Inside the Crypto Options and Derivatives Boom

Mike Ippolito

Everyone assumes because they, they got product market fit in crypto for the first time. But it actually, it wasn't like Arthur didn't invent perpetual, so perpetual futures. Actually, that was actually proposed by none other than Robert Schiller back in 1992. And I just find that such a fun like at dependence sort of fact of history. It never really took off in trad five, but just found product market fit with our specific type of dgens.

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But for now, Uniswap, thanks for making this episode possible. We're right back to it. All right, everyone, welcome back to another episode of Bell Curve. Before we jump in, quick disclaimer, the views expressed by my co host today are their personal views, and they do not represent the views of any organization with which the co hosts are associated with. Nothing in the episode is construed or relied upon as financial, technical, tax, legal, or other advice.

You know the deal. Now let's jump into the episode.

All right, everyone, welcome back to another episode of Bell Curve. Today I'm joined by Nick Troleski, who's a crypto options trader at Cumberland Drw. Nick, welcome to the show, man. Hey, Mike, nice to meet you. Nice to be here on blockworks.

Nick Troleski

It's going to be fun. Yeah, man. This is going to be a great one. Yeah, I think what I'd love to do is you have a really interesting seat in this industry at an options market making desk. And I think there are a lot of folks that would say that they understand what's going on in derivatives, options, et cetera, but don't have a very clear picture.

Mike Ippolito

And you have a very boots on the ground understanding of what's going on. So can we just start at a 10,000 foot level and just describe what does the sort of options and derivative space look like in crypto today? Yeah, sure. So options and derivatives and crypto started quite a while ago, actually. Surprisingly, it was like 2017 when Derbit and these offshore exchanges started to kind of pick up steam and people started trading small size on them.

Nick Troleski

But I would say the kind of the explosion of crypto options really happened in 2021, as more and more sophisticated players kind of came in and started to market make, and then also start trading strategies to. To generate yield and to also take various kinds of directional risk using options. But the space in general has been kind of a quiet grower underneath the explosion of the crypto derivatives markets. Obviously, everyone knows perps. They're just a great product that is very simple to understand.

There's just linear risk on instruments with a funding rate. So for a lot of retail and a lot of institutional participants, perps have been a very good product for either hedging their portfolios or just expressing risk in a capital efficient way. But at the same time, options have been growing as kind of more and more sophisticated people enter and wish to express opinions on non linear risk. So, like, if they want to express direction at a certain strike price or at a certain maturity or play some kind of event. And as you know, we've had a lot of events in crypto, options kind of allow people to structure like trades in that kind of way.

They also have a lot of implicit leverage in them as well. So, and another benefit of them is that you get rid of the risk of liquidation. And, I mean, the biggest thing, like, the biggest end users kind of in the overarching ecosystem of options traders are yield generating strategies. So, like people who have large holdings of BTC or ETH or miners or staking providers, they are the ones that kind of come in and say, like, hey, we have fixed costs, we generate all this BTC and ETH. We want to also figure out a way to extract yield from this so that we can pay for our fixed costs.

So they have been predominantly the first mover and first entrant into this market, and then the rest of the market has grown around them. All right, maybe we could. So, I think you just outlined the three major instruments, right? There's futures, options, and then perpetuals. So maybe we could talk a little bit about sort of the history and current state of the union of each one of those different instruments, like, who are ultimately using each of those things.

Mike Ippolito

Then what the market structure looks like that supports trading, and then maybe we can sort of back into, at the end of the conversation, something intuitive about what any sort of metrics coming out of each one or the usage of each of those products tells us about just sort of like where we are in the cycle, which is like the perennial question that everyone's always interested, everyone's. Always trying to time that. But, yeah, I mean, yeah. So crypto obviously started off with spot. Like people.

Nick Troleski

Spot exchanges were the first things to kind of come around in crypto, and it was just very simple to understand. But as people started to trade crypto and wanted to secure, borrow, to short something or to run a neutral position, it became pretty obvious that you needed a future product. So one of the biggest first movers that took off in this space was bitmex. I'm sure everyone remembers those days when. Run the stops.

Yeah, run the stops, exactly. So Bitmex was one of the first movers in that. And obviously binance, Derbit, Bybit, you know, FTX, all these other exchanges obviously came out and like, leaned in and they just, you know, crushed it with perps. Like, that was the product to use. So also, Nick, fun fact, like this is, I've got one fun fact about perpetuals.

Mike Ippolito

Everyone assumes because they, they got product market fit in crypto for the first time. But it actually, it wasn't like Arthur didn't invent perpetual. So perpetual futures are actually, that was actually proposed by none other than Robert Shiller back in 1992. And I just find that such a fun, like, dependence sort of fact of history. It never really took off in trad five, but just found product market fit with our specific type of dgens.

Nick Troleski

Yeah, it's really, it's really fascinating. It's such a good, I think part of it is just that we had better technology, like in current day to support this, like perpetual funding. You know, the way that banks and settlement operates on like, traditional exchanges in the US, where it's like t plus one settlement, I think, was probably not too supportive of that. And then on top of that, they just banned any kind of swaps. So like this.

