Crypto's Biggest Trading Market Is Still Missing

Transcript

Banks Nation. I am here with Nick Forester. He's the co-founder and CEO of Derive. Derive is the largest onchain options exchange on Ethereum. Nick, welcome to the show. >> Hey, David. Thanks for having me on. >> Nick, I want to kind of get to just some very basic questions about crypto and options. mainly options really haven't come online in the crypto sense in ways that the perpetual has or in ways that if we extrapolated to from how much Tradfi loves options they don't the options in crypto don't really meet that level of popularity in the in the crypto industry and I I want to know why like why haven't options grown as large in crypto as we would have otherwise

expected. >> Yeah, it's a great question. I think to some extent it's the natural evolution of all financial markets. Options are always the last vertical to mature. You kind of need to anchor the market like some of these bigger slower moving institutional players um really trying to earn yield on their assets whether it's equities in the equity market um or in crypto like on Bitcoin and ETH or you need structural hedgers. So things like um you know airlines hed hedging their jet fuel costs or um you know farmers hedging the the sort of price of their crop before harvest like those are the big repeat flows just take a while to emerge in a new industry a new asset class and for options you know in crypto

speculation is dominated and options are good for speculation but to really serve that use case they need those guys in you know in the market selling options creating a competitive two-way marketplace first and it's just taken a long time for that to happen, but now it really is starting to accelerate. And what options do really well, and it's a criticism people give them often, is like there are just so many of them. There's so many choices and different strikes and expireies. And it's like kind of the point. It's the same reason prediction markets are beginning to take off. They give you this level of control and granularity and ability to express lots of different opinions about the market. And when typically you can do that in a more precise and defined way, you can make more money on your trading opinion when you're correct. So, um, I

expect options to continue. They've started to really grow as a market share in crypto. I expect that to really, um, you know, kick on over the next couple of years. >> So, your answer is that really there needs to be a pretty rich diversity of market participants in order for the options markets to grow. And maybe that stands in contrast to the perpetual as an instrument where really you just need two market participants. You need people to LP. You need people to lend to the people going long or short. And then you need people going long or short. And the simplicity is maybe what allowed the perpetual to grow so fast. Options on the other hand has a a wider variety of a need of different participants doing different things to create the double

coincidence of wants and a lot of them in order for the options market to really uh manifest. Is that is that correct? >> Yeah, that's uh that's really really well said. Um, and I think to date in crypto, again, if you think about the assets that have been popular or available in the market, you know, we've got this new recent wave of tokenized equities and commodities that's bringing like big useful assets on chain, but to date, we've had Bitcoin, Ethereum, maybe a couple other coins, but a lot of the coins that have done per trading, those, you know, meme coins or whatever it is, they last for two or three weeks uh before people move on to the next thing.

And there's just not enough time for that market and that coincidence and ones to develop. Um but now as I said you've got this you know more and more high quality crypto tokens that are emerging um with longer term more sophisticated holder bases like hype is kind of the most recent one that's had a breakout options market over the last year for that reason. Um and then also you have you know all of these quality assets RWAS equities commodities being issued and available and tokenized on chain. Um and I think those two trends um are really really good for uh the emergence of options markets and those coincidences of wands um across the board.

>> Okay. So your your primary answer your first answer as to why options haven't come on chain yet is just a market structure one. The market structure for options is complex. It needs to be rich. It needs to be liquid. It takes time for these pieces to come together. What about technical constraints? Uh technically speaking, what has inhibited options from coming on chain up to this point? >> Couple things. So one, we've been doing this for five years now. We started with like an AMM architecture back in 2021 um on an L2. Um we've been kind of at the forefront, I think, of scaling and and sort of blockchain technology since that time. Um now we've kind of come to this model which we think is the right structure which involves um you know

like an off-chain order book and integrated RFQ um for price matching and price discovery and all of these different instruments and low latency and written in Rust and very high performance but the onchain components the critical pieces um self-custodial portfolio margin clearing and settlement is all happening in smart contracts and now the systems are good enough uh to support all of that at like the level of like the institutional level that is kind of expected by a lot of traders and we're now competing with um you know centralized exchanges just on merit alone and the tech is finally good enough uh on that front and I think on the other front it just takes time to like really build out all of the stack it's like a very difficult problem to solve um to build liquidity and I I do think I guess one final reason for why

