Authors: Sumanth Neppalli, Joel John
Translated by: Luffy, Foresight News
Do you remember Sam Bankman-Fried? He once worked at Jane Street, later becoming known for his 'effective altruism' experiments and misappropriating funds. Over the past month, Jane Street has made headlines for two reasons:
First, allegedly assisting a coup; second, conducting arbitrage trading experiments in the Indian options market (also allegedly, since I can't afford a lawyer who can beat them in court).
Some of these trades are so large that the Indian government decided to ban Jane Street's operations in the country entirely and confiscated their funds. Matt Levine provided an excellent summary of this in his Bloomberg column; to make a long story short, this 'arbitrage' operates as follows:
Sell put options in a liquid market (like $100 million in size);
Steadily go long on the underlying asset in an illiquid market (like $10 million daily trading volume).
In markets like India, options trading volume often exceeds that of the underlying stocks by several times. This is a market characteristic, not a flaw. Even if the underlying asset is insufficient, the market always finds liquidity. For example, the total amount of gold ETFs far exceeds the actual gold reserves; likewise, the dramatic rise in GameStop's stock price in 2022 was partly due to the short position size exceeding the number of shares in circulation. Back to the case of Jane Street.
When you 'buy' a put option, you are betting that the price will fall, or in other words, you are purchasing the right to sell the asset at an agreed price (the strike price). Buying a call option is the opposite: you are purchasing the right to buy the asset at a predetermined price. Let me illustrate this with the upcoming PUMP token.
Suppose I bet that the fully diluted valuation (FDV) of the PUMP token when it launches will be less than $4 billion (perhaps out of aversion to venture capital and the meme market), I would buy a put option. The one selling me the option could be a venture capital firm holding a quota of PUMP tokens, believing the price will be higher at launch.
Venture capital firms selling put options will receive the premium. Suppose I pay a $0.10 premium, if the token's launch price is $3.10, and my strike price is $4, then exercising the put option can yield a profit of $0.90, with an actual profit of $0.80 after deducting the premium. The venture capital firm would be forced to sell the token at a price lower than expected ($3.10), effectively incurring a $0.90 loss in the price difference.
Why would I do this? Because the leverage is extremely high: I invest $0.1 and can short $4 worth of assets. How can I achieve such high leverage? Because the option sellers (venture capitalists) believe the price won't drop below $4. Worse, the venture capitalists (and their network) may buy PUMP at the $4 price level, ensuring that the price remains at $4.5 when exercising. This is exactly what the Indian government accused Jane Street of.
Source: Bloomberg
However, in Jane Street's case, they were not trading the PUMP token. They were trading Indian stocks, specifically the NIFTY bank index. Due to the high leverage offered by this market, retail investors often trade options. They just need to do this: buy some underlying stocks that form the index but have relatively low liquidity.
Then, as spot buying pushes up the index price, sell call options on the index at a higher premium; simultaneously buy put options on the index; finally, sell stocks to lower the index. Profits come from the premiums of call options and the gains from put options, with minor losses potentially arising from spot trades, but the gains from the put options usually cover this loss.
The above diagram explains how this transaction works: the red line is the index trading price, and the blue line is the option trading price. In reality, they sell options (lowering the price, collecting premiums) and buy the underlying asset (raising the price, without paying for the option) — it's all arbitrage.
What does this have to do with today's topic?
It doesn't matter. I just want to clearly explain the concepts of put options, call options, and strike prices to those who are new to these terms.
In this issue, Sumanth and I explore a simple question: why hasn't the cryptocurrency options market exploded? With Hyperliquid leading the narrative, on-chain perpetual contracts are once again hot, and stock perpetual contracts are about to launch, but what about options? Like most things, we start with the historical context, analyze the operational details of these markets, and finally look to the future. Our hypothesis is that if perpetual contracts can establish a foothold, the options market will develop alongside it.
The question is: which teams are developing options products? What mechanisms will they adopt to avoid repeating the mistakes of DeFi Summer 2021?
We currently do not have a clear answer, but can provide some clues.
The puzzle of perpetual contracts
Do you remember that pandemic? That time when we sat at home, guessing how long this large-scale social isolation experiment would last was a 'wonderful time.' 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 decrease in the demand for oil and related products.
When you buy physically settled futures (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, I will 'receive' oil when the contract expires. Most traders do not actually hold the commodity but sell it to factories or counterparts with logistics capabilities (like oil tankers).