Yeah, that was like kind of a regulatory reason for why perps are still not allowed in the US. Great. Can you, what is the connection between the settlement time there and actually, for listeners who might not be as familiar with, like, the actual structure of perps, can you describe how those actually work under the hood? Yeah. So perps have some kind of funding rate, which just depends on the difference between the index price and the market price of the perpetrator.

Perpetual future. So that funding price is usually paid out continuously or in some kind of time block. I mean, a lot of people look at it and like an eight hour basis. So three times a day, some exchanges have it continuous, and then, yeah, it just hits your account and it's very easy to think about why, like what the funding rate is. You know, people look at it annualized, or people look at it on a daily basis.

So it's like, okay, if I risk, if I have $100 of position and I have to pay 1% funding, I know that my margin decreases by this amount. The other thing that's nice about perps is that there's different kinds. There's some that have margin in underlying collateral. So you can margin BTC to get long BTC, or you can margin USDT tethers to get long BTC and vice versa with shorts.

The general product is very simple for someone to understand. It's just that you pay, there's either a long funding or a short funding. You either paying funding or collecting funding based on the balance of positions in this particular instrument.

And it's just like it's pure delta direction, so you just have exposure in price whichever way moves. Obviously you also run the risk of liquidations if your margin is depleted. So it allows greater capital efficiency. And one of the biggest unlocks with perps, with these exchanges coming around and trying to win over retail users, is that they allowed huge amounts of leverage. I mean, binance and all these other exchanges kind of had leverage up to leverage profiles on small accounts like up to 100 x leverage.

And I think we start to see some of that as well, as well in the on chain world as they start creating new perps. Perp exchanges on chain like, that's how they're drawing in all these new retail users. And on top of that, I think also they were very quick with listings of new tokens. That was a pretty big reason why people love to use perps, because every time there's a new token, you have these implied fugitives. Markets allowed users to speculate and get.

Mike Ippolito

Longer short Nick is part of the reason as well. I would guess that this is the demand driver on the exchange standpoint for why they do that is there's probably an enormous amount of demand for vc's that have unlocks or something like that. They bought some illiquid token, it's now been marked up like 100 x, it's about to go live and they just want to lock their gains in. So basically they've still got the underlying, but then they'll just go short the perp to lock those gains in. Is that like a big reason why you think, like, driver of that market?

Nick Troleski

Yeah, for sure. And I think like, you know, just on top of that, they can also hedge other instruments that are closely correlated that have, might be more liquid and have better funding profiles. Because usually when some kind of new, hotly anticipated coin releases a token and there's all this lockup that sometimes extends past a year, it's very difficult to carry a short proposition to lock in your gains for when the funding rate, when everyone, every single vc that invested into it goes through and hedges it and pushes the funding rate to something that's unreasonable, where you're not going to, not really going to make a lot of money. And on top of that, it's also capital intensive. So you have to maintain margin.

If you're short a coin that you just released a token and you have some kind of locked token on the other side, and it starts to take off. From a retail perspective, you have to keep posting more dollar margin, USDT collateral, so it could quickly turn into a capital inefficient trade. But overall, especially as the unlocks get closer, we typically see some kind of action in perp funding as people kind of hedge their allocations. It's definitely a useful tool for funds and venture. So one of the debates that you often see is, all right, perps have been this extremely dominant instrument that especially, like, retail will choose.

Mike Ippolito

But honestly, I feel like there's a decent amount of institutional adoption of perps. However you want to define institutional adoption amongst crypto native institutions, let's call it, and every now and again, people say, well, what about options? Options are the dominant instrument that more traditional institutional money managers use to speculate in tradfi. It just hasn't really seemed like that's taken off in crypto. There's obviously Darabit, there's Evo more recently that has on chain options, but this doesn't seem like that's taken off.

And my pet theory for that, it's a little bit of a, I mean, I just think the average probably retail user, in some ways they're more sophisticated than their tradfi counterparts, but in terms of, like, options or more traditional sort of market sophistication, there may be a little bit lower. It's like easier from a user perspective. And I don't know, like, what do you think about that? Like, why do you think perks just have so much better adoption than, like, options in crypto? Yeah, that's a, that's the, that's the age old question that people have been trying to solve for quite some time.

Nick Troleski

Yeah, and you're right. Like in tradfi, if you look at, like, you know, just the general how much market cap or open interest there is in options on, say, like a stock. Like, I mean, Coinbase, for instance, is like one of the top ten open interest stocks in terms of options on, like, us exchanges. You know, that's how much. And the options open interest, you know, obviously outweighs anything that's in the future space.

So, like, if you look at a product that has futures like e minis there, the options open interest is massive relative to the futures open interest. In crypto, we have the opposite. Like, we have huge futures open interest scattered across exchanges like Binance and CME now, which is the market kind of like the market leader, but the options open interest is like, not like a crazy multiplier of that. And that just shows that the demand and the options space has not been as big as it should be in a fully developed market. And I think it's primarily because the primary users of options are going to be people that are a little bit more sophisticated.

