On-Chain Options, Will It Be the Next Big Thing in Crypto?

Original Article Title: Putting All Your Calls in One Basket
Original Source: variant.fund

Translation: Zhou, ChainCatcher

If the core value of cryptocurrency is to provide a new financial track, then the lack of mainstream adoption of on-chain options is puzzling.

In the U.S. stock market alone, the daily trading volume of single-stock options is around $450 billion, representing approximately 0.7% of the $68 trillion total market capitalization of U.S. stocks. In contrast, the daily trading volume of cryptocurrency options is around $20 billion, accounting for only 0.06% of the approximately $3 trillion cryptocurrency market cap (10 times lower than stocks). Although decentralized exchanges (DEXes) currently account for over 20% of cryptocurrency spot trading volume, almost all options trading still occurs through centralized exchanges (CEXes) such as Deribit.

The difference between the traditional options market and the on-chain options market stems from early design choices, limited by the original infrastructure, which failed to meet two key elements of a healthy market: protecting liquidity providers from adverse order flow impact and attracting high-quality order flow.

Today, the infrastructure needed to address the former exists—liquidity providers can finally avoid being front-run by arbitrageurs. The remaining challenge, which is also the focus of this article, is the latter: how to devise an effective go-to-market strategy (GTM) to attract high-quality order flow. This article believes that on-chain options protocols can thrive by targeting two distinct sources of high-quality order flow: hedgers and retail.

The Trials and Tribulations of On-Chain Options

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

In the early days of Ethereum, transaction activity was scarce, and gas fees were relatively low. Therefore, 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 (a few months after EtherDelta, the first popular on-chain spot order book on Ethereum, was launched). However, on-chain market-making was extremely challenging, as gas fees and network latency made it difficult for market makers to provide accurate quotes and avoid losing trades.

To address these issues, the next generation of options protocols embraced automated market makers (AMMs). AMMs no longer rely on individuals to make markets but instead derive prices from the internal token balances of a liquidity pool or external price oracles. In the former case, as traders buy and sell tokens from the liquidity pool (altering the pool’s internal balance), the price updates; liquidity providers themselves do not set prices. In the latter case, when a new oracle price is published on-chain, the price updates periodically. From 2019 to 2021, protocols such as Opyn, Hegic, Dopex, and Ribbon adopted this approach.

Unfortunately, AMM-based protocols have not significantly increased the adoption of on-chain options. The reason AMM can save gas fees (i.e., by having traders or lagging oracles, rather than liquidity providers, set prices) is precisely because its characteristics make liquidity providers vulnerable to losses from arbitrageurs (i.e., adverse selection).

However, what may truly hinder the mainstream adoption of options trading is that all early versions of option protocols (including those based on order books and automated market makers) require short positions to be adequately collateralized. In other words, sold call options must be hedged, and sold put options must be cash-secured, making these protocols capital-inefficient and depriving retail investors of a key source of leverage. Without this leverage, retail demand diminishes as the incentive mechanisms disappear.

Sustainable Options Trading Platform: Attracting Quality Order Flow, Avoiding Toxic Order Flow

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

· The ability for liquidity providers to avoid 'toxic order flow' (i.e., avoiding unnecessary losses). 'Toxic order flow' refers to arbitrageurs sacrificing the liquidity provider's interest to earn almost risk-free profits.

· A strong source of demand to provide 'quality order flow' (i.e., making money). 'Quality order flow' refers to traders who are not price-sensitive and who, after paying the spread, earn profits for the liquidity provider.

Looking back at the history of on-chain option protocols, we find that they failed in the past because both of these conditions were not met:

· The technical infrastructure of early option protocols prevented liquidity providers from avoiding toxic order flow. The traditional way for liquidity providers to avoid toxic order flow is to update quotes on the order book for free and frequently, but the 2016 order book protocols' latency and costs made it impossible to update quotes on-chain. Transitioning to Automated Market Makers (AMMs) also failed to solve this issue because its pricing mechanism was slower, putting liquidity providers at a disadvantage in competition with arbitrageurs.

· The requirement of full collateralization eliminated the leverage that retail investors value in options, and leverage is a key source of quality order flow. With the lack of alternative on-chain option use cases, quality order flow was also non-existent.

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

In recent years, many changes indicate that we can now build infrastructure to enable liquidity providers to avoid toxic order flow. The rise of specific application (or industry) infrastructures has significantly improved the market design for liquidity providers in various financial application areas. The most important of these include: deceleration bands for delayed order execution; sorting priority for limit orders only; order cancellations and price oracle updates; extremely low Gas fees; and anti-front running mechanisms in high-frequency trading.

With scalable innovations, we can now also build applications that meet the demand for good order flow. For example, improvements in consensus mechanisms and zero-knowledge proofs have made the on-chain space cost low enough to implement complex margin engines on-chain without the need for full collateralization.

Addressing the toxic order flow issue is primarily a technical problem and in many ways, paradoxically, a "relatively easy" one. Indeed, building this infrastructure is technically complex, but that is not the real challenge. Even if new infrastructure can support protocols that attract good overflow traffic, it does not mean that good order flow will magically appear. On the contrary, the core question of this article, also its focus, is: assuming we now have infrastructure supporting good order flow, what kind of Go-To-Market (GTM) strategy should projects adopt to attract this demand? If we can answer this question, we have hope of building a sustainable on-chain options protocol.

Price-Insensitive Demand Characteristics (Good Order Flow)

As stated above, good order flow refers to demand that is insensitive to price. Generally, demand that is insensitive to price for options is mainly composed of two core customer types: (1) Hedgers and (2) Retail Customers. These two customer types have different goals, hence their use of options differs.