But in 2020, things got out of control. No one wanted that much oil, and traders who bought futures were forced to take delivery. Imagine: I am a 27-year-old analyst at an investment bank, and I have to take delivery of 1 million gallons of oil; a 40-something compliance officer would definitely make me sell it all first. And that was indeed the case.
In 2020, oil prices briefly fell below zero. This vividly illustrated the limitations of physical futures: you must take delivery of the goods, and taking delivery incurs costs. If I am a trader betting on the prices of oil, chicken, or coffee beans, why would I want to take delivery? How do I transport goods from the production site to the Dubai port? This is the structural difference between cryptocurrency futures and traditional futures.
In the cryptocurrency space, taking delivery of the underlying asset is nearly costless: just transfer it to a wallet.
However, the cryptocurrency options market has yet to experience a true explosion. In 2020, the U.S. options market saw a trading volume of about 7 billion contracts; today, that number is close to 12 billion, with a notional value of around $45 trillion. The U.S. options market is about seven times the size of the futures market, with nearly half of trades coming from retail investors eager for short-term options expiring the same day or weekend. Robinhood's business model is based on this: providing a fast, convenient, free options trading channel and profiting through 'payment for order flow' (paid by market makers like Citadel).
However, the situation is vastly different for cryptocurrency derivatives: perpetual contracts trade approximately $20 trillion monthly, which is 20 times that of options (around $100 billion monthly). The cryptocurrency market has not inherited existing models from traditional finance but has built its ecosystem from scratch.
The regulatory environment shapes this difference. Traditional markets are constrained by the Commodity Futures Trading Commission (CFTC) in the U.S., which requires futures rollovers, introducing operational frictions; U.S. regulations cap stock margin leverage at around 2 times and prohibit '20x perpetual contracts.' Hence, options have become the only way for Robinhood users (e.g., retail investors with only $500) to turn a 1% fluctuation in Apple stock into over 10% returns.
The unregulated environment of cryptocurrency has created space for innovation. It all started with BitMEX's perpetual futures: as the name suggests, these futures have no 'settlement' date and are perpetual. You do not need to own the underlying asset; you can trade repeatedly. Why do traders use perpetual contracts? For two reasons:
Compared to spot trading, perpetual contract fees are lower;
Leverage on perpetual contracts is higher.
Most traders prefer the simplicity of perpetual contracts. In contrast, option trading requires understanding multiple variables at once: 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, quickly becoming the favorite leveraged tool for cryptocurrency traders. In the same year, a small Dutch team launched Deribit, the first trading platform focused on cryptocurrency options. At that time, Bitcoin was priced below $1000, and most traders felt that options were too complex to bother with. Twelve months later, the tide turned: Bitcoin soared to $20,000, and miners holding large inventories began buying put options to lock in profits. By 2019, Ethereum options were launched; by January 2020, the open interest in options first surpassed $1 billion.
Today, Deribit handles over 85% of cryptocurrency options trading volume, indicating that the market is still quite concentrated. When institutions need to make large trades, they do not choose the order book but contact pricing service desks or communicate on Telegram, settling through the Deribit interface. A quarter of Deribit's trading volume comes from this private channel, highlighting institutional dominance in this seemingly retail-driven 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 $95,000 worth of put options. If the price of Bitcoin falls, the futures long will incur a loss, but the appreciation of the put option can prevent liquidation. Of course, there are many variables, like option expiration time or futures leverage, but Deribit's cross-market collateral feature is a key reason for its dominance.
In theory, 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 is still 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 review the three development stages of on-chain options.
The Stone Age of options
In March 2020, Opyn initiated the democratization of option issuance: locking ETH as collateral, choosing strike prices and expiration dates, smart contracts 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 independently tradable token: a $1000 call option for July is one token, and a $1200 call option is another, leading to fragmented user experience, but the market can operate normally. At expiration, holders of 'in-the-money' options can exercise them to realize gains, and the remaining collateral will be returned to the seller. More troublesome is that the seller must lock the full notional value: selling a call option for 10 ETH requires freezing 10 ETH until expiration to earn a $0.5 premium.
This system continued to operate well until DeFi Summer arrived. When gas fees soared to $50-$200 per transaction, the cost of issuing an option often exceeded the premium itself, leading to the collapse of the entire model almost overnight.
Developers turned to Uniswap-style liquidity pool models. Hegic led this transformation, allowing anyone from retail to whales to deposit ETH into a public treasury. Liquidity providers (LPs) concentrate collateral into one pool, and smart contracts quote prices for option buy/sell. Hegic's interface allows users to select strike prices and expiration dates.
