Variant Fund: Why do we say that on-chain options are ready for a breakout?

Source: variant.fund

Compiled by: Zhou, ChainCatcher

If the core value of cryptocurrency lies in providing new financial rails, then the lack of popularity of on-chain options is perplexing.

In the U.S. 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 the $68 trillion U.S. stock market. In contrast, the daily trading volume of cryptocurrency options is about $2 billion, only 0.06% of the approximately $3 trillion market capitalization of cryptocurrencies (which is roughly ten times lower than stocks). Although decentralized exchanges (DEXs) currently account for over 20% of cryptocurrency spot trading volume, almost all options trading still occurs through centralized exchanges (CEXs) like Deribit.

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

Today, the infrastructure needed to solve the former issue is 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 quality order flow. This article argues that on-chain options protocols can thrive by targeting two distinct sources of quality order flow: hedgers and retail investors.

Trials and Tribulations of On-Chain Options

Similar to the spot market, the first on-chain options protocol borrowed the dominant market design from traditional finance—order books.

In the early days of Ethereum, trading activity was sparse, and gas fees were relatively low. Thus, an order book seemed like a reasonable mechanism for options trading. The earliest options order book can be traced back to EtherOpt in March 2016 (the first popular spot order book on Ethereum, EtherDelta, launched a few months later). However, in reality, on-chain market making is very difficult; 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 of options protocols adopted automated market makers (AMMs). AMMs no longer rely on individuals for market trading but obtain prices from the internal token balances of liquidity pools 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 themselves do not set the price. In the latter case, when new oracle prices are published on-chain, prices are updated periodically. From 2019 to 2021, protocols like Opyn, Hegic, Dopex, and Ribbon adopted this approach.

Unfortunately, AMM-based protocols did not significantly improve the popularity 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 from 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 capital usage and deprives retail investors of a crucial source of leverage. Without this leverage, when the incentive mechanism disappears, retail demand diminishes as well.

Sustainable Options Exchanges: Attracting Quality Order Flow and Avoiding Adverse Order Flow

Let’s start with the basics. A healthy market requires two things:

• The ability for liquidity providers to avoid "adverse order flow" (i.e., to avoid unnecessary losses). Adverse order flow refers to arbitrageurs earning nearly risk-free profits at the expense of liquidity providers.
• A strong source of demand to provide "quality order flow" (i.e., profitable trades). Quality order flow refers to those traders who are insensitive to price and earn profits for liquidity providers after paying the spread.

A review of the history of on-chain options protocols reveals that their past failures stemmed from the fact that neither of these two conditions was met:

• The technical infrastructure limitations of early options protocols prevented liquidity providers from avoiding adverse order flow. The traditional method for liquidity providers to avoid adverse order flow is to update quotes frequently and for free on the order book, but the delays and costs of order book protocols in 2016 made on-chain quote updates impossible. Transitioning to automated market makers (AMMs) also failed to solve this problem, as their pricing mechanisms were relatively slow, putting liquidity providers at a disadvantage in competition with arbitrageurs.
• The requirement for full collateral eliminated the options functionality (leverage) that retail investors value, and leverage is a key source of quality order flow. Without other on-chain options usage scenarios, quality order flow becomes a moot point.

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

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

With scalable innovation, we can now also build applications that meet the needs 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 without requiring full collateral.

Addressing the issue of adverse order flow is primarily a technical problem, and in many ways, 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 in attracting good spillover flow, it does not mean that good order flow will appear out of thin air. Instead, the core question 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 projects adopt to attract this demand? If we can answer this question, we have a chance to build a sustainable on-chain options protocol.

Characteristics of Price-Insensitive Demand (Good Order Flow)

As mentioned above, good order flow refers to demand that is insensitive to price. Generally, the price-insensitive demand for options is primarily composed of two core customer groups: (1) hedgers and (2) retail customers. These two groups have different goals and therefore use options differently.

Hedge Funds

Hedgers are those institutions or businesses that believe reducing risk is worth enough to pay an amount above market value.

