Overview of Crypto Options Exchanges – Part 1

The difference between a highly liquid, mature market which offers a consistent, predictable trading experience…and an illiquid, immature market which offers an unpredictable trading experience…is typically delineated based on the availability of OPTIONS to trade in that market. You see, larger players and institutional investors simply refuse to trade financial markets in which they cannot hedge their holdings through options. 

Crypto has come a long way in the five years that we’ve been following the derivatives market for this asset, however it still has a long way to go. 

This week, I’ll dive a little deeper into the different vehicles in which retail investors the world over can trade options on crypto assets, which are generally limited to Bitcoin at this time, with few exceptions. 

Exchange vs. Broker

One area that differs greatly between the trading of crypto assets vs. other “traditional finance” assets like stocks or equity options is the use of “exchanges” vs. “brokers.” An Exchange is typically where transactions are conducted between counterparties, and in traditional markets only the “professional” has direct access to an exchange through the leasing of an expensive “seat” on the exchange. 

A broker, on the other hand, is the direct interface between the retail investor and an exchange. 

In the traditional world, an “exchange” might be the Chicago Board Options Exchange (CBOE), and a “broker” might be E*Trade or TDAmeritrade, the latter being household names. 

Crypto does all of this differently, however. 

Crypto Exchanges

Crypto uses “exchanges” which really perform double-duty as the broker as well. For example, Coinbase doubles as a retail broker, and it’s an exchange as well. Deribit acts as an options exchange as well as a broker. LedgerX (now part of FTX.us) also acts as an exchange and online broker. There are a handful of crypto exchanges that offer options on crypto in various forms, such as Bybit, Binance, OKX, FTX US, Delta, Quedex, Bit.com, and Hxro Trade. 

Arbitrage Opportunities

One of the ways that Sam Bankman-Fried made his wealth was by arbitraging the differences in prices between these various exchanges, which can be thought of as financial “islands.” If exchange “A” is selling an instrument for 1.00 and exchange “B” is listing it for 1.10, then you would want to buy all that you can of the inventory of exchange A and sell it on exchange B, until you started to raise the price of the asset on exchange A, while depressing the price on exchange B. Arbitrage opportunities typically abound in immature markets that have wide disparities between similar assets on different exchanges. Conversely, arbitrage opportunities are extremely difficult on liquid, heavily-traded assets. An example of this is the HFT, or “high Frequency Trading” used on the most active US stock exchanges, that are splitting the difference of assets in fractions of a penny. There’s no space for retail to compete in this game in traditional financial markets due to their maturity and razor-thin pricing, however some opportunities still exist in crypto arbitrage. . 

US vs. Non-US Exchanges

As of this writing, the US is still on a financial island as most offshore exchanges don’t want to deal with litigation from the punitive US-based SEC. Retail customers must select between US-based brokers/exchanges, vs. Non-US brokers/exchanges. In some cases, Non-US exchanges will look the other way by blocking customers based on their identification of IP address, which can be side-stepped by the use of a VPN that terminates into an “approved” country. Other exchanges will use KYC (know your customer) which requires heavy authentication of the user in order to prove that they are who they say they are, and are not located in a non-served country. Deribit is an example of the latter exchange. 

We’ll do a deep dive on different options exchanges available to global retail customers this week.