And that has been kind of the trajectory of every single developed market. It's like pension funds, long holders, banks, lenders. So it's like these people that own a lot of it on their balance sheet and have to manage it effectively and have to do it through options and try to think about that holistically. Retail most recently has been like, a very big growth factor and, like, zero DTE options and, like, short dated options for speculation. I mean, we saw that mania in 2021 with GME and other stocks.

And most recently, we saw this pickup, like, in short dated options, zero dtes. So retail still exists. And I think one of the reasons why that kind of traditional finance retail, in traditional markets retail has not spilled over into options on crypto is primarily because of, like, a, there's not enough liquidity. And, you know, on traditional finance exchanges, you have insane liquidity on these options. And then here, you just don't.

There's only, like, the main leader exchange is Derbet, and it's closed off to majority of American Reed. I mean, it's closed off to american retail, so you're not going to get that. And then on top of that, you also have, they have the ability to trade perps, so, like, people have ability to trade futures, and it's just like an easier product to understand. So for retail, it's just, it's a better, it's a better product mark product that they can understand the direction, they can understand the funding, and they can. They can trade it in a much more cohesive way versus on options, it's a little bit more tricky to understand.

So you have to deal with many different strikes, many different expirys. And I think that the current way that exchanges kind of build it makes it really difficult for a retail consumer to come in and say, hey, I want to trade some options. And then you have a million strikes and you have a million expirys, and there's no really clean interface that simplifies it for you and says, hey, if you want to express upside direction or downside direction on this particular crypto, this is what you got to do. I think for the average retail participant, they just come in and they're overwhelmed with how many strikes and instruments there are. And I think that's something that will, as the UX and liquidity matures over time, it'll get solved, and then as there's more institutional interest and more deep markets and more flow, that's going go one side and, like, two sided flow, essentially.

I think this is something that's going to kind of mature and coalesce into, like, a developed market, and this is something we have actually seen over the past, like, kind of nine months to a year. Yeah. So one more question before we go a little bit deeper into options still on the perp side. What are the different venues that, like, where volume is sort of aggregated around? And then how do you see the relative development of, like, perps volume versus spot in general?

Mike Ippolito

Like, I'm actually not sure what the relative volumes are. I know derivatives, there's far more volumes on derivatives these days than spot in crypto. But what does that look like, just perp versus spot? And how do you see that trend continuing? Yeah, for sure.

Nick Troleski

So the various exchanges. So there's obviously offshore exchanges like darabed and a few others. And I would say you could count the. The on chain exchanges like Avo as well. There's onshore, which is CME, which has been recently has flipped binance in overall open interest and futures on bitcoin ETH.

Not yet, but over time, I think that also kind of happened. So that's the regulated way to trade options in the US. After that, there's OTC. So that's something that we, Cumberland, GRW, kind of specialize in. We think that we see roughly, like 50% OTC and, like, 50% like, exchanges as, like, the total volume profile for us.

So OTC is kind of special. It's more more tailored for the customer. So it allows customers to margin in. USDC allows customers to margin in dollars, it allows customers to margin underlying tokens and really fits their profile of what they're actually seeking to do, what they're seeking to trade. If they're trying to just buy options, it's very simple.

You just pay the premium and move on. If they're trying to sell options, they have to, obviously margin with coins or with dollars. And I think the flexibility allows them to express it, or allows the flexibility of margin is kind of the big winner for why people like to trade OTC. And on top of that, also just different expiries and different strikes, different instruments, like more exotic options that people don't have listed on exchanges as well. So those are the three venues.

Each one of them have benefits and drawbacks. CME obviously is a highly regulated us drivers exchange, which never has seen any sense of stress at all, including 2008 crisis COVID. No one ever thought that anything would happen on the CME. No one ever had any kind of trust issues with the CME. People blow up all the time during these kind of crises and they get carted out.

And the CME stands and has this hundred year history of never blowing up derivatives exchanges that are offshore. I mean, everyone knows every cycle there's at least one that gets carted out. The last thing you want to do is have options positions which are harder to unwind than a futures position on a failing exchange. So. Yeah, why is it harder to unwind an options position?

Well, if you think about it, like, if you're structuring an options position of many different strikes over many different expiries, versus like, you have ten coins that you just need to like, hit, buy and sell on to get out of them and clear out your margin, it can get a little bit more difficult there. So options positions also get tricky when volume markets go crazy. It might be harder to get liquidity versus you're never not going to have liquidity in BTC or ETH, for instance.

Counterparty risk is central to why offshore exchanges are perceived as a risk versus like CME. And then over the counter, same kind of thing, way more customizable. You know, you face counterparty risk on directly to the market maker that you're dealing with. Some market makers have, you know, especially if they're crypto native. We saw many crypto native market makers get carted out last cycle after, you know, all the loans and all the FTX and exchange things blew up.

For someone like us, that is a traditional finance company that's been around since the 1990s and handled many different kind of tail events and crises. It's not as much of a risk because we also have publicly traded debt and we have the risk management of a sophisticated tradfi firm. So we face less counterparty risk on our end. But, yeah, you kind of give that up. You kind of give up.

