What Are Decentralized Derivatives and How Do They Work in DeFi?

Derivatives in Crypto

Institutional investors and traders, unable to risk the substantial amounts they usually deal with, may also shy away from low-liquidity markets. Lastly, we’d note that traditional fund structures can be used as a more developed alternative to DOVs. GSR’s investment advisory arm has researched one such product that seeks to generate a premium in addition to a core bitcoin holding through an actively managed options strategy, selling OTM call options across various strikes and expirations.

Option DEXs allow users to mint and trade vanilla options onchain, and they typically trade using an AMM, a liquidity pool with a pricing oracle, or an order book. The majority of activity has congregated on AMM/liquidity pool-based option DEXs like Lyra and Dopex so far. With order books requiring greater transaction throughput, the majority of these protocols were built on Solana and have seen diminished activity in the wake of FTX. Despite Ethereum’s Opyn v2 deprecating its 0x-powered onchain order book, Opyn is still a top option protocol by TVL due to its use as an infrastructure layer to mint options onchain.

Why Are Derivatives Essential in the Crypto Economy?

However, there are some ways traders minimize risks and maximize their chances of success. Another risk is the unclear legal status of derivatives https://www.tokenexus.com/derivatives-in-crypto/ trading in some jurisdictions. You wouldn’t want your trading strategies to result in potential legal and compliance risks.

  • Traders need to have a thorough understanding of the products, develop a trading plan, manage risk, stay informed, practice with a demo account, diversify investments, monitor the regulatory environment, and engage in continuous learning.
  • For example, crypto derivatives exchange Deribit reported yesterday a trading volume over the past 24 hours of $12.4 billion, an all-time high.
  • Both can be entered into as a long position (i.e., buying the option) or a short position (i.e., selling the option).
  • Crypto derivatives provide an opportunity to apply leverage in trading decisions to unlock bigger profits.
  • Centralized options exchanges typically trade around $30 billion in volume per month, closely rivaling the volume of decentralized perps but amounting to just 1-2% of all futures volume.
  • Additionally, liquid options markets have failed to materialize on centralized venues for assets beyond BTC and ETH, so the breadth of listed solutions is far narrower than for perps that trade on hundreds of assets10.

Protocols like Ribbon and Thetanuts have found success in the simplicity of their DeFi Option Vaults (DOVs). Unlike trading options directly, DOVs enable users to gain short option exposure without having to choose amongst expiration dates or strike prices. The implementation approaches vary across DOVs, but in many cases, vaults obtain their short option exposure by minting options via a protocol like Opyn and selling them to market makers via an auction process like Paradigm’s. OTC derivatives provide increased flexibility on terms and allow users to customize components of their trade like the notional size, tenor, strike, and settlement. OTC markets also offer a wider suite of derivative instruments like variance swaps, average price options, and other exotic derivatives that can be advantageous for hedging specific exposures. For example, a producer of a commodity, like an oil rig operator or a bitcoin miner, may be interested in hedging with average price options to align the pricing of the hedge with daily production.

Crypto Futures and Perpetual Swaps

Futures and options are two common types of derivatives, and perpetual futures are a special type of futures contract unique to crypto markets. These advantages make derivatives a versatile tool for strategic trading in the volatile crypto market. While the crypto options market continues to develop with many new exchanges and DeFi protocols entering the space, overall adoption of crypto options has been muted relative to perps. Centralized options exchanges typically trade around $30 billion in volume per month, closely rivaling the volume of decentralized perps but amounting to just 1-2% of all futures volume. Additionally, liquid options markets have failed to materialize on centralized venues for assets beyond BTC and ETH, so the breadth of listed solutions is far narrower than for perps that trade on hundreds of assets10. Complexity may contribute to the relative lack of adoption, with market participants favoring the simpler pricing dynamics of linear derivatives thus far.

Derivatives in Crypto