options haven't been that successful is again like the most liquid venue in in the market for a long time was Dervit and they've done a great job they did a great job of building a great business but like never really managed to you know switch up their user interface or really go after like a broader audience other than like the big institutional OTC desk and I think we're now on the cusp of you know we are kind of liquid enough for the very first time to start making a push at um you know a more broader audience for options too >> is there an appetite conversation as well uh I know we talked about like that we need more market participants who are interested in options to come online obviously but uh has just the appetite, the typical investor base in the crypto market, the crypto industry, just have

they just not been interested in options or is it really just a lack of a venue that has prevented them from having options? What can you say about the appetite of the typical crypto market participant up to like, you know, this year for example? >> There was a step change on October 10 last year, the the 1010 crash. Um, so we had like very little interest across the board up until 1010. I think what 1010 did was showcase a couple of things. One was that like it obviously the obvious point is that per uh are very path dependent and you can do everything right and be delta neutral and manage your risk and yet still get blown out on on like a scam wick to the downside. And a lot of people lost a lot of money doing that. Options, you know, you lose in other ways in options. You put a bet

on, you buy an option, you you have to get the timing right. Otherwise, if you don't, you're going to lose your whole premium. But at least you've kind of locked into that bet. Whereas with PEPS, you can be very right on everything and still have like a a bad print on a where it can get liquidated if you're using leverage and and people found that out on 1010 and started looking for other forms of leverage. And that's when they started to think on the speculation side of things, okay, we're going to look to maybe trade options um and use them for that. I think on the other side, there's this whole like really you use options for three things. Speculation is clearly one of them. Um hedging is one of them because you can sort of buy insurance and buy downside and then yield generation. You can sell options on your

asset and ring yield out of any asset, not just USDC but stocks and whatever by selling the volatility and expressing that view. Um I think the the other thing that happened on 1010 was it was the death nail for two big sources of yield in crypto. The first was um the basis trade like it was already on the decline and this like truly killed it where the leverage in the industry got wiped and those rates got reset and there were a lot of like hedge funds, family offices, liquid funds that had built their entire like four-year trajectory and like track record on earning, you know, 10 to 15% delta neutral and that went up in in flames on 1010. And the second was it crushed a ton of token valuations across the space. And there were a lot of teams kind of playing this game where you

would sell tokens pre-TGE um and get TVL um into your protocol and make it look like you had traction and you could sort of promise investors some sort of a yield um in your own native token on that and hedge it out with OTC markets or some of the Pendle premarket point stuff. Not that Pendle had anything to do with it. It was just like a function of people were using that as the venue to clear. Um and so that got wiped out too because all the valuations got crushed. So at that point you have this like you know kind of really nice um beginning of like an inflection point for options where the speculators started looking into it and also on the yield generation side it was kind of the only place you could earn yield um in crypto and it kind of has been

sustainably really for the last year at institutional scale. Uh and those trends have been uh a tailwind uh and a turning point in the market. >> That's fascinating. I did was not ready for the idea that 1010 was a tailwind for options. Can we go into why that's true? What about the market structure of a perpetual does uh an option buffer against like what are its what what are an option strength against a perpetual and why was 10 10 so illustrative about the strength of an option and the risk of a perpetual? Yeah, I'll give you an example. And like pers are great. Like you can use them for lots of things.

They're just not the solution to everything. And I think that's been a lot of people's um opinion in crypto to date is that you have pers. Why do I need anything else? I'll give you an example from a trade that went up on derived yesterday. Um and it was a user buying the Ethereum March 2027 expiring. So we got about 6 months from time of recording. It was the they were buying the 5,000 calls and selling the 7,000 calls. So that's a 5,000 7,000 call spread expiring March. he has put down $300,000 worth of premiums. If ETH goes to 7K by March, that call spread will pay out about $20 million. Um, which is about like, you know, you could look at it as like a 66x payout on the original, you know, 300 grand in capital um with