You have to kind of give up certain things to trade on one venue versus the other. Some venues will also have better pricing. Some venues will have worse pricing but better margin. So it's kind of a trade off in deciding which one to deal with. I would say that institutions and high net worth individuals will generally opt for either something where they can more, like, closely feel the counterparty risk and either, you know, face and face a regulated exchange or get, like, some clarity on financials versus, you know, more retail participant.

Retail participants won't really care about counterparty risk. They're just trying to enter and exit a trade for, like, you know, a day or two. So for them, it doesn't really matter as much. Everyone want to give a big shout out to today's title sponsor, say, now I want to talk to you guys a little bit about why I think say is cool from a design standpoint, a big problem that it solves for ETH devs out there and then some cool stuff that say has coming up. The reason I like say from an architecture perspective is, again, it's a very fast blockchain, parallelization, all of that stuff.

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Cheers, guys. Nick, let's talk a little bit about some of like, who is using options today. So we were talking about this dynamic of maybe liquid funds that are benchmarked to bitcoin or ethereum, and then they use options to sort of juice their. Maybe juice their returns is the wrong thing, but basically look like they're performing favorably relative to their benchmark. Can you describe that dynamic a little bit?

Nick Troleski

Yeah, sure. So I would say I talked a little bit about the yield generation. Obviously, if you have large holdings of BTC and ETH, and you write calls on it, or you also can write puts on it as the price is going up and as volatility is exploding, you get to collect premium on this and you get to sell some if it goes above the strike. That's kind of the yield generation framework. And on the other side, you have these liquid funds that are, like you said, benchmark to BTC and ETH, their LP's are tapping on their back and saying, where are the returns?

But for some, you also need to show that you're going to be in line with this performance. So we see a lot of liquid venture funds come out and try to buy upside in options to capture this kind of move where BTC or ETH outperform. And then they know that you, you know, they have all their other venture capital investments that will score if the cycle kind of continues, but it keeps like a smoother performance for them overall. And that's kind of a theme that we saw this year, especially like after, like as the ETF's were getting approved and after they got approval, is that people started to kind of just buy upside so that they didn't miss out like this further rally. Yeah, out of curiosity, I know it's probably different at every fund.

Mike Ippolito

And actually some of these funds almost came at it more from a trading or more hedge fund oriented standpoint. And then they started to do some venture investing. There were definitely some funds that came at it more from the venture standpoint and were like, hey, we should be, they got distributions of liquid tokens, or they started to say, hey, there's some upside to having a liquid part of our book as well. But these funds that are starting to trade options, do you think that's some of these investors necessarily have the competency to understand the options? I would just think about venture as a skillset, and buying or trading options is a very different skillset.

So I'm just wondering how that plays out in practice. Yeah. For yield generation, I guess I kind of hate calling it yield generation. What you're doing is really selling volume risk premium or volatility risk premium. You're selling the demand for volatility, which is usually, you know, over time carry some kind of risk premium as to, like, how it actually realizes.

Nick Troleski

So that's just kind of like a technicality that a lot of people like to highlight. But I think for people that are selling, selling options for yield, it generally, I don't think you need like, that much options expertise because you know exactly what you're doing. You are, you know, selling saying that, oh, you know, BTC right now is 70k or, or whatever, 65k right now. I want to let go of some upside above 70k. Like I would sell bitcoin above there.

I can collect for June, actually say like 100k. Like everyone's talking about the 100k strike for June. I can collect $2,700 right now to sell that call, I would sell bitcoin at 100k in June anyways. If it gets up there, I would sell it there now. Right now, I can sell that call for $2,700 and generate that p and l per BTC or generate that yield per BTC.

So it's very simple to think about. And I think that's kind of like the approach that a lot of funds kind of come into it with. And I don't think that requires a lot of expertise, obviously, timing wise. Like, if you can time it better, if you can time like pops and BTC to sell it like on a pop and sell it on a pop in a lot of volatility, that's better. So I think they, some funds might have an edge in that so they can enter and start trading it like that.

Obviously, you know, for some funds also can't trade perps. It's, you know, they're, they don't have a mandate where they cannot, like, especially after FTX, like have, you know, capital on other exchanges that support perps. So how do they, you know, express leverage? They come in through options over OTC. So they will, you know, if they think that we might have, if they just saw like a flurry of on chain activity or like a flurry of retail entering the market, they might come in and say, like, oh, short dated, I want to buy some upside calls.

And effectively it gives you similar leverage profiles to running a perp. And just like running a trade on a perp, obviously, it's very defined risk. You buy a certain strike, you know, your terminal p and l based on where it settles. So that's kind of like the people that enter, enter these kind of trade. These are the kind of funds.

I don't think it takes that much competence to do that, to run more like relative value and BTC versus Ethereum and trade different parts of the term structure where they're trading one expiry versus the other and saying, I think June is very expensive versus December is very cheap because of the election or something like that, I think that takes a little bit more competency. But for pure price action oriented things and yield generation, I think it's a very approachable topic. So on the subject of volatility, this is another one of those things where I feel like I understand it at a relatively high level. I think if you ask many other folks in this space, they would say they understand it. But it's unclear sometimes what the implications of high or low, either realized or just regular volatility is.

