Written by: Sumanth Neppalli, Joel John
Translated by: Luffy, Foresight News
Remember Sam Bankman-Fried? He worked at Jane Street and later became known for his 'effective altruism' experiments and misappropriation of funds. In the past month, Jane Street has made headlines for two things:
One is allegedly assisting in a coup; the other is reportedly experimenting with arbitrage trading in the Indian options market (also reportedly, since I can't afford lawyers who can beat them in court).
Some of these trades were so large that the Indian government decided to completely ban Jane Street from operating in the country and seized their funds. Matt Levine wrote a brilliant summary of this in his Bloomberg column; in short, this is how this 'arbitrage' operates:
Sell put options in a liquid market (like $100 million in size);
Gradually accumulate the underlying asset in a thin market (like $10 million in daily trading volume).
In markets like India, options trading volumes are often several times that of the underlying stock. This is a market characteristic, not a flaw. Even if the underlying asset is insufficient, the market can always find liquidity. For example, the total volume of gold ETFs far exceeds the actual gold reserves; similarly, the price surge of GameStop in 2022 was partly due to its short positions exceeding the number of circulating shares. Back to the case of Jane Street.
When you 'buy' a put option, you are betting that the price will go down, or in other words, you are purchasing the right to sell an asset at a specified price (i.e., the strike price). Buying a call option is the opposite: you are buying the right to purchase an asset at a preset price. Let me illustrate with the upcoming PUMP token.
Suppose I bet that the fully diluted valuation (FDV) of the PUMP token at launch will be below $4 billion (perhaps out of disdain for venture capital and the meme market); I would buy a put option. The seller of the option might be a venture capitalist holding a quota of PUMP tokens, who believes the price will be higher at launch.
Venture capital firms that sell put options receive premiums. Suppose I pay a $0.10 premium; if the token launches at $3.10, and my strike price is $4, then exercising the put option would yield a profit of $0.90, with a net profit of $0.80 after deducting the premium. Meanwhile, the venture capital firm is forced to sell the token at a lower than expected price ($3.10), effectively incurring a $0.90 loss in price difference.
Why do I do this? Because the leverage is extremely high: I invest $0.1 to short an asset worth $4. Why can I achieve such high leverage? Because the sellers of the options (venture capitalists) believe the price will not drop below $4. Worse still, the venture capitalists (and their network) might buy PUMP at the $4 level, ensuring the price holds at $4.5 at the time of exercise. This is precisely what the Indian government accused Jane Street of doing.
Source: Bloomberg
However, in the case of Jane Street, they were not trading PUMP tokens. They were trading Indian stocks, specifically the NIFTY Bank Index. Because that market offers high leverage, retail investors frequently trade options. They only need to do this: buy a few underlying stocks that make up the index and are relatively illiquid.
Then, as spot buying pushes up the index price, sell index call options at a higher premium; simultaneously buy index put options; finally, sell stocks to lower the index. Profits come from the premiums of call options and the proceeds from put options; spot trades may incur slight losses, but the gains from put options usually cover this loss.
The above illustration explains how this trade works: the red line is the index trading price, and the blue line is the option trading price. In reality, they sell options (driving the price down and collecting premiums) and buy the underlying asset (pushing the price up without paying for options) — it’s all arbitrage.
What does this have to do with today’s topic?
It doesn't matter. I just want to clarify the concepts of put options, call options, and strike prices for those who are new to these terms.
In this issue, Sumanth and I discuss a simple question: why has the cryptocurrency options market not exploded? With Hyperliquid leading the narrative, on-chain perpetual contracts are hot again, and stock perpetual contracts are about to launch, but what about options? As with most things, we begin with the historical context, then analyze the operational details of these markets, and finally look to the future. Our hypothesis is: if perpetual contracts can stabilize, the options market will develop in tandem.
The question is: which teams are developing options products? What mechanisms will they adopt to avoid repeating the mistakes of the 2021 DeFi Summer?
We currently do not have a clear answer, but we can provide some clues.
The riddle of perpetual contracts
Remember that pandemic? Those times when we sat at home, guessing how long this massive social isolation experiment would last were the 'good times.' It was also then that we saw the limitations of the perpetual contract market. Like many commodities, oil has a futures market where traders can bet on its price. But like all commodities, oil is only valuable when there is demand. The restrictions caused by the pandemic led to a sharp decline in the demand for oil and related products.
