Author: ARP Digital co-founder Abdulla Kanoo, CoinDesk; Translator: Baishui, Golden Finance
From July 2021 to June 2022, the cryptocurrency options sector, mainly on the retail side, experienced a period of exponential momentum, followed by a sharp decline in vault TVL and absolute returns during a period of significant realized volatility. Options and structured product vaults use systematic short volatility strategies, and the consensus among retail investors is far from good.
Options and structured products are naturally complex and require at least quasi-active management. While the demand for convexity increases and 0DTE options are resurgent in retail consciousness, institutional providers have been quietly advancing the infrastructure needed for non-retail investors to participate. These types of structured products offer investors a broad range of crypto returns while also addressing the degree of customization.
The Problem
The problem here and in the development of many other crypto instruments is alwaysmarket microstructure. Cryptocurrency began as a grassroots ideological experiment, purchased by a small niche group of people who wanted to trade an uncertain asset. As a result, the market microstructure designed to serve it was selfish, unguided, and naturally unregulated. Some of the infrastructure issues that exist in crypto today, such as fragmented liquidity, no consensus around centralized pricing mechanisms, and supply and demand differences from one exchange to another, are legacy challenges that are now becoming more solvable as crypto begins to transition from an exchange to a fully retail market.
Exciting Opportunities
While on-chain structured products have received much attention, an equally exciting opportunity lies in delivering crypto returns to traditional investors. As crypto becomes more important in portfolio allocations, we will begin to witness a more significant capture of strategic allocations than we have seen in the past. This is driven by the breadth and quality of institutional-grade products and delivery corridors that have been developed, including ETFs, ETPs, and other unlisted instruments.
There is already back-tested data to support the idea that adding BTC to a balanced portfolio can improve the aggregate, as measured by the Sharpe and Sortino ratios. Check out the chart below from Coinshares:
More crypto-based products can also make a positive contribution to a balanced portfolio.
Volatility Products
Crypto volatility is a dynamic, rapidly changing space, impacted by polarization among market participants, access to massive leverage, and market microstructure. The historical lack of adoption is the result of a reflexive cycle where there was not enough demand for crypto traders to prioritize their own distribution, and bank dealers had no clear regulation or incentive to drive it. As a result, the historical volatility profile (shown below, courtesy of Amberdata) very vividly depicts the results of a lack of institutional infrastructure and participation.
Since the traditional delivery channel for crypto structured products relies on integration between crypto participants and traditional intermediaries, there are several barriers, resulting in significant compromises from capital efficiency to collateral management, which further suppresses investor demand.
Conclusion
As the spot Bitcoin ETF continues to achieve great success and broader awareness recognizes the value of this asset class from an investable and psychological level, the demand for product development will also follow. Mimicking the trajectory of other asset classes, the crypto structured product space will grow exponentially.
Following the volatile events of 2022, investors are starting to think more deeply about where their returns come from and how to quantify the risk they take to earn them; there is no such thing as a "free lunch". Structured products offer returns that are certain and can be mathematically verified against market outcomes, which, with luck, will lead to calmer nights.