ETH at like 2500. Now, if you were to try and like get 66x leverage on a per, let's use $1,000 as the example because it's easier to work with than 300,000, but it's the same thing scaled up. You do like $1,000 at 66x leverage. Um, at 10% funding, you get a $66,000 position on ETH. If there's a negative 1.5% draw down from the current spot, which we might have just seen in the last 10 minutes before recording this, you getting instantly liquidated. Um, and that's at 66x leverage, which is like, you know, kind of reckless and big. Um, you also have the the double beat of the funding rate is, you know, typically around 10% for these things. Um, after a year on

$66,000, that's, you know, $6,600 in funding, um, which is six times as much margin as you're putting down. You just can't express that view in any way, shape, or form using the perbs. Um, and so like we're starting to find users beginning to express those like leverage speculative bets um, using options versus per. And I think the other thing to note is um, on 1010, right? Like people weren't doing 66x leverage, they were doing, you know, 1.5x leverage um, or 1.25x leverage. And you can get those big dislocations on a given exchange um, where it's like a one-touch on the liquidation. It's not some T-W. It's you can you know you're path dependent and if the exchange infrastructure the

liquidity is shaky you can get ADL even if you have maybe you have a long on one alt and a short on another or long Bitcoin shorty you have you know correlation hedge doesn't matter you're getting wiped out nonetheless and I think that's what a lot of people found out so obviously the example I gave was extreme you can't really replicate that payoff with per that scales into you know the shorter dated lower leverage stuff too >> would you say that it's accurate that a perpetual as an instrument strument is better for longer tail assets on shorter term time frames and options are better for fatter tail assets on longer term time frames. And like what I'm really getting out of that story is that you know going leverage long on a perpetual

exposes you to a number of risks beyond just the price of the asset. you know, platform risk, contagion risk, uh uh you said um path dependency risk where with an option I can have an extreme option, something very very high out on the risk, but I won't be liquidated on my way there. I will only be liquidated at the date of expiry, which is by design. And that's not true with a perpetual. A perpetual, you could be >> directionally correct, but still get liquidated on the way there. And so just bluntly, perpetuals are better for longer tail assets in shorter term time frames and options are better for fatter tail

assets on longer term time frames. Would you say that that's a fair summary? >> Yeah, I mean I would even argue that you can still speculate better on the short term with options too. Uh again, they're more precise. They're still less path dependent. You can get a lot more leverage out of them. people don't quite realize that they are a little more complicated and my I'm I'm not out here advocating people do that like you need to have an opinion and I think you should just consult and see whether like what what is the best way to express it and the trade-off to be very explicit around options is you have to be right within the time frame um the bull case for per example is if the price of Ethereum never moves for six months you get your money back in the per case

minus the funding um >> whereas in options case you're you're losing it if it doesn't go beyond on 5K. You go to 4,500 E and you still would expire at zero. So, you know, there are like trade-offs here, but it's about like the bet that you make and and kind of making sure that you know that you're expressing in the best way possible. >> So, options and per are just so frequently placed headtohead with each other. Like per bulls will tell you that like options are obsolete. You know, PERBs are the cool new thing just like options are for boomers, they're for tradi like we found this cool new thing called the per and it's going to replace everything. And like directionally, both of these instruments allow you to take a small amount of capital and get an

outsized amount of return if if you are correct. And so directionally the the form factor is like congruous. Uh is it fair to say options verse hers? Is it really verse? Like how much verse is it versus it just being just these are two different instruments that actually don't conflict with each other. Do you have an opinion on this? >> That's the thing. They're completely complimentary. Um and we support options in PEPS like cross like portfolio margined and cross margin on derive like you need them both in different spots. Um and per are great as I said great instruments. You're not going to hear me arguing against pers at any point in time but you need options also. Um because I would say per yeah like more of a blunt instrument. They're simple to

use. You have a leverage slider. They're good for price discovery and shortdated speculation. Options are much more like a Swiss Army knife. Um the reason we started derive in the first place was because um you can create any payoff structure imaginable for hedging um yield generation or speculation out of a different combination of calls and puts. And so you put them into a programmable environment for capital and you you've kind of got like it's like the perfect form factor for uh you know like the onchain economy in my opinion because they're so malleable and flexible um and programmable and that was the thesis we started with 5 years ago. It's the thesis we still believe today. I do think that's something per can't replicate and I think they go hand in hand. per for like quick price