Mike Ippolito

Can you just give us an overview of how you think about volatility in general, and then maybe we could start to back into some historic information. I know we were talking about before the show, ETH volatility was at an extremely low level at one point this year. And how should folks who are listening in here kind of generally think about volatility as maybe a timing indicator in markets? Yeah, for sure. Well, yeah, I mean, volatility is just a measurement of.

Nick Troleski

It depends on the timeframe that you measure it. So people like to measure it over the past month or a past week. So it's just a measurement of price action and how volatile prices. And just to give you a range so people understand, it's referred to in an annualized way. So what's the annualized volatility of Ethereum right now it's roughly 60% annualized.

What is the range for that? Well, it can go from, like I talked about in the summer last year, especially when there was a large call overrider on Ethereum. It got as low as, like 25, 30, 30% annualized. And it can range up to, like, it can explode up to, like 150 to 200. So this is kind of the range that you're dealing with.

And. Yeah, the way, the way you do is you measure it over various different timescales, like over a week or over a month, and then you try to predict it based on, like, future events, like events like the merge or, you know, EIP 4844 or, you know, the havening or the ETF. All these things will generally increase volatility because there's going to be more price action, whether up or down. You don't care. But as far as timing goes, timing cycles of volatility is pretty important because you generally start to see every single top of the market has usually had some kind of very high volatility event leading up to it.

I don't think we're there yet because volume got so low over the last, you know, year, especially the summer. Like, over the summer, it was just, it got so obliterated, and it's starting to climb up there. You know, we're in like, the 80 80 volume range, which a few funds have always been talking about, like, oh, yeah, this is like, where things start to get kind of interesting because, you know, we generally always see some kind of explosion of, like, north of, like, 100 volume. So that's kind of where we're at right now. Like, volatility has been steadily, like, as these ETF's came on, market has been climbing, and it's gotten into, like, 80, even though it has its ebbs and flows.

But generally, that's where it's at and that's where it's priced. And I would say December is kind of the target. December and June are the two points of interest right now. It's like, how does everything play out with the election, and how does everything play out with the bitcoin happening? So that's where you see a lot of trading and people kind of speculating on, like, okay, right now those two are, like around 80 volts.

If it really takes off, where does it go? And there's a relationship between the price of volatility and the profitability of selling options. One thing that you and I were talking about a little bit as well before we got started here is this dynamic of miners selling call options as we approached previous all time highs. And I don't know, I do think there was a little bit of market psychology we've talked about on this program, talked about it many times. I thought the sort of mental model that I think was consensus in the market is once we break through all time highs, it's go time.

Mike Ippolito

And it hasn't really been like that this time. It's actually been sort of a break. And one thing that has maybe changed, you sort of hear anecdotally as people usually retail, it's like, okay, what should I buy? But now you actually have bag holders from 2021 or 2022 saying, okay, is this the right time that I should finally sell these bags? And I do think maybe that's something that's a little bit different.

I mean, what's your read on that whole, the whole psychology around the all time high? Yeah, I think there's always, like, you know, it's such like a psychological barrier to cross all time highs. I remember we had the same kind of thing happen in previous cycle with twenty k. I think we broke off like 20k down to, like, sixteen k, and then we finally revisited it. And then, like.

Nick Troleski

Like, Elon, was it like Elon? I guess, like, tweeting that will, like, really, like, sent us through it. But, yeah, it was, it's definitely like a psychological barrier. And, you know, you see, like, I would say, like, a lot of sophisticated investors, like, come in and just like, you know, every time we tap that area, they just start, like, unloading calls that they had before or, you know, taking some kind of profits, especially the last few times we visited. But at the same time, you have those people that are like, oh, my God, I'm underexposed I sold everything out, and there's like, a famous, like, trade that one fund did, like, where, you know, they sell out all their spot at all time highs, but then they don't want to miss out on further upside, and then they just go out and buy calls.

So we saw, like, some of that activity, too. It's like where, you know, people are clearly selling spotted all time highs, and then they're just coming out, turning around and buying calls. Like, oh, this thing, like, pops off to like, we're at 72k. Like, if this thing goes to, like, 880, 90k, we want to see some of that appreciation as well. So you kind of start to see, like, a little bit two way in that space.

I think this cycle, we're also seeing a lot of these defi coins that people kind of held onto and never sold. And that's always been a thing in crypto. It's like, oh, you forgot to sell the all time highs, or you didn't sell it on the way down or you added or whatever. Now it approaches back up. Like, what do you do?

I think that's actually a benefit of options, is that it allows you to, when you're selling calls, it allows you to force yourself to sell, and otherwise you generate some kind of p and l if it doesn't eclipse that area. But, yeah, I think that it enforces stricter profit taking to your mindset.

Mike Ippolito

What is your overall read? I guess just backing into. All right, so we had sort of a similar situation play out in, if you go back to November of 2020, where, yeah, it kissed like 19k, kind of went back down, meandered sideways to downish for about a month, had a couple of attempts to break through. And I guess that feels actually very similar to today. I don't really remember what volatility was doing or I do remember at that time listening to none other than Suzu talking about, I think, three arrows capital.

