DeFi Derivatives Trading Has Untapped Potential

If we learn to read the markets, make smart use of the data at our disposal and overcome a few speed bumps along the way, options will certainly drive the next era of DeFi to higher highs than ever before.

AccessTimeIconDec 23, 2022 at 2:34 p.m. UTC
Updated Sep 28, 2023 at 2:28 p.m. UTC
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As cults of personality and centralized platforms lose their sheen, we must return to the fundamentals that drove the crypto industry at its inception: decentralization, self-custody and economic empowerment for all. In a phrase: decentralized finance (DeFi).

DeFi brings a lot of diversity to our economy, but one specific sector of DeFi that will continue to see prolonged, exponential growth in 2023 is the derivatives market, and even more specifically options trading. The reasons for crypto options' high probability of growth in the new year can be pinned to massive yet-unrealized potential for trading in both retail and institutional capacities. If we learn to read the markets, make smart use of the data at our disposal and overcome a few speed bumps along the way, options will certainly drive the next era of DeFi to higher highs than ever before.

Greg Magadini is director of derivatives at Amberdata. This op-ed is part of CoinDesk's Crypto 2023 series.

Everybody wants options

According to DeFi Llama, just the top 10 DeFi options marketplaces alone have a combined total value locked (TVL) of over $180 million. This shows how popular options are. And for good reason – options are, essentially, insurance policies that allow the ability for investors to tailor trades and risk tolerance, which is why they’ve remained a popular investment strategy during the bear market.

Options give traders, well, options. Think about insuring your home – certainly every homeowner will carry fire insurance to help protect their investment. This behavior is what allows you to tailor or insure the risks that you don't want to take, and basically trade that risk away to someone else. With options you're able to express investment views that incorporate new elements; instead of just saying “price go up” or ”price go down,” you can say “price go up by this date,” or “in this timeframe” or “with this velocity.”

And while the crypto options market continues to grow extremely fast, there is still plenty of room for growth. If we consider the market cap of bitcoin versus the outstanding notional open interest of crypto options, it's about 6%. Whereas in traditional finance, that number is 200%. Let’s call it an opportunity to see a 30 to 35 times increase just to match the same sort of relative levels as traditional finance.

So, what’s holding the options market back from achieving this growth in the here and now?

Read more: The Year Crypto Yields Blew Up | Opinion

Crypto is still trying to figure out what’s important

On the surface, there are a lot of similarities between crypto options and traditional finance (TradFi) options. But the main difference is that we’re still learning how external events affect the crypto market, while in TradFi people know how to identify big mover events. TradFi investors have access to earning reports or substantial company news covered by the media. These events inform traders what the smartest trades will be, as long as they pay close attention. But crypto is the exact opposite.

In crypto, we don't necessarily know what it looks like when an encryption algorithm breaks. When someone tweeted that Vitalik Buterin had died, ether (ETH) temporarily “crashed” on the “news” before swinging right back. With such fast-moving tech, there are numerous events and forks that are necessary and common, and yet people don't know how they will affect the market. Even the Ethereum Merge in September – a hugely anticipated event that had people expecting extreme volatility – came and went and the prices remained remarkably stable.

The lesson? We don't know how to value the true potential of crypto yet, and we know even less about how it should move based on volatility events. But all is not lost. Not only do trading strategies like options provide us with ways to mitigate losses and customize risk levels, but the way our underlying blockchains are designed provides us with access to an enormous amount of consistently-generated, granular data such as spot data, which provides a true source of price and volatility. Analyzing this data will teach us to recognize trends and movement events. And the best part is the more use DeFi gets, the more data we have at our disposal and the more we learn. DeFi only gets stronger as it grows.

DeFi options will continue to see exponential growth due to their dynamic nature, massive investment prospects and, soon, ease of access and use. There are currently many competing models, and certainly many questions still loom large, especially with regard to regulation. Yet, as things mature we can expect to see the barriers fall. More investors will see DeFi for the next evolution in our economy that it truly is. Options trading will help drive this adoption, because as an investment strategy it offers immense utility to institutions and retail traders alike.


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Greg Magadini

Greg Magadini, CFA, is director of derivatives at Amberdata.

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