discovery, pre-market stuff, excellent for speculation, options for, you know, like the almost everything else, structured products, yield generation, um fine-tuned hedging and speculation. Um and I think the whole thing really comes together and the vision for what we've been trying to build is the infinite payoff factory. You can really build any trade um on any asset 247 um in a programmable way. And uh that's what we've been setting up for this whole time and finally starting getting close to to realizing that vision I think. >> How do you like this comparison in crypto? The AMM really beat out the order book on chain as like the f in the first and maybe even to this day the iteration of just like liquidity and dexes like the AMM really found

resonance with like the nature of a blockchain. It was really good for longtail liquidity. It was really good for centralizing liquidity in one single place. Whereas like the onchain order book, it's just there's more moving parts. It's harder to bootstrap liquidity. You need more sophisticated actors to do market making. Uh but me as like a a retail less sophisticated, you know, trader, I'm not doing order book management. I'm buying and selling into the liquidity. And that kind of seems to be like an order book seems to be more like an options platform. whereas the perpetual seems to be more like the AMM where it's so much more passive and simple and accessible and maybe that's why it just kind of got bootstrapped in

the crypto context first. How how do you uh how do you like this comparison where like order books are more like options and AMMs are more like perpetuals? >> I don't hate that at first pass actually. I kind of like it. I would say it's definitely true that um you know pers are one it's great to unify liquidity. It's one instrument per asset. Um it is certainly easier to market make and that's why it's easier to spin up like new per devices in theory and get liquid. Um and they they both have their roles to play. I do think if I had to sort of draw the distinction, I do think AMMs as someone who was building early AMM technology and um you know we did we did okay with

it. It they do have a fundamental limit on like how good they can get in terms of um you know competitiveness in the market in the long run and I do think that differs from per just going to be really really big. I am very bullish on perves in the long run and I don't think um it's it's it's going to be a you know it's going as I said it's going to be both whereas I think I don't really know the latest on the AMMs but my my gut feeling is with the unis swap v4 they do kind of function behind the scenes um in terms of like how participants engage with them like how they would similar to an order book it has to be really actively managed if you want to make money over the long run um having said that unis swap again for the longest of

tail assets where no market makers are going to touch at the beginning. It's still great for spinning up, you know, new pools, new assets, new liquidity, which I love. >> I've been trading crypto for almost a decade and I've used so many different wallets exchanges aggregators different frontends over the years, and I'm always kind of looking for the same thing, just one interface with deep liquidity across a bunch of chains and assets where I can access all the markets like per earn yield, trade confidentially, and still control all my own funds. And I've never really found this experience. And I'm always switching wallets, juggling gas fees, and just getting eaten by slippage.

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I've been following him for years. And this year, we started recording weekly podcast episodes. Each one we get into his portfolio, what he's holding, the market structure, entry targets, fair market value of Bitcoin and Ether, and where we are in the cycle. There's new episodes that are released every Wednesday. They're 30 minutes, they're short, they're punchy. I think this crypto cycle is harder to navigate than most. So, let's do it together. Go subscribe to this podcast. Search the DeFi Report wherever you get your podcast. YouTube, Apple, Spotify, or find a link in the show notes. There's a new episode waiting for you. Now, this was this was a super educational section. It's for me. I really really enjoyed this. I want to move on to just the sector, the options sector in crypto. Can you just paint some numbers as to how big options are in crypto? And

then is it possible also just to talk about how big options are generally speaking so we can kind of like anchor the size of the crypto industry options market versus what we hope it to be vers if we were to extrapolate like tradies options market. Yeah, I think um relative to pers were uh in terms of the crypto market and my stats could be like slightly off on this, but I think order of magnitude it's probably correct. We're like 3% or 4% of the per market and in Tradfi they're about the same if not options being slightly bigger. Um so that's like you know 30 or 40x to go to to sort of equalize to where we are in Tradfi. I mean the absolute numbers are are staggering um in terms of like the

amount that options desks are making on the market maker side, how much volume is going through them. There really was an inflection point. Um I was on a desk um at Saskuana in 2019 2020 2021. It's kind of at the beginning of that inflection point around um you know zero commission trading with Robin Hood leading to some early meme- like activity on cannabis stocks through to the the pandemic and then finally like the GameStop stuff in in in 2020 2021 and that's really when we saw that inflection point and and the numbers just have continued to grow since then.