If a trader wants to buy a call option for 1 ETH next week, the automated market maker (AMM) prices it using the Black-Scholes model, sourcing ETH volatility data from external oracles. After the trader clicks 'buy', the contract withdraws 1 ETH from the pool as collateral, mints an NFT recording the strike price and expiration date, and sends it directly to the buyer's wallet. The buyer can resell the NFT on OpenSea at any time or wait for expiration.
For users, this is almost magic: a trade completes without a counterparty, and the premiums flow to LPs (minus protocol fees). Traders enjoy the one-click experience, while LPs appreciate the yield; the treasury can simultaneously issue options for multiple strike prices/expiration dates without active management.
This magic lasted 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 out far more than expected in ETH. In just one week, a year's premium income evaporated, and LPs learned a painful lesson: issuing options in calm markets may seem easy, but without proper risk management, a storm can wipe everything out.
AMM must lock collateral to underwrite options
Lyra (now renamed Derive) attempts to solve this problem by combining liquidity pools and automated risk management: after each trade, Lyra calculates the net delta exposure of the pool (the sum of all option deltas for strike prices and expiration dates). If the treasury has a net short exposure of 40 ETH, it means that for every $1 increase in ETH price, the treasury loses $40. Lyra will establish a long position of 40 ETH in Synthetix perpetual contracts to hedge directional risks.
AMM prices using the Black-Scholes model, outsourcing expensive on-chain calculations to off-chain oracles to control gas fees. This delta hedging reduced the treasury's losses by half compared to unhedged strategies. Despite its sophisticated design, this system relies on Synthetix's liquidity.
When the Terra Luna collapse triggered panic and traders withdrew from Synthetix's staking pool, liquidity exhaustion led to skyrocketing hedging costs for Lyra, significantly widening spreads. Complex hedging requires deep liquidity sources, which DeFi has struggled to provide reliably to this day.
Seeking the spark
Decentralized options vaults (DOVs) sell order flow through auctions, source: Treehouse Research
At the beginning of 2021, decentralized options vaults (DOVs) emerged. Ribbon Finance pioneered this model, which is quite simple: users deposit ETH into the treasury, and every Friday they sell covered call options through off-chain auctions. Market makers bid for order flow, and the premiums are returned to depositors as profits. Every Thursday, after the options settle and collateral is unlocked, the entire process resets.
During the bull market of 2021, implied volatility (IV) remained above 90%, and weekly premiums translated into astonishing annualized returns (APYs). Weekly auctions continued to generate significant returns, and depositors enjoyed seemingly risk-free ETH yields. However, when the market peaked in November, and ETH began to fall, the treasury started to show negative returns, with premium income insufficient to cover ETH's decline.
Competitors Dopex and ThetaNuts replicated this model and added rebate tokens to mitigate the impact during loss periods, but still failed to address the core vulnerability of dealing with significant volatility. In the AMM and DOV models, funds must be locked until expiration. Users depositing ETH to earn premiums face difficulties when ETH falls and cannot close positions when needed.
Order book
The Solana ecosystem team learned from the limitations of AMMs in early options protocols and adopted a radically different approach. They attempted to replicate Deribit's central limit order book (CLOB) model on-chain, achieving near-instant settlement with a sophisticated order matching engine, and introducing market makers as counterparties for each option.
First-generation products like PsyOptions attempted to place the order book entirely on-chain, with each quote occupying block space, requiring 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 orders and settling on-chain afterward. The Ribbon team returned to the battlefield with Aevo, placing the order book and matching engine on high-performance Optimism Layer2.
More importantly, these products support perpetual contracts and options on the same platform, equipped with a combined margin system that can calculate the net exposure of market makers. This is similar to the success factors of Deribit, allowing market makers to reuse collateral.
The results are mixed. As market makers can frequently update quotes without incurring high gas fees, spreads narrow. However, the weaknesses of the CLOB model become apparent 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 dependence on active market makers leads to temporary 'dead zones', while AMMs, despite their flaws, have never experienced such situations. Teams like Drift have completely turned to perpetual contracts, abandoning options.
Teams like Premia explore AMM-CLOB hybrid models, seeking a middle ground between providing 24/7 liquidity with an on-chain order book and market makers that can add depth. However, total locked value (TVL) has never exceeded $10 million, and large trades still require market maker intervention, resulting in high slippage.
