2018 November 19 - Volume.2 Issue.45

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2018 November 19 - Volume.2 Issue.45

Goto Full Issue

Op-Ed: Do We Need Stablecoins After all? An Options Market Perspective

Emmanuel Goh and Tim NoatSkew

Stable coins are in focus this year in response to last year’s frenzy in crypto markets where daily swings versus the US Dollar of 10%+ were fairly common. The fate of bitcoin as a global currency was then quickly decided: it is too volatile to meet the three requirements that define a currency - store of value, medium of payment & unit of account. In a short period of time, $300m of funding went into over 50 stable coin projects globally to solve the problem.


When discussing stability, it is important to first agree on what it means to be stable. If bitcoin is the reference currency - many of its supporters already see it that way - then it is stable by construction. People in general imply stability versus the US Dollar which we will discuss here.

Despite record calm experienced recently - with bitcoin moving on average less than S&P500 in October - it is likely the cryptocurrency will remain reasonably volatile over the short term as this nascent asset hasn’t reached its critical mass yet. Over the long run, some structural forces could however modify the picture and allow bitcoin to “self-stabilize”.

If one asset can give us a flavor of what bitcoin could look like in ten years, it’s probably gold. Bitcoin is often described as the “digital” version of the shiny metal: the two assets in particular share similarities in the way they are being issued with inelastic and exogeneous supply functions. The yearly inflation rate of bitcoin, irrespective of what its price does, is at 4% currently compared to gold at 2%. This is one of the technical reason why stable coins got traction in the first place: if the supply function is determined in advance then it cannot adjust to demand shocks which force adjustments to be made only through price and hence it can’t be stable.

Statistics on gold volatility since 1991

wdt_ID Years Average absolute daily price change No of > 2.5% days (%) Average absolute monthly price change
1 1991 - 1995 0.42% 0.56% 2.10%
2 1996 - 2000 0.52% 1.11% 2.66%
3 2001 - 2005 0.70% 1.83% 3.32%
4 2006 - 2010 1.00% 7.38% 4.68%
5 2011 - 2015 0.76% 3.33% 4.24%
6 2016 - 2017 0.60% 0.99% 3.30%

Gold should logically also experience the same problem. With a daily average volatility of 0.67% since 1991, it is however one of the most stable asset globally and is widely perceived as the ultimate store of value. One of bitcoin’s value proposition is to compete in this particular use case and our best guess is that it will - should it succeed - be ultimately highly stable. Part of this evolution will come as a consequence of a shift in the public’s perception as people understand better what bitcoin has to offer and gradually start seeing the asset as a safe haven. However, the process could potentially take decades and bitcoin should probably show some stability first as a prerequisite. Derivatives products might contribute speeding up the journey.


If 2017 was the year of ICOs & altcoins - personified by the rise of Binance -  2018 is most likely going to be remembered as the year in which futures took over. Bitmex and Bitflyer’s bitcoin perpetual swaps are trading over $1bn on most days when physical exchanges have had a much harder time maintaining volumes. Is it purely a coincidence if volatility has structurally decreased over the year while this trend gathered pace?

Bitcoin futures markets have experienced rapid growth this year and are at this stage fairly well developed relative to the underlying market. The four main bitcoin perpetual swaps combined - Bitflyer, Bitmex, Deribit and Crypto Facilities - traded on average $2.2bn a day over the last month which represents a volume similar to physical fiat to bitcoin transactions. CME bitcoin futures also exhibited gradual growth in volumes this year.

Bitcoin options on the opposite trade on average $5m notional a day. In comparison, options on S&P500 trade on average $390bn notional a day. Amazon - one of the most popular stock globally - trades on most days a similar volume of options and stocks - around $10bn each.

Traditional derivatives markets rose in Chicago in the 19th century to answer the hedging needs of American grain farmers. Successful derivatives products - futures, options or more sophisticated ones - share in common that they answer a demand for hedging and risk management (see The Futures by Emily Lambert).

This is partly the reason why futures grew so popular this year - after such a great crypto run, demand for hedging liquidity and neutralizing exposure grew increasingly strong.