Um globally it is a enormous market both from a retail perspective as well as like an institutional hedging perspective. A lot of that activity doesn't even show up on the exchange. A lot of that is in OTC bilateral type deals. Um, as well, I think the market split is like, you know, 50/50 even. Um, so like there's double the actual amount of reported volume. In terms of like actual raw stats, like it's it's really hard to come up with. It's in the quadrillions of notional volume. Um, you have deaths from single market makers turning out like, you know, three or four billion dollars of profit in a quarter. um you're hearing like the the sort of Jane Streets of the world now um it's just gargantuan numbers um and it is because of you know this broader

trend in markets where there are so many people with uh you know money and opinions on the markets and you know the sort of finance and the value of the stock market has just gone up so much uh and all of these trading tools are getting democratized um and you know costs to entry are coming down and um you know at some point in the next 10 to 15 years as well you're going to have this big wealth transfer from the boomers over to uh the younger generations and um yeah I think uh trading will continue to just have this this this big tailwind behind it in general >> as we know in crypto the exchange is the first business of crypto the first business after like producing hard assets so like after we you know built

blockchains we built you know bitcoin we built ether we built the monies the next big product in crypto is the exchange and that's the most lucrative business model in crypto Uh and then the perpetual again exchanges love per because of how lucrative pers are. Like you just take a spot exchange. You ratchet it up by 3x, 5x, 10x, and that's the amount of fees that you get. And so super lucrative uh industry here like the exchange is just like such a cash cow. How lucrative are options as a product and like what is that actual like fee structure or take rate look like? Can you kind of paint a picture of the economics of options as a as an exchange?

>> Yeah, as an exchange, I mean, we do have I think the lowest fees of like any liquid market place. Um, in general, it's like a you know, basis point structure like on the notional. Um, I think our our headline rates around three basis points um for takers, lower from makers as well. uh on the notional value it's capped because some options are uh you know very like tail or wingy so they cost a lot of like not very much money to get a lot of notional exposure like the out of the money deep out of the money stuff and those are capped at like a you know percentage of the premiums. Um we're confident we have the lowest fees but the business model in general because they are more specialized because uh it's harder to build liquidity for. There are stronger network effects around options exchanges

um even more so than per because of how slowmoving the anchor you know participants are the big institutional traders who are building the market. It's why Derit had such a you know strangle hold on the market despite wellunded attempts from you know Binance to to sort of muscle in in 2020 and they had more liquid ps. But it doesn't matter. It's about like that options liquidity network effect. Um so yeah, there's a lot of I would say pricing power. At the same time, we are running, you know, derive to try and encourage people to come and build on top of us. Um and the new version that we have out in in a month is going to make it exceptionally easy to do that. We want people to come in and build, you know, retail interfaces on top of us, like structured products using the options,

hedging products using the options. Um and you know the economics for those sort of integrators can be even better because you can sell people you know not just options but you can sell them like a payoff structure like hey you put your bitcoin in our structured product and you earn 10% on your bitcoin uh and it gets converted into cash if bitcoin goes above you know $90,000 that's a covered call. um anything in the English language, they can charge a you know kind of like a commission on on that yield or uh you know they can mark it up how they want if they're a retail facing app too. Um and you know retail uh it's you know for options and what Robin Hood was making on their options as part of their payment for order flow was zero commission but they were making buckets

on on the actual order flow that they were selling to. So a lot of big business has been built around this flow. I think it will only continue. Um, and we want other teams to come in and try and monetize that themselves. >> Talk to me about just like the market structure of options in crypto as it stands. You talked about Darabit kind of owning the golden goose of options and you know this this analogy can apply to like spot exchanges too, right? Binance holds the golden goose. It holds the most liquidity. It can monetize the strongest. Coinbase also very dominant in the US market. What's it look like currently today in the options world?