When you buy a physically settled future (not cash-settled), you gain the right to receive the underlying asset at an agreed price in the future. So, if I go long on oil, when the contract expires, I will 'receive' oil. Most traders do not actually hold the commodity but instead sell it to factories or counterparties that have logistical capabilities (like tankers).
But in 2020, things spiraled out of control. No one wanted that much oil, and traders buying futures contracts had to bear the responsibility of storage. Imagine being a 27-year-old analyst at an investment bank, yet having to receive 1 million gallons of oil; the compliance officer in their 40s would definitely tell me to sell it all first. And indeed, that was the case.
In 2020, oil prices briefly fell into negative territory. This vividly illustrated the limitations of physical futures: you must receive the goods, and receiving goods incurs costs. If I'm just a trader betting on the price of oil, chicken, or coffee beans, why would I want to take physical delivery? How do I transport goods from the point of origin to the Dubai port? This is a fundamental structural difference between cryptocurrency futures and traditional futures.
In the cryptocurrency space, receiving the underlying asset is almost cost-free: just transfer to a wallet.
However, the cryptocurrency options market has never truly exploded. In 2020, the U.S. options market traded about 7 billion contracts; today, that number is close to 12 billion, with a nominal value of approximately $45 trillion. The U.S. options market is about 7 times the size of the futures market, with nearly half of the trades coming from retail, who are eager for short-term options expiring the same day or weekend. Robinhood's business model is based on this: providing a fast, convenient, and free options trading channel, profiting through 'payment for order flow' from market makers like Citadel.
However, the situation with cryptocurrency derivatives is entirely different: perpetual contracts have a monthly trading volume of about $2 trillion, which is 20 times that of options (approximately $100 billion monthly). The cryptocurrency market did not inherit existing patterns from traditional finance; instead, it built its own ecosystem from scratch.
The regulatory environment shapes this disparity. Traditional markets are subject to the U.S. Commodity Futures Trading Commission (CFTC), which requires futures rollover, introducing operational friction; U.S. regulations set the limit on stock margin leverage at about 2x and also prohibit '20x perpetual contracts.' As such, options have become the only way for Robinhood users (like retail investors with only $500) to convert 1% volatility in Apple stock into more than 10% returns.
The unregulated environment of cryptocurrency creates space for innovation. It all started with BitMEX's perpetual futures: as the name suggests, these futures have no 'delivery' date and are perpetual. You don't need to hold the underlying asset; you just trade it repeatedly. Why do traders use perpetual contracts? Two reasons:
Compared to spot trading, perpetual contracts have lower fees;
Perpetual contracts have higher leverage.
Most traders prefer the simplicity of perpetual contracts. In contrast, options trading requires understanding multiple variables simultaneously: strike price selection, underlying asset price, time decay, implied volatility, and delta hedging. Most cryptocurrency traders transition directly from spot trading to perpetual contracts, completely skipping the learning curve of options.
In 2016, BitMEX launched perpetual contracts, instantly becoming the favorite leveraged tool for cryptocurrency traders. That same year, a small Dutch team launched Deribit, the first trading platform focused on cryptocurrency options. At that time, Bitcoin was priced below $1,000, and most traders thought options were too complex and unnecessary. Twelve months later, the tide turned: Bitcoin surged to $20,000, and miners with large inventories began buying put options to lock in profits. In 2019, Ethereum options launched; by January 2020, open interest in options surpassed $1 billion for the first time.
Today, Deribit handles over 85% of cryptocurrency options trading volume, indicating that the market remains highly concentrated. When institutions need to execute large trades, they do not choose the order book but instead contact pricing desks or communicate through Telegram, then settle through the Deribit interface. A quarter of Deribit's trading volume comes from these private channels, highlighting the dominance of institutions in this seemingly retail-led market.
Deribit's uniqueness lies in allowing cross-market collateral. For example, you can go long on futures (Bitcoin at $100,000) while simultaneously buying put options at $95,000. If Bitcoin's price drops, the futures long will incur losses, but the appreciation of the put options can prevent liquidation. Of course, there are many variables, such as the expiration time of the options or the leverage of the futures, but Deribit's cross-market collateral function is a key reason for its dominance.