One of the first big trades that they made very successfully, actually was buying a bunch of cheap volatility at that time. So they were buying a bunch of those options. Then sellers got sort of steamrolled. I mean, do you see a similar risk today? Right.

If there's a bunch of folks who are selling options that if prices really take off, they could. It's kind of like the picking up pennies in front of a steamroller type trade or. What's your sort of analysis there, for sure? Yeah, I mean, we see a lot of funds that are continuing to kind of accumulate upside, especially, like, again, like the 100k area, like 90 to 100K area, especially as you approach the election. I think that's kind of like the trade that everyone likes to think about.

Nick Troleski

Like, where does BTC end the year? So obviously, if they're buying, there's someone else selling, whether it's market makers or, like, on the other side, yield generating funds selling it. There's definitely that. I wouldn't say volatility is cheap anymore. Like, I think the real opportunity was to, to really get long it in the summer where it was just like, I mean, but people at that point have kind of given up.

Like, people thought it was. The opportunity was to get long it in March and April. And then, like, it's like people were just giving up. And, I mean, there weren't any, like, long dated options trading at that time. So maybe it was like, the right time was October when you could actually get some exposure to the ETF stuff.

But, yeah, I do think that, like, there's people still continuing to accumulate options. If we do kind of break, break all time highs again and really send it to, like, 100k, we will definitely perform. It always performs whenever you break out all time highs, and we've seen it go above 100. So I think that's definitely the angle that those funds are playing for. So do you think that this market now really moving into the editorializing part of this, does it feel a little bit like this market has barbelled?

Mike Ippolito

Obviously, CME volumes and open interest has been, there's been a massive spike there. Lots of institutional, like, bitcoin ETH buying, et cetera. And then it sort of feels like meme coins are working, and then that's just about it. And my assumption would be the missing participant here is retail. And you really have crypto doing these PvP sort of games.

You know, they're the one. The natives are the ones that have seen these cycles play out. They know it goes bitcoin ETH, you know, blue chip defi, all l one slash altcoins fin with doge, you know, like, that's right. And they're trying to skip to the end of the cycle and just buy the meme coins right out. And it feels like that's what's happening over in sort of meme.

Like, even if you just look at what's going on today, you know, everything is down. Like, bitcoin's down. ETH is down anywhere from, like five to 10%, whatever, but catcoin is up 43%. This is not an endorsement of capcoin. That was just the number one trending thing that I see on coinback.

I shouldn't even name specific meme coins on this podcast, but you know what I mean, that's going on. Yeah. And I think that's something that you touched on before. It's like a lot of people coming in and they were vesting their, whatever, blue chip Defi over the last four years, and this is their final vest of them taking this part off. So, yeah, I mean, some of these protocols obviously have tremendous growth and tremendous tvl and tremendous use case, like the classic blue chip Defi.

Nick Troleski

But at the same time, I think you're also just getting all these new coins that are entering the market at these very high either market caps or fdvs. And I think they're just being priced more accordingly. I mean, look at blue chip Defi. When it first came out and then when it ripped a lot was not blue chip defi. It was something new where people just started using it and no one really knew what, what the hell it was and how big and how useful it could be, just like later.

Now we refer to as blue chip defi because people keep using it. People keep using Uniswap and Aave and compact or all these other things. Now you have these new narratives come out, whether it's algorithmic, stablecoins, or restaking is really hot right now. And these protocols are going to launch at like, billion dollar fdvs, like multi billionaire like, or, you know, double digit billion ftvs. So, you know, that capital is coming or that capital is coming from somewhere.

And I think that's like, what, you know, the next, like, blue chip defi of the next cycle is going to be. And I think it's just getting priced a little bit more accordingly as it comes out of the gates. And I think they're also, you know, this, like, slow issuance of, you know, points. The whole points meta is like kind of delaying, like this liquid token being around and then it ripping versus, like, it just kind of launches this FDV and people come out and have points and they sell it to liquid funds that end up allocating to it, like right on the launch because everyone's kind of aware of it. It's been around for so long and has generated so much user growth.

I think it's kind of, that's the kind of difference of this cycle. And then the meme coins are just in the background, kind of, you know, there's money sloshing around the system. That's the exhaust. That's how I always think about it. Meme coins are just, like, exhaust of how much money is sloshing around while people wait for whatever.

And yeah, retail just loves it.

Explaining BTC and ETH is simple to retail. They'll buy it. They can now buy it in their brokerage accounts. Explaining liquid restaking or explaining how this protocol is going to work and why they should buy that coin is a little bit more difficult to Defi, explaining its catcoin season and buy the hottest cat coin, that's a lot easier. And I think that's why they end up buying them.

Mike Ippolito

Yeah, I'm torn on this because I just haven't seen on the retail side of things. I'm just so used to now when crypto's taking off, I get all these random calls, like people come out of the woodwork. I just haven't really seen that quite as much. And I don't know. I mean, obviously, retail is buying Dogecoin back in 2021, but that took Elon Musk to tweet about it.