Derbit I think is still number one in terms of volume. Who are the players? Who's dominant? And then also what's your strategy at derive for penetrating into this market? How do you wrestle the golden goose out of the hands of >> Darabit? Yeah. So Darabit I think are still like 70 75% of the market. They have some wellunded attempts to disrupt them from like the bullishers of the world. uh maybe buy bit as well are growing at OKX doing some market share but they're not making like huge headwinds in and we are now to finally so we went from doing almost nothing like 0.15% like a year year and a half ago um but we managed to like the product finally got good enough we you know improved our liquidity by orders of magnitude and I think the big wedge that

we had um we think we're like the fastest moving most innovative options exchange and so we listed Hyperlquid options um in November last year when Hype was at $20 um or a lot lower than it was um and suddenly you know we were the only venue for hype and hype went on this this huge run um and we started getting interest from you know big takers who were doing dealing with like OTC desk directly um because Darabid hadn't listed hype options um and over time we started to get more and more takers for our hype options and we became the most liquid venue globally for it and started to win market share from the OTC desks um and now derit you know took they only launched it like two two months ago or something and we're still the the dominant majority of hype volume. Um and we've created that

network effect around that market. Um and that's you know kind of the playbook we're going to be running back for every new asset. Um both on the crypto front where you know we have the most alt markets. I think we're biggest on Salana now too. Um we're competitive in Bitcoin and ETH shows now. Um, and then also for RWAs, commodities, anything that becomes popular in crypto which has that sort of like profile I described before with like a sophisticated holder base, a long-term view um, and a big market cap like we're going to list um, and we will be able to out compete and go faster than both Darabit um, but also faster than uh, you know, the OT and provide a better experience than a lot of the OTC desks and the bilateral deals that a lot of the big takers are using currently

because they don't have an option to go anywhere else. What can you do with onchain options that you can't with like trad options? And you know it's it's worthwhile to note that you know Darabit is a crypto options platform but it's it's like centralized. It's traded database with you know centralized infrastructure. That's not what derive is. You guys are onchain. Is there what what advantage or what option what can be unlocked with onchain options that you can't with like a centralized or or trad options platform? Yeah, there's a couple of things. I mean, one is the obvious point that like some people really value and particularly in crypto, but less so over time, which is it is self-custodial. You can verify the state of this the risk engine and the margin

in real time. And that has been a problem for some other exchanges all the way up to regulated traditional ones. Like this is still a problem uh that people don't quite realize because there hasn't been a blow up since 2011, I think. But these, you know, even regulated um commodities exchanges can go under because of like capital mismanagement. And we have all of our you know the state and of the system is verifiable um and transparent um and it's you know the the credit risk is is kind of you can view it entirely by how and all the rules are written in smart contracts um with you know the margin and the the liquidations and the settlement. I think like that is a a major win for some people and particularly relative to some of these OTC desks that we're in competition with for some of the big chunky order flow

via our RFQ. um when you're doing a deal with an OTC desk, you're kind of taking credit or like underwriting that desk solveny. And you know, crypto has a long history of those desks blowing up uh at exactly the time you need them to function. Um with respect to like just raw like user experience stuff, I think the thing that we get out of the box and particularly with the new version in V3, um you can integrate and build a product on top of derive an hour of work. um even structured product or vaults like quantitative investment strategies like vaults asset management vaults with like you know really like transparent execution clear track records you're going to be able to spin up and deploy

those with three clicks on derive um like copy trading vaults um things that are just not possible to do uh in a transparent or verifiable way anywhere else um but also like just the ease of integration you don't have to deal with like five different service providers and on-ramps and off-ramps like if It's just tokenized. We can interact with it, list it as collateral um and uh you know start to build structured products um you know other people can start to build structured products or user interfaces and they know that they can do that on top of us because we are you know they can see the open source code. they can see um how the exchange is built and and the collateral in the system and the solvency and they don't have to you know hack through five or six different service providers onboarding offramps on

ramps and just to be rugged by like a terms of use update from derbit um or another you know third party provider we found people who were building those sorts of products on us um who couldn't do it on a centralized venue uh and I think that that advantage is only going to sort of continue as more high quality assets come online and are tokenized um we can on board interact with them very very quickly. >> Technically speaking, how is derive actually built? So like if we pop the hood open >> and we look into the engine the engine compartment of of derive, what what do we actually see? What are the components that go into building derive?