Hedge Funds

Hedgers, also known as those who believe that reducing risk is valuable enough to pay an amount higher than the market value, are willing to pay any institution or operating enterprise.

Options are very attractive to hedgers because they allow them to precisely control downside risk by choosing the exact price level (the strike price) at which to stop losses. This is different from futures, where hedging is all or nothing; futures protect your position in all circumstances, but do not allow you to specify the price at which protection kicks in.

Currently, hedgers dominate the demand for cryptocurrency options, and we expect this to come mainly from miners, who are the first wave of "on-chain institutions." This can be seen from the dominance of Bitcoin and Ethereum options trading volumes and the fact that mining/validation activities on these chains are more institutionalized than on other chains. Hedging is critical for miners because their income is denominated in highly volatile crypto assets, while many of their expenses—such as salaries, hardware, custody, etc.—are denominated in fiat currency.

Retail

The so-called retail investors refer to those individual speculators who aim for profit but are relatively inexperienced—they usually trade based on intuition, belief, or experience rather than models and algorithms. They generally seek a simple and user-friendly trading experience, and their driving force is fast wealth accumulation rather than a rational consideration of risk and return.

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

Although options are popular in the financial trading space, retail investors' acceptance of cryptocurrency options is actually close to zero. This is because for retail investors, there is a better cryptocurrency tool available to utilize leverage for long and short trades, and this tool is not yet available in the financial trading space: perpetual contracts (perps).

As seen in hedge trading, options' greatest advantage lies in their granularity. Options traders can consider long/short, time, and strike price, making options more flexible than spot, perpetual contracts, or futures trading.

While more combinations can bring higher precision, which is what hedgers expect, it also requires more decisions, which often leaves retail investors feeling overwhelmed. In fact, the success of 0DTE options in retail trading can largely be attributed to the fact that 0DTE options improve the user experience issue of options by eliminating (or greatly simplifying) the time dimension ("zero-day"), thereby providing a simple and user-friendly leverage long or short tool.

The reason why options are not seen as a leverage tool in the cryptocurrency space is that perpetual contracts (perps) are already very popular and are simpler and more conducive to leveraged long/short operations than 0DTE options. Perps eliminate the time and strike price factors, allowing users to continuously engage in leveraged long/short trading. In other words, perps achieve the same goal as options (providing leverage to retail investors) with a simpler user experience, thus significantly reducing the additional value of options.

However, options and cryptocurrency retail investors are not entirely without hope. In addition to leveraging simple long and short operations, retail investors also crave interesting and novel trading experiences. The granularity of options means they can bring a completely new trading experience. One particularly powerful feature is allowing participants to directly trade on the volatility itself. Taking the example of the Bitcoin Volatility Index (BVOL) offered by FTX (now closed). BVOL tokenizes implied volatility, allowing traders to directly bet on the magnitude of Bitcoin price volatility (regardless of direction) without managing complex option positions. It packages the trading that would typically require straddle options or strangle options into a tradable token, enabling retail users to easily and conveniently speculate on volatility.

Market Adoption Strategy for Price-Inelastic Demand (Good Order Flow)

Now that we have identified the characteristics of price-inelastic demand, let's describe the GTM strategies the protocol can use to attract good order flow to the on-chain options protocol for each characteristic.

Hedgers GTM: Meeting Miners Where They Are

We believe that the best market adoption strategy to capture hedging flows is to target hedgers, such as miners currently trading on centralized exchanges, and offer a product that gives them ownership of the protocol through tokens while minimizing changes to their existing custody setups.

This strategy aligns closely with Babylon's user acquisition approach. When Babylon was launched, there were already significant off-chain Bitcoin hedge funds, and miners (some of the largest Bitcoin holders) likely already had access to this liquidity. Babylon primarily built trust with 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 entail additional trust assumptions. Miners opting for Babylon indicated that they valued the option to choose custody providers (whether self-custody or others) and to gain ownership through tokens or a combination of both. Otherwise, Babylon's growth would be hard to explain.

Now is the perfect time to leverage this global trading platform (GTM). Coinbase recently acquired the leading centralized exchange for options trading, Deribit, posing a risk for foreign miners who may be reluctant to hold large funds in a US-controlled entity. Additionally, the feasibility of BitVM and the overall improvement in Bitcoin bridge quality are providing the necessary custody assurance to build an attractive on-chain alternative solution.

Retail Market Adoption: Providing a Brand-New Trading Experience

Instead of trying to compete with criminals using their usual tricks, we believe the best way to attract retail traders is to offer a novel product 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. An on-chain options protocol can build a treasury that allows retail users to engage in volatility trading with a straightforward user experience.

Previous options protocols (such as those on Dopex and Ribbon) were easily arbitraged due to imperfect pricing mechanisms. However, as we have mentioned before, with recent innovations in application-specific infrastructure, we now have clear reasons to believe that you can build an options protocol that is immune to these issues. An options chain or aggregator can leverage these advantages to enhance the execution quality of the long-short volatility options pool while also promoting liquidity and order flow in the order book.

Conclusion

The conditions for successful on-chain options are finally coming together. The infrastructure is maturing to a point where it can support more capital-efficient solutions, giving on-chain institutions a real reason to hedge directly on-chain.

By building infrastructure that helps liquidity providers avoid toxic order flow and focusing on two types of users who are less price-sensitive—those looking for precise trading like hedgers and those seeking a completely new trading experience like retail traders—a sustainable market for on-chain options protocols can be established. With these foundations in place, options can become a core part of the on-chain financial system in ways never seen before.

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