Theoretically, on-chain options can easily achieve this: smart contracts can track strike prices and expiration dates, escrow collateral, and settle profits without intermediaries. However, after five years of experimentation, the total trading volume of decentralized options exchanges remains less than 1% of the options market, while decentralized exchanges for perpetual contracts account for about 10% of futures trading volume.
To understand the reasons, we need to look back at the three developmental phases of on-chain options.
The Stone Age of options
In March 2020, Opyn democratized options issuance: lock ETH as collateral, choose strike prices and expiration dates, and the smart contract would mint ERC20 tokens representing rights. These tokens can be traded on any platform supporting ERC20: Uniswap, SushiSwap, or even direct wallet transfers.
Each option is an independent tradable token: a July $1,000 call option is one token, while a $1,200 call option is another, leading to a fragmented user experience, but the market can operate normally. At expiration, 'in-the-money' option holders can exercise their options, realizing gains, and the remaining collateral is returned to the seller. More troublesome is that the seller must lock the full nominal value: selling a call option on 10 ETH requires freezing 10 ETH until expiration to earn a $0.5 premium.
This system worked well until DeFi Summer came. When gas fees soared to $50-$200 per transaction, the cost of issuing an option often exceeded the premium itself, causing the entire model to collapse almost overnight.
Developers are turning to Uniswap-style liquidity pool models. Hegic has led this transformation, allowing anyone from retail to whales to deposit ETH into a public treasury. Liquidity providers (LPs) concentrate collateral into a single pool, and smart contracts quote prices for the buying and selling of options. Hegic's interface allows users to select strike prices and expiration dates.
If a trader wants to buy a call option for 1 ETH expiring next week, an automated market maker (AMM) will price it using the Black-Scholes model, obtaining ETH volatility data from external oracles. After the trader clicks 'buy', the contract will withdraw 1 ETH from the pool as collateral, minting an NFT recording the strike price and expiration date, and send it directly to the buyer's wallet. The buyer can resell the NFT anytime on OpenSea or wait until expiration.
For users, it feels almost like magic: a trade is completed without a counterparty, with the premiums flowing to LPs (after deducting protocol fees). Traders love the one-click experience, while LPs appreciate the yield; the treasury can issue multiple options with various strike prices/expiration dates simultaneously without active management.
This magic continued until September 2020. Ethereum experienced a severe crash, and Hegic's simple pricing rules caused put options to be sold too cheaply. Put option holders exercised their options, forcing the treasury to pay far more ETH than expected. In just one week, a year’s worth of premium income vanished, and LPs learned a painful lesson: issuing options in calm markets seems easy, but without proper risk management, a storm can drain everything.
AMMs must lock collateral to underwrite options
Lyra (now renamed Derive) attempts to address this issue by combining liquidity pools with automated risk management: after each trade, Lyra calculates the net delta exposure of the pool (the sum of the deltas of all options across strike prices and expiration dates). If the treasury has a net short exposure of 40 ETH, it means that for every $1 increase in the price of ETH, the treasury will lose $40. Lyra will establish a long position of 40 ETH on Synthetix perpetual contracts to hedge directional risk.
AMMs use the Black-Scholes model for pricing, offloading expensive on-chain calculations to off-chain oracles to control gas fees. Compared to unhedged strategies, this delta hedging reduces treasury losses by half. Despite being cleverly designed, this system relies on the liquidity of Synthetix.
When the Terra Luna collapse triggered panic, traders withdrew from Synthetix staking pools, and the exhaustion of liquidity caused Lyra's hedging costs to soar, resulting in wide spreads. Complex hedging requires deep sources of liquidity, which DeFi has still struggled to provide reliably.
Finding the spark
Decentralized options vaults (DOVs) sell order flow through auctions, source: Treehouse Research
In early 2021, decentralized options vaults (DOVs) emerged. Ribbon Finance pioneered this model, with a simple strategy: users deposit ETH into the vault, and every Friday, they sell covered call options through off-chain auctions. Market makers bid on order flow, with premiums returned to depositors as yield. The entire process resets each Thursday after options settlement and collateral unlocking.