>> At at a high level, as I said before, we have like an order book and an RFQ um product, both of them live written in Rust offchain. Um and then once a price gets matched between parties, so someone wants to buy some options or some burps or whatever it is, it gets sent through to the protocol um for margin clearing and settlement. So all of the rules for margin, we have both portfolio margin which looks at your entire like all of the assets that you have in your account. So uh maybe some Bitcoin spot, some USDC, uh like a few calls, and maybe like a short per position. You look at all of that and it runs it through 27 different risk scenarios like what happens if spot goes up 20% and volatility goes up to 100% like what is

the maximum loss of this portfolio. Um and it takes the worst case scenario and that is your margin out of those those margin you know like that's what you have to post. So that's really really capital efficient. It's very common in the industry but not so common in terms of onchain protocols. Um and so that's the portfolio margin. Then we have standard like isolated margin which a lot of us users and traders are familiar with where it's just like you know one position you have your margin it's like what most per exchanges use um and so you have to make sure you're above your init you know you post initial margin you have to stay above your maintenance um and the positions don't offset you don't get any cross margin or cross collateral um so all of that is written in smart contracts those rules like what

the margin is um and when a user goes below their margin requirements. There is an onchain liquidation which is open for anyone to participate in. What it does is it starts kicks off like a Dutch auction um which offers your portfolio of assets. So maybe it's like $100,000 worth of assets at a discount um to know the value. So it'll be auctioned off. You can buy it for like $95,000 in cash. Um and then that that decays out to you know like 80% really quickly and then it goes down to 100% at which point like the onchain insurance fund which is funded by fees from trading fees from the protocol um starts to pay out users to take on the bad debt. Um and then if

that gets blown through I'm just going through the whole waterfall now uh you get to like ADL rules which again are transparent and written up front. So like that is the sort of core of the system. It's been in production now this version for almost three years. We've seen some pretty crazy market conditions with it. Um, and yet like you know we're we're always very um kind of monitoring the risk parameters and you know the system itself but it's worked very well in practice. >> You guys over at Der are very close to delivering v3 version three of derive onchain. What does v3 bring? Uh what what is in v3?

>> Yeah, I think it it takes us from like what we are now which is at the moment we're like a L2. there's a lot of custom work and difficulty integrating and building on top of derive. We're in a bit of a straight jacket. It takes a while to list new collaterals and new markets. Um, we go from all of that into like almost like a a Ferrari. Like we think this is going to be the most integraable exchange and protocol and composable protocol in existence. Um, and I think there's a huge opportunity to grow in parallel with our builders of people building on top of derive. Um, like the margin system is getting a huge upgrade. um allowing for like just more complex portfolios like more high performance in terms of the margin like industryleading in my opinion as well as

like multi-asset borrow lend a lot of like technical details around the options exchange which might be like too in the weeds to really get into here um but the the sort of takeaway from it is that we become I think um extraordinarily fast um so fast and high performance um that we can continue to like really start to innovate on the product from both ourselves and as well as our builders. They're going to have access to like the most complete payoff factory uh in crypto. You can take and draw on all of these new markets that we're going to be listing on the RWA front as well as the existing crypto markets. Um route users through you know the RFQ or the order book and start to stand out like these sort of structured

products, quantitative investment strategies which are you know massive markets in traditional finance as well as start to build like more retail friendly applications on top of derive. Um, and that is going to be something that like a lot of other exchanges in crypto are kind of shooting towards over like a one to two year time horizon. Um, but we've been built natively for it from day one. Um, and so yeah, I think we're in a really really interesting spot um to handle um the next wave of growth as well as to deal with um you know kind of like an agent first API and you know integration experience too. Uh which again we can get into but it's a whole other can of worms that I don't want to open up just yet.