Options are attractive to hedgers because they allow them to precisely control downside risk by choosing the exact price level at which to stop losses (the strike price). This is different from futures, where the hedging method is binary; 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 cryptocurrency options demand, which we expect primarily comes from miners, who are the first "on-chain institutions." This is evident from the dominance of Bitcoin and Ethereum options trading volume and the fact that mining/validation activities on these chains are more institutionalized than on other chains. Hedging is crucial for miners because their income is denominated in volatile crypto assets, while many of their expenses—such as salaries, hardware, and hosting—are denominated in fiat currency.

Retail

Retail refers to individual speculators who aim for profit but are relatively inexperienced—they typically trade based on intuition, belief, or experience rather than models and algorithms. They generally prefer a simple and easy trading experience, and their demand is driven by the desire to get rich quickly rather than rational considerations of risk and return.

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

Despite the popularity of options in trading finance, retail acceptance of cryptocurrency options is effectively zero. This is because there is a better cryptocurrency tool available for leveraging long and short trades, which is currently not available in trading finance: perpetual contracts (perps).

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

While more combinations can lead to greater granularity, which is what hedgers desire, it also requires making more decisions, which can often overwhelm retail investors. In fact, the success of 0DTE options in retail trading can largely be attributed to the fact that 0DTE options improve the user experience of options by eliminating (or greatly simplifying) the time dimension ("zero days"), thus providing a simple and easy-to-use leveraged long or short tool.

Options are not viewed as leveraged tools in the cryptocurrency space because perpetual contracts (perps) have become very popular and are simpler than 0DTE options, making leveraged long/short operations easier. Perps eliminate both the time and strike price factors, allowing users to continuously engage in leveraged long/short trades. In other words, perps achieve the same goal (providing leverage for retail) with a simpler user experience than options. As a result, the added value of options is significantly diminished.

However, there is still hope for options and cryptocurrency retail. Beyond leveraging for simple long/short trades, retail investors also crave interesting and novel trading experiences. The granular nature of options means they can provide entirely new trading experiences. One particularly powerful feature is the ability for 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, allowing 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, enabling retail users to easily speculate on volatility.

Go-To-Market Strategies Targeting Price-Insensitive Demand (Good Order Flow)

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

Hedgers GTM: Meeting Miners Where They Are

We believe the best market promotion strategy to capture hedging capital flows is to target 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 akin to Babylon's user acquisition approach. When Babylon launched, there were already many off-chain Bitcoin hedge funds, and miners (some of the largest Bitcoin holders) likely had access to 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 require additional trust assumptions. Miners choosing to adopt Babylon indicates that they value the autonomy of choosing custody solutions (whether self-custody or selecting other custodians), gaining ownership through token incentives, or both. Otherwise, Babylon's growth would be difficult to explain.

Now is an excellent time to leverage 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. Additionally, the improved feasibility of BitVM and the overall quality of Bitcoin bridges are providing the necessary custodial assurances to build an attractive on-chain alternative.

Retail Marketing: Providing a New Trading Experience

Rather than trying to compete with the tricks commonly used by criminals, we believe the best way to attract retailers is to offer them novel 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 considering price movements. On-chain options protocols can build a vault that allows retail users to engage in long and short trading on volatility through a simple user experience.

Previous options vaults (such as those on Dopex and Ribbon) suffered losses due to arbitrageurs exploiting their inadequate quoting mechanisms. However, as we previously mentioned, with recent innovations in application-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 to enhance the execution quality of long and short volatility options vaults while also promoting liquidity and order flow on the order book.

Conclusion

The conditions for the success of on-chain options are finally becoming increasingly favorable. The infrastructure is maturing enough to support more efficient capital utilization schemes, and on-chain institutions now have legitimate 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 price-insensitive user groups—hedgers seeking precise trades and retail investors seeking new trading experiences—we can ultimately establish a sustainable market. With these foundations, options can become a core component of the on-chain financial system in unprecedented ways.

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