Nick Troleski

Right. It wasn't like everyone was doing that. We needed the most famous guy in the world, arguably, to tweet about Doge and Shib and whatever. I don't really think that retail, for the most part, is, like, finding out about the next, like, now these things, I mean, you know, you had, like, boom or whatever that went up to a billion dollars in 24 hours. Like, that's not.

Mike Ippolito

That's not your grandpa's. Like, your mom and pop retail, right? Like, that's 100% insider crypto natives just aping in to that. I just think they're different crowds would. Be like, yeah, I think it's.

Nick Troleski

It's probably different crowds because I think a lot of, like, people have, you know, set up their Coinbase accounts, and they probably already bought doge last cycle, and they see it where it is now. Maybe they come in and buy some more. But, yeah, maybe people are exploring. I mean, people are exploring Solana much more because it's much more palatable for retail to go in and pay a few dollars for a swap rather than pay $100 for a swap on mainnet. I think there's some people that are waiting into the unchained world, and there's some evidence of retail there.

I would say a lot of it is also probably just crypto natives that have been around and made a lot of money in the last, like, six months, and now they're just like, you know, playing these rotation games. So, yeah, it's probably not the mom and pop retail just yet. I don't think those, you know, those people have entered the on chain world and mass. And I don't think there have been any like super hot exchange listings that outside of, I guess, you know what wif or. I don't know which exchanges that's listed on.

I mean, that's been kind of like the. The big cycle. Yeah, yeah, I think. Or maybe it's bonk that's on finance, but yeah. With is the one that's done super well.

Mike Ippolito

I don't know, I just, you know, there was a. There was an interest. So we just did this conference. Das London. Yeah.

Oh, nice. Great. There was really interesting. So a thousand x one of the podcasts on our. On our network, Avi and Jonah, we did a, like a live recording.

And Avi asked this question, like, how many folks in the room, like, bought one of the bitcoin ETF's? And literally in this room of like 400 people, two people raised their hand, and then it was like, well, how many people own crypto in the entire room, raise their hand? And I think that just like, what does that tell you? Like, that tells you that there aren't that many new. Like, I don't own any of the bitcoin ETF's because I have bitcoin spot.

And probably there's not much. Like, I'm not the target audience for. For this, am I? Yeah. And so I just think it tells you that there just hasn't been much new eventually.

Nick Troleski

Yeah. Yeah, it's possible. Yeah. I mean, I bought the bitcoin ETF just to get the. I love how when you buy a new ETF, they deliver the prospectus, the fat stack of paper.

So I have that sitting on my desk for the ibet ETF. That's the fun part about it. But, yeah, I would say it's hard to gauge, like, you know, whether it's a lot of new retail entering versus this big institutional entry that has happened, especially in BTC. I mean, it's pretty evident that through the CME open interest, like, now you have a lot of hedge funds running the carry trade, which is like buying spot ETF's, selling futures against it, and kind of providing capital into the ecosystem. So you just start to see, I think this is a much more institutional cycle that we have seen kind of take off and the retail bid, maybe it will come.

But, you know, anecdotally, a lot of my friends that I've chatted with and talked to, I think, still feel a little bit stung by the last cycle where they haven't come in with open arms into something just brand new. And I think that's like the retail bid and crypto is always caused by some kind of new breakthrough and something that you can. I mean, Uniswap was like a huge thing that, like, it took a while for people to realize what it was in Defi. That was what drew retail in. Right now, there's not anything that breakingly new in the space that is going to draw them in to do the same thing.

Mike Ippolito

Nick, I got a question for you I was seeing on Twitter today. Shout out to Larry engineer Larry Zero X on Twitter. He's asking this question about Athena. If Athena's strategy is Delta neutral, why aren't hedge funds already doing it? Basically, this is something I sort of remember from last cycle as well.

When people started talking about this carry trade or the basis trade, etcetera, they're like, why aren't people hopping in and closing the spread? If you could just basically get 20% risk free, why aren't more people doing that? And I think that's basically what Larry's asking here with this question of if there's 20% to 30%, basically risk free yields, or at least it's being portrayed that way a little bit. Not that Athena is necessarily doing that, but you know what I mean? Like, why aren't more participants, like, why more people in the hedge fund community hopping in to close down that spread?

Feels like a no brainer. Yeah, I mean, they are very much so in BTC and ETH, like on the futures and CME, where they can get access to, they are hopping on and doing it. I mean, there still exists like, so much, it just becomes a capital game. The basis trade overall is how much capital do you have and how much can you put into it and how much demand is there to push it the other way? So it's like if you can evenly match the capital in a perfect world, your basis or whatever, your carry rate is going to be the risk free rate.

Nick Troleski

But it's, if you look at the gold market, for instance, it's pretty evident there, like every single future is perfectly lined up with the risk free rate because every single bank in the world can go out there and trade this thing, and they have infinite capital to match all the buyers and sellers and crypto. Now with the ETF's, it's been the big unlock for hedge funds that previously couldn't even touch coin. Now they can just buy any one of the ETF's and sell the CME listed future. And that will capture the basis. It's not perfect.

I think it's like, last I checked, it's like twelve or 10%. So it's not quite down to five and a half where it could potentially go. But it's also like a capital game. If they run out of. If you are posting dollars on CME, if it keeps going up, you have to post more and more dollars.