>> Yeah. I don't I don't know if I'm ready as an interviewer to start saying the words options and agents in the same sentence. So maybe we'll save that for 2027. >> Um >> Nick, let's say options, you know, grow, evolve, expand as we expect them to to kind of meet par meet parody with like the trady world. So like again, as we've stated, options are very loved, used popular financial instrument. they're like lagging in crypto just because they're complicated and sophisticated, but nonetheless, they are they are coming. And in the future, hopefully in the short term future, uh let's just say that they they grow into what you expect them to grow into. How does that change the market structure in crypto? Like

what would be different in this world when options like 10x 100x uh just like how would that impact the rest of the industry? Well, the first thing is when our options markets become liquid, volatility actually generally comes down um because you get a lot of these um options sellers who um you know stuff dealers with like you know kind of vol and gamma and then they have to hedge that themselves. Uh so you you start to see things in markets develop more in a more mature way over time and I do think that that will happen like at the moment there are still lots of assets where you can you know and like a lot of the OTC desks are doing this um or like you know OTC takers are doing this they're selling volatility into the OTC desks um and earning yield and and uh as that

becomes more productized you start to get like you know a dampening effect across the industry. I do think like options will become a mandatory offering for a lot of the exchanges. They're going to have to figure out a way to support it. Um, and for a lot of them, it's going to be very difficult to build themselves. It's really hard to retrofit a per risk engine to add options. And I think a lot of teams are finding this out at the moment. You kind of have to start from day one with the options, cross margin with the pers for a variety of technical reasons. So I I would expect to see a lot of white labeling, a lot of integrations. Obviously, that's our thesis. Um, we stand to benefit from that. That's kind of what we want to play into. But um >> you guys are doing the DeFi mullet

thesis. You guys are trying to do DeFi mullet. >> Exactly. Um and we think options are kind of perfect for that. I think we're going to see a lot of options as a back backended into both like just a trading experience but also you know you can imagine options our options integrated into like a neo bank offering where again it's like you can earn 8% annually back tested uh with this options covered call spread selling strategy with a maximum defined draw down of like 1% in a given week or a given month and like these sorts of offerings are at the moment limited to like the highest sort of private wealth um high net worth kind of individuals and they're massive markets behind the scenes. We think democratizing them, bringing them out in the open, making them transparent,

reducing the fees, making all of that more competitive is going to be a huge market that serves users particularly um for things like tokenized stocks, which you can't really do much for them uh at the moment. Like you can lend, you can borrow against them, that's useful, but you can't really earn yields. There's not too much to do um you know dep like new or different um unless you're kind of accessing them internationally for the first time. Um we think options are the perfect building you know playground for for those sorts of use cases too. Um so I would expect to see options DeFi mulleted structured products to really come up uh and then a variety of new you know strategy vault curators integrators um starting to incorporate them um and also you know it can enable some more fun use cases which we haven't seen in a

long time. So like cryptonative stable coins that are overcolateralized in Bitcoin and ETH. You can have hedges embedded via the options to protect against massive downsides and big wicks that could potentially blow up lending, you know, lending protocols. We want to be integrated with them and and start to become like kind of the risk absorption engine for a lot of those different hedging flows and you can really capture that with uh with options. With the success of options, it's like and all of the volume that options bring, doesn't that also mean that number must go up in the sense that if there's a very rich options market, you know, BTC has all of these dated options, you know, 3 months out, 6 months out, two years out, you know, so does ETH, so does like all of the assets. Doesn't that mean that like

more market makers, more market participants need to get their hands on the assets in the first place in order to create that volume? And so if like volume 100x's, wouldn't that imply that all of these assets that have volume and liquidity in the options world have gone up in price because people needed to buy the asset in the first place to create that volume? Like is is large volume associated with number go up? It can be. Uh it's not necessarily. So, not when the markets get created, but we saw that. I mean, I saw that at, you know, when I was at SIG, Araos, if you remember them, they blew up. Um, the guy was like buying

just insane amounts of like the big tech stocks at the time. He was single-handedly moving the NASDAQ with his options trades and it was forcing all of the mark. who's buying calls, call spreads, out of the money calls both on single names like Microsoft and Google as well as you know CRM and some of the you know the more SAS kind of stocks and then also buying NASDAQ options and it was pushing the whole index up because dealers had to scramble on like this is like the gamma squeeze kind of concept that a lot of people are familiar with for GameