The crypto options space, primarily on the retail side, has had stints of exponential momentum starting from July 2021 until June 2022, followed by a decimation in vault TVL and absolute returns during periods of pronounced realized volatility. The retail consensus from options and structured products vaults, which have employed systematic short volatility strategies is far from good.
Source:defillama.com/protocols/Options
Options and structured products are naturally complex and require at least quasi-active management. While the demand for convexity increases, and 0DTE options rise again in the retail consciousness, institutional providers have been quietly advancing the required infrastructure for the non-retail investor base to get involved. These types of structured products give investors a breadth of crypto payoffs while also solving for degrees of customization.
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The problem
The issue, here and in the development of many other crypto instruments, has always been market microstructure. Crypto began as a grassroots ideological experiment with buy-in from a very niche group of people who wanted to exchange an asset that had no certainty around it. As a result, the market microstructure that was designed to service it was self-serving, unguided, and naturally unregulated. Some of the infrastructural issues that exist today in crypto such as fragmented liquidity, no consensus around centralized pricing mechanisms, and supply/demand disparities from one trading platform to another are legacy challenges that are just now becoming more addressable as crypto begins to transition from a fully retail market.
Where we are
While there has been a big focus around on-chain structured products, an equally exciting opportunity lies in delivering crypto payoffs to traditional investors. As crypto becomes increasingly relevant in portfolio allocation, we will begin witnessing a strategic allocation capture that is far more material than we have seen in the past. This is made possible by the breadth and quality of institutional grade products and delivery pipes that have been developed including ETFs, ETP, and other non-listed notes.
There is already back tested data that supports the view that adding BTC to a balanced portfolio leads to improvements in both gross terms and as measured by both Sharpe and Sortino Ratios. View the below table from Coinshares:
Further crypto-based products can contribute positively to a balanced portfolio as well. At ARP Digital, our role as a structured product provider is to optimize a broader portfolio with volatility products across the suitable crypto universe.
Volatility Products
Crypto volatility is a dynamic, rapidly changing space influenced by the polarization of market participants, access to outsized leverage, and market microstructure. The lack of historical adoption has been the result of a reflexive cycle of crypto dealers not having enough demand to prioritize it with their own distribution and bank dealers not having regulatory clarity, or incentives to advance it. As such the historical volatility profile, shown below in a graph by Amberdata, is a very telling depiction of the outcomes of the lack of institutional infrastructure and participation.
Since traditional delivery pipes for crypto structured products rely on integrations between crypto participants and traditional intermediaries, there have been hurdles that have resulted in important compromises, from capital efficiency to collateral management, which have further deterred investor demand.
Conclusion
As spot bitcoin ETFs continue to be a massive success, and the broader consciousness recognizes the value of the asset class from an investable and psychological level, the demand for product development will follow. Modeling the trajectory of other asset classes, the crypto structured product sector will have exponential growth.
At ARP Digital, we are confident that there will always be a demand for yield-bearing and volatility products. In crypto, the first generation of yield products involved unsecured lending to various market participants to deliver yield, sometimes unknowingly.
Following the destabilizing events of 2022, investors are beginning to think deeper about the sources of yield and how to quantify the risk they take for it; there is no such thing as “a free lunch.” Structured products offer yields that are deterministic and mathematically verifiable based on market outcomes, which fortunately lead to more peaceful nights.
Edited by Benjamin Schiller.