During the bull market of 2021, implied volatility (IV) remained above 90%, with weekly premiums translating into astonishing annualized returns (APYs). Weekly auctions continued to yield substantial returns, and depositors enjoyed seemingly risk-free ETH earnings. But when the market peaked in November and ETH began to decline, the treasury started to experience negative returns, with premium income insufficient to cover ETH's drop.
Competitors Dopex and ThetaNuts have replicated this model and added rebate tokens to mitigate the impact during loss periods, but still fail to address the core vulnerability of handling large volatility. In both AMM and DOV models, funds must be locked until expiration. Users who deposit ETH to earn premiums may find themselves trapped when ETH declines, unable to close their positions when needed.
Order book
The Solana ecosystem team learned from the limitations of early options protocols' AMMs and took a distinctly different approach. They attempted to replicate Deribit's centralized limit order book (CLOB) model on-chain, achieving near-instant settlement with a complex order matching engine and introducing market makers as the selling counterparties for each option.
First-generation products like PsyOptions tried to place the entire order book on-chain, with each quote occupying block space, forcing market makers to lock 100% collateral, leading to scarce quotes. Second-generation products like Drift and Zeta Markets moved the order book off-chain, matching and then settling on-chain. The Ribbon team has returned to the battlefield with Aevo, placing the order book and matching engine on high-performance Optimism Layer2.
More importantly, these products support both perpetual contracts and options on the same platform, equipped with a portfolio margin system that can calculate net exposures of market makers. This is similar to the success factors of Deribit, allowing market makers to reuse collateral.
The results are mixed. Since market makers can frequently update quotes without incurring high gas fees, spreads narrow. However, the weaknesses of the CLOB model emerge during non-trading hours: when professional market makers in the U.S. go offline, liquidity evaporates, and retail traders face significant spreads and poor execution prices. This reliance on active market makers leads to temporary 'dead zones,' a situation that AMMs, despite their flaws, have never encountered. Teams like Drift have completely shifted to perpetual contracts, abandoning options.
Teams like Premia are exploring hybrid models of AMM-CLOB, seeking a middle ground between a full-chain order book providing 24/7 liquidity and market makers that can increase depth. However, the total locked value (TVL) has never exceeded $10 million, and large trades still require market maker intervention, resulting in high slippage.
Why are options struggling?
Options liquidity is shifting from AMMs to order books. Derive has disabled its on-chain AMM and rebuilt its exchange around an order book, equipped with a cross-margin risk engine. This upgrade has attracted platforms like Galaxy and GSR, and the platform now handles about 60% of on-chain options trading volume, becoming the largest decentralized options exchange in DeFi.
Vlad discusses limit order book design
When market makers sell $120,000 worth of BTC call options and hedge with spot BTC, the system recognizes these offsetting positions and calculates margin requirements based on net portfolio risk rather than on individual positions. The engine continuously evaluates each position: underwriting a $120,000 call option expiring in January 2026, shorting next week's weekly contract, buying spot BTC, and requiring traders to pay margin based on net directional exposure.
Hedging can offset risks, freeing up collateral to be redeployed into the next quote.
On-chain protocols break this cycle by tokenizing each strike price and expiration date into their own ERC-20 token vaults. A $120,000 call option minted next Friday cannot identify the hedge of BTC perpetual contracts. Although Derive has partially addressed this issue by adding perpetual contracts to its clearinghouse for cross-margining, the price difference remains significantly higher than Deribit; the price difference for equivalent positions is often 2-5 times higher.
Note: Let me explain using mango prices. Suppose I sell someone the right to buy mangoes for $10, collecting a $1 premium. These mangoes will ripen in three days. As long as I have mangoes (the underlying asset), I can collect the premium ($1) without worrying about the market price of mangoes rising.
I won't incur a loss (thus achieving a hedge) unless the price of mangoes rising causes an opportunity cost. If Sumanth buys this option (paying me $1), he can turn around and sell the mangoes for $15, netting a profit of $4 after deducting the premium. These three days constitute the expiration date of the option. At the end of the trade, I will either still have the mangoes or receive a total of $11 ($10 mango price + $1 premium).
In centralized exchanges, my mango farm and the market are in the same small town, and they know the collateral I trade, so I can use the premium paid by Sumanth as collateral to offset other expenses (like labor costs). But in on-chain markets, the two markets are theoretically located in different places and do not trust each other. Because most markets rely on credit and trust, this model has low capital efficiency — I might lose money just transferring Sumanth's payment to the logistics provider.
