Crypto derivatives: A tale of two trading options

Disclosure: The views and opinions expressed herein belong solely to the author and do not necessarily represent the views and opinions of crypto.news editorial.

Crypto can’t stay the same forever. However, the effort to expand blockchain-based finance into new, useful, or wealth-generating areas has proven to be more difficult than expected.

However, crypto derivatives have gained momentum as more experienced investors look for more complex trading categories. Derivatives are, of course, a staple in traditional financial markets, so much so that they are often part of compensation packages for employees joining startups or already public companies.

But crypto derivatives do not mirror fiat currencies exactly. Like other aspects of blockchain technology, the “hidden” technology and infrastructure means they do not always work in the same way as traditional market drivers.

Yes, crypto derivatives like options create an opportunity to capitalize on the industry’s volatility and its response to sociopolitical events, but investors have two ways to do so.

Many crypto derivatives platforms today only offer options trading based on inverse contracts that use cryptocurrencies like Bitcoin (BTC) as both the underlying asset and collateral. This essentially means that the value of the contract is inversely proportional to the price of the underlying asset. If the price of BTC increases, the value of the contract decreases, and vice versa.

In this model, both profits and losses are paid in the cryptocurrency itself, exposing investors to both higher volatility and more complex pricing dynamics. This may be preferable for investors looking to speculate on the asset’s price volatility through direct exposure, especially during bear markets. Similarly, investors can potentially earn higher returns by taking advantage of option price movements and underlying currency positions, especially in highly volatile markets. Inverse contracts also allow for more advanced hedging strategies, as investors can hedge options and underlying assets at once.

On the other hand, given the pricing mechanics of reverse options contracts, investors are exposed to uniquely high volatility risks. Since the option value and underlying asset prices affect returns, investors are much more vulnerable to extreme volatility, especially when profits and losses are paid in non-asset-backed cryptocurrencies. With higher liquidation risks and unpredictable returns, it’s no surprise that reverse options trading is not so welcoming to new investors.

Despite the complexity, platforms like Deribit have made reverse options contracts the backbone of their platforms, accounting for over 90 percent of crypto derivatives trading as of last July. But are reverse contracts really the only option here (not intentionally)?

More recently, Deribit competitors have been offering alternatives to break the platform’s dominance of crypto derivatives. The most notable exchange in the space is Thalex, which offers stablecoin-backed options trading as opposed to inverse contracts.

While the clue is in the name, stablecoin-backed options trading uses stablecoins as collateral for trades, creating a direct correlation between the value of the contract and the price of the underlying asset. Platforms like Thalex offer both collateral and payout in stablecoins, allowing the exchange to offer a simpler pricing model while also offering much lower volatility risk.

Thalex’s appeal to investors looking for more stable and predictable returns is immediately obvious. Since the collateral is in a fiat-linked stablecoin, investors have a more solid value base that is not as affected by market volatility, and any profits will have a more certain value as they are not exposed to crypto price fluctuations. However, in the long term, this model can eat away at potential returns, which may not appeal to risk-hungry, profit-focused investors.

Sure, a stablecoin-backed options trading model offers less leverage and lower potential returns in bull markets, and requires access to stable assets to participate in. But for newer investors just starting out in crypto derivatives, that’s not necessarily a bad thing. Similarly, more experienced or institutional investors who aren’t as enticed by the high-risk, high-reward game of inverse options contracts now have a more reliable way to trade derivatives.

Crypto derivatives mark an evolution in what crypto can do, demonstrating the industry’s ability to match or even surpass what is possible in traditional financial markets. However, the emergence of alternatives this early in the space also highlights the need to stay competitive and always provide ways to expand access to new tools. Otherwise, crypto will simply mimic traditional markets rather than improve on what it offers.