So you have to have more capital and kind of work that into the basis trade with the ideal basis trade, which is what Athena captures, is where you post coin collateral. So you don't have to add additional collateral. You can just post Ethereum to sell Ethereum futures. So those kind of collateral. That kind of collateral is like, obviously, yeah.

Those will actually trade even closer to. In line to fed funds. Yeah. And I think it's just, it's a capital thing, and there's just not enough people with enough capital, and there's too much demand for leverage on the other side, which is why it hasn't compressed down to that level. But if banks could participate in coin margin futures, those things would be flat.

Right now, it's just a few funds and the funds thing to have. It's like, do you want to earn 20% yield on that, or do you want to go airdrop farm and earn 70% yield or whatever? So, yeah, it's an opportunity cost. So if it's just a supply and demand or, like, supply of capital problem, like, what happens when more capital comes online, either directly from Athena itself or just from other, like, hedge funds that are looking to close down that spread? Like, yeah, I guess I sort of asking, like, are you bullish or bearish on Athena here?

Mike Ippolito

What does that mean ultimately, for the future of that product? Yeah, I mean. I mean, ideally, that's, you know, that's what they want. I mean, they'll have more TVL and it'll help them grow and be able to issue more and more stables. So I think that's the fact that they launched into an environment where there's a very high basis trade is probably pretty good timing because it draws more people to create TVL and loop this thing and grow the protocol in general.

Nick Troleski

Yeah. Athena is an interesting idea, obviously. I'm sure you could go and find the fud on Twitter about running such a very large, you know, trade, running such a very large basis trade. There's definitely risks with basis trades. You can look up how many times have basis trades blown up in very liquid securities like treasuries?

It's. It's a lot like, there's a lot of funds, very sophisticated funds, that blow up on the basis trade all the time for funding, whatever. How does that happen in, like, treasuries? Like, how does that scenario happen that a big fund blows up? Yeah, I mean, it's like some kind of demand goes, some kind of.

Either supplier demand comes through that pushes the basis trade outside of their risk limits. And then the people that run it are so levered because it seems so safe. So they just like, borrow more and more and more capital and leverage it up so much just to capture that yield. Then something happens, some kind of big shock, like COVID blew out the basis trade on a lot of people because, you know, the bid or the offer disappears, and then all of a sudden you're mark to market with an exchange, and then you have spot on the other side if you're mark to market with the exchange leg. So in this case, on Athena, it's going to be short futures.

If that goes through the floor or goes against you, then you could potentially get into trouble there, because then you have basically realized p and l on one side, and then you have unrealized p and l on your spot on the other side. So that's like, you know, that's a part that can always kind of impact you. And then on top of that, when people run very large, like trades like that, people generally know about it because it either shows up in an open interest or whatever, and then that, you know, that becomes like a target for people to like, oh, well, they'll have to get out of it x, y and z here. And I mean, on top of that, like, you know, I guess you're always going to have, with somebody that, like, runs most of it's a trade on, on offshore crypto exchange, you're going to have counterparty risk as well. So people were freaking out about counterparty risk of USDC just a year ago, and it was being held in a us bank.

Half of Athena is being held on offshore exchanges, basically. So there's always counterparty risk there as well. Those are the risks of it. You can weigh them however you want. I don't know, it's hard to say how it will play out in the future, but everyone's always talking about how we need an algorithmic stablecoin.

We'll see how it works out. Don't really have a straight opinion on which way it's going to go. That's tough, man. I've seen today people, everyone always wants a decentralized algorithmic coin, and it's just this is the challenge that Maker ran into all those years ago when it decided to go down the RWA strategy. It's really just like, what is the demand to borrow here?

Mike Ippolito

So maybe at some point Athena runs into something similar. But Nick, this has been great, man. You've been super generous with your time. I guess like, any closing words for the listeners or if folks want to find out more about you, follow you on Twitter, whatever. What's the best way to do that?

Nick Troleski

Yeah, for sure. I guess closing thoughts is that I think this crypto options market is going to continue to grow. I think it will get to the point of the stature, of size, of how developed cryptocurrency or options markets are in general. I think retail will be there. I think people will be trading zero GTE options just like they did on GameStop and all this other stuff in no time as.

Just as the UX liquidity and access kind of grows a bit. And I would say that for institutions, it's a pretty great time to get involved because you're always going to make it in crypto if you're here. But if you don't, you know, be careful and manage your risks, that's sometimes how people get wiped out. And I think options are just a great way to do that. And, you know, doing it OTC or on exchanges with, you know, good market makers is generally the way.

The right way to do it. Awesome. Well, Nick, thanks for coming on, dude. We'll have to do it again soon. Yeah, thanks a lot.

Mike Ippolito

Yeah, thanks a lot.

Nick Troleski

Yeah, thanks a lot.

Inside the Crypto Options and Derivatives Boom | Nick Trileski

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1: Introduction to Crypto Options and Derivatives

2: Historical Perspective and Market Evolution

3: Detailed Analysis of Futures, Options, and Perpetuals

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