Why options struggle
Options liquidity is flowing from AMMs to order books. Derive has disabled its on-chain AMM and rebuilt the exchange around an order book, equipped with a cross-margin risk engine. This upgrade has attracted platforms like Galaxy and GSR, which now handle 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 offset positions and calculates margin requirements based on net portfolio risk rather than individual positions. This engine continuously evaluates each position: underwriting $120,000 call options expiring in January 2026, shorting next week's weekly contracts, buying spot BTC, and requiring traders to post margin based on net directional exposure.
Hedging can offset risks and release collateral to redeploy in the next quote.
On-chain protocols break this cycle by tokenizing each strike price and expiration date into their respective ERC-20 token vaults. The $120,000 call options minted next Friday cannot identify the hedge for BTC perpetual contracts. Although Derive has partially solved this problem by adding perpetual contracts to its clearinghouse for cross-margining, the price differences are still much higher than Deribit; equivalent position spreads are usually 2-5 times higher.
Note: Let's explain this with mango prices. Suppose I sell someone the right to buy mangoes for $10, collecting a $1 premium. These mangoes ripen three days later. As long as I have mangoes (spot asset), I can collect the premium ($1) without worrying about the market price of mangoes rising.
I won't incur a loss (thus achieving hedging) unless the price of mangoes rises, causing opportunity costs. If Sumanth buys this option (paying me $1), he can flip the mangoes for $15, netting $4 after subtracting the premium. These three days are the option's expiration date. At the end of the trade, I either still hold the mangoes or receive a total of $11 ($10 for the mangoes + $1 premium).
In centralized exchanges, my mango farm and the market are in the same town; they know the collateral I'm trading, 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. Since most markets rely on credit and trust, this model's capital efficiency is very low — I may lose money just by transferring Sumanth's payment to the logistics provider.
Deribit benefits from years of API development, along with numerous algorithmic trading platforms optimized for its system. Derive's risk engine has been online for just over a year, lacking the deep order book needed for effective hedging in both spot and perpetual contract markets. Market makers need instant access to deep liquidity across multiple tools to manage risks; they need to hold option positions while easily hedging with 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 the market structure.
This design has led to significant success for platforms like Hyperliquid: their treasury often acts as a counterparty to retail trades, distributing trading fees to treasury depositors.
In contrast, options decentralize liquidity into thousands of 'micro-assets': each strike price - expiration date combination forms an independent market with unique characteristics, leading to fragmented funding, 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 soon.
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, no matter how complex their pricing models or smooth their interfaces, ultimately lose liquidity.
Professional market makers operate on extremely 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 for hedging, rather than viewing these collaterals as offsetting risks (which may only require $20,000 in net margin), then it becomes unprofitable to participate in the market. Simply put: no one wants to tie up a lot of capital for only a small profit.
Source: TheBlock
The spot markets on platforms like Uniswap often exceed $1 billion in daily trading volume, with minimal slippage; decentralized exchanges like Hyperliquid handle hundreds of millions in daily trading volume, with spreads competitive with centralized exchanges. The liquidity base urgently needed by options protocols now exists.
The bottleneck has always been infrastructure: the 'pipeline' 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 have written about Hyperliquid's shared infrastructure approach, which creates a positive-sum state that DeFi has long promised but rarely delivered: each new application strengthens the entire ecosystem rather than competing for scarce liquidity.
We believe options will eventually go on-chain through this 'infrastructure-first' approach. Early attempts focused on mathematical complexity or clever token economics, while HyperEVM addresses the core 'pipeline' issues: unified collateral management, atomic execution, deep liquidity, and instant settlement.
We see several core aspects of market dynamics changing:
After the FTX collapse in 2022, the number of market makers participating in new primitives and taking on risks decreased; now, traditional institutional participants are returning to the cryptocurrency market.
There are more proven networks capable of meeting higher trading throughput demands.
The market has a higher acceptance of certain logic and liquidity not fully on-chain.
If options are to return, three types of talent may be needed: developers who understand product operation, experts who understand market maker incentives, and individuals who can package these tools into retail-friendly products. Can on-chain options platforms enable some to earn life-changing wealth? After all, Memecoins have done it — they have made the dream of turning a few hundred dollars into millions a reality. The high volatility of Memecoins makes this effective, 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 speculative rather than hedging. However, as crypto infrastructure matures and truly goes into commercial operation, this situation will change. Institutional-level liquidity will go on-chain through reliable infrastructure, supporting cross-margin systems and composable hedging mechanisms.