Deribit has benefited from years of API development and systems optimized for its platform by numerous algorithmic trading platforms. Derive's risk engine has been online for just over a year and lacks the deep order books needed for effective hedging in spot and perpetual contract markets. Market makers need immediate access to deep liquidity from multiple tools to manage risk; they need to hold options positions while easily hedging through perpetual contracts.
Decentralized exchanges for perpetual contracts solve the liquidity problem by completely eliminating fragmentation. All perpetual contracts for the same asset are identical: one deep pool, one funding rate, regardless of whether traders choose 2x or 100x leverage, liquidity is unified. Leverage only affects margin requirements, not market structure.
This design has allowed platforms like Hyperliquid to achieve significant success: their treasury typically acts as a counterparty to retail trades, distributing transaction fees to treasury depositors.
In contrast, options diffuse liquidity across thousands of 'micro-assets': each strike price-expiration date combination forms an independent market with unique characteristics, resulting in fragmented capital and making it nearly impossible to achieve the depth required by mature traders. This is the core reason why on-chain options have failed to take off. However, given the liquidity emerging on Hyperliquid, this situation may change quickly.
The future of cryptocurrency options
Looking back at the launch of all major options protocols over the past three years, a clear pattern emerges: capital efficiency determines survival. Those protocols that force traders to lock separate collateral for each position, regardless of how complex their pricing models or smooth their interfaces are, ultimately lose liquidity.
Professional market makers operate on very thin profit margins, and they need every penny to work efficiently across multiple positions. If a protocol requires them to post $100,000 in collateral for a Bitcoin call option and another $100,000 for the perpetual contract used in hedging, instead of considering these collaterals as offsetting risks (which might only require $20,000 in net margin), participation in the market becomes unprofitable. Simply put: no one wants to tie up large amounts of capital for minimal returns.
Source: TheBlock
Platforms like Uniswap have spot markets with daily trading volumes often exceeding $1 billion, with minimal slippage; decentralized exchanges for perpetual contracts like Hyperliquid handle hundreds of millions in daily trading volume, with spreads that can compete with centralized exchanges. The liquidity foundation urgently required for options protocols already exists.
The bottleneck has always been infrastructure: 'pipelines' that professional traders take for granted. Market makers need deep liquidity pools, instant hedging capabilities, immediate liquidation when positions deteriorate, and a unified margin system that treats the entire portfolio as a single risk exposure.
We previously wrote about Hyperliquid's shared infrastructure approach, which creates a win-win situation that DeFi has long promised but rarely delivered: each new application reinforces the entire ecosystem rather than competing for scarce liquidity.
We believe that options will eventually go on-chain through this 'infrastructure-first' approach. Early attempts focused on mathematical complexity or clever token economics, while HyperEVM solved the core 'pipeline' problem: unified collateral management, atomic-level execution, deep liquidity, and instant settlement.
We see several core aspects of market dynamics changing:
After the FTX collapse in 2022, market makers participating in new primitives and assuming risk decreased; now, traditional institutional participants are returning to the cryptocurrency market.
More proven networks can meet higher trading throughput demands.
The market is more accepting of certain logics and liquidity that are not fully on-chain.
If options are to return, three types of talent may be needed: developers who understand how the products work, experts who understand market maker incentives, and people who can package these tools into retail-friendly products. Can on-chain options platforms help some people earn life-changing wealth? After all, Memecoins have done it — they’ve made the dream of turning a few hundred dollars into millions a reality. The high volatility of Memecoins makes this work, but they lack the 'Lindy effect' (the longer they exist, the more stable they become).
In contrast, options have both the Lindy effect and volatility, but are difficult for the average person to understand. We believe there will be a class of consumer-grade applications focused on bridging this gap.
Today's cryptocurrency options market resembles the state before the Chicago Board Options Exchange (CBOE) was established: a bunch of experiments, lacking standardization, primarily focused on speculation rather than hedging. However, as crypto infrastructure matures and enters true commercial operation, this situation will change. Institutional-level liquidity will be brought on-chain through reliable infrastructure, supporting cross-margin systems and composable hedging mechanisms.
