage. The explosive growth of zero-day options (0DTE) in retail trading confirms this — 0DTE is widely regarded as a speculative leverage 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 (especially on the Robinhood platform).

Despite the popularity of options in the trading finance sector, retail investors have virtually zero acceptance of cryptocurrency options. This is because there is a better cryptocurrency tool for retail investors to leverage for long and short trading, which is currently unavailable in the trading finance sector: perpetual contracts (perps).

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

Although more combinations can lead to higher granularity, 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”), thus providing a simple and easy-to-use leveraged tool for going long or short.

Options are not regarded as 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 engage in leveraged long/short positions. In other words, perps achieve the same goal as options (providing leverage for retail investors) with a simpler user experience. As a result, the added value of options has significantly decreased.

However, retail options and cryptocurrency traders are not completely without hope. In addition to using leverage for simple long/short positions, retail traders are also eager for interesting and novel trading experiences. The refined characteristics of options mean that they can bring a whole new trading experience. One particularly powerful feature is the ability for participants to trade directly on the volatility itself. Take the Bitcoin Volatility Index (BVOL) provided by FTX (now defunct) as an example. BVOL tokenizes implied volatility, allowing traders to directly bet on the magnitude of Bitcoin price fluctuations (regardless of direction) without having to manage complex options positions. It packages trades that would typically require straddles or strangles into a tradeable token, enabling retail users to easily and conveniently speculate on volatility.

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

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

Hedgers GTM: Meet miners where they are

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

This strategy is identical to Babylon's user acquisition approach. When Babylon launched, there were already a large number of off-chain Bitcoin hedge funds, and miners (some of the largest Bitcoin holders) likely had the ability to leverage these funds for 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 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 of choosing their custodial solutions (whether self-custody or selecting other custodians), obtaining 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 Deribit, a leading centralized exchange in the options trading space, which poses a risk for foreign miners who may be reluctant to store large amounts of funds in U.S.-controlled entities. Moreover, the improvement of BitVM's feasibility and the overall quality of the Bitcoin bridge are providing the necessary custodial assurances to build an attractive on-chain alternative.

Retail Market Promotion: Providing a Brand New Trading Experience

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 observe volatility directly without considering price movements. On-chain options protocols can build a vault that allows retail users to engage in volatility long and short trading through a simple user experience.

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

Conclusion

The conditions for successful on-chain options are gradually being met. The infrastructure is maturing to the point where it can support more efficient capital utilization schemes, and on-chain institutions now 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 brand new trading experience — a sustainable market can ultimately be established. With this foundation, options can become a core component of the on-chain financial system in unprecedented ways.