Futures remain fairly generic instruments with linear exposure to the underlying asset - what is commonly called a “delta one” derivative. For example, if a company produces oil or mine bitcoins, it is not possible to specifically hedge its breakeven cost by simply selling a future contract: it would also force it to renounce to the financial upside. In that case, the relevant instrument would be a put option. The next natural step for crypto markets would be to embrace options so that much better tailor-made hedging solutions can be delivered to industry stakeholders. This would in return allow them to scale their businesses in a meaningful way and benefit the crypto economy overall.

If everyone is properly hedged, then there is less chance of a panic firesale such as the one we had on ether during the ICO complex capitulation in August and September. When looking at the cryptocurrency economy, there is a need for hedging in a number of areas:

• Cryptocurrency “producers” - miners, exchanges, ICO projects - are behind $25bn of natural selling flows this year which could be much better handled;

• Cryptocurrency “consumers” - merchants & customers - are struggling to embrace the product because prices and fees are too unpredictable. If Amazon or another global merchant is to one day accept bitcoin as a payment currency on its platform - an idea which has great merits! - it will need a panel of hedging solutions at its disposal;

• Cryptocurrency exchanges are long volatility and could benefit from a vol selling program. This is quite striking when comparing daily volatility and volumes. In traditional markets, it is quite common to see an asset not moving and large trades being crossed. This is not a behaviour we have seen so far in cryptos as execution methodologies are primarily coming from the FX world and are mostly done “at market” which has the consequence of moving the price in the absence of enough market depth. Another reason is that the market is primarily traded by retail customers which use less sophisticated trading execution methods than institutions.

On the investor side, the natural flows will most likely come from long term holders -  in a similar fashion to what we see in gold markets. A meaningful part of bitcoin investors - the “hodlers” - believe in the store of value narrative and are holding bitcoins for the very long term. Those investors don’t have access to “saving” or “yield enhancement” products to optimize their holdings. Using options is one possibility that could make the “1 BTC today = 1 BTC in one year” mantra potentially evolve to “1 BTC today = 1.1 BTC in one year”.


A common attribute of those options flows is that they would materialize by large amounts of call selling - providing large quantities of volatility to the market as option market makers start “delta hedging” their positions. This would likely tame the volatility of bitcoin over time - at least on the upside. This phenomenon called “pinning” is relatively well known in traditional markets. It is not uncommon to see historically very volatile stocks experience a structural drop in realized volatility as a set of structured derivatives products are being released.

The options market experienced rapid growth in traditional markets after 1973 when Black and Scholes found a straightforward formula to price them - a discovery which earned them the Nobel prize in economics in 1997. Also, commodity futures have happened to soar since 1973 as the oil crisis introduced instability in a previously quiet market. As a result, extensive academic literature studying the impact of derivatives on the price of their underlying’s was published in the 80s and 90s. Figure 2 quite convincingly points in the direction of lower volatility post options listing.

To conclude, it has to be noted that overly complex credit derivatives played an important role during the financial crisis of 2008. To learn from the mistakes of the past, it will be key for market participants to work with regulators towards finding the right level of financial innovation so that the crypto economy can benefit without introducing systemic risks.

Skew, founded by former JPMorgan flow equity derivatives trader Emmanuel Goh and former Citi/UBS flow and exotic equity derivatives trader Tim Noat have setup shop in London to trade Bitcoin and Ether options. Visit their website, or twitter.

Effect of stock options listing on volatility and beta
Literature Review – The impact of Derivatives on Cash Markets: What have we learned? - Mayhew, 2000)

wdt_ID Author Sample Period Market Volatility Beta
1 Nathan Associates (1974) 16 1973 USA
2 CBOE (1975) 40 1974-75 USA
3 Trennepohl and Dukes (1979) 32 1973 USA
4 Klemkosky and Maness (1980) 103 1973-75 USA ? ?
5 Whiteside, Dukes and Dunne (1981) 35 1973-75 USA ?
6 Whiteside, Dukes and Dunne (1983) 71 1973-81 USA ?
7 Nabar and Park (1988) 390 1973-86 USA
8 Bansal, Pruitt and Wei (1989) 175 1976-86 USA ?
9 Conrad (1989) 96 1974-80 USA ?
10 Skinner (1989) 293 1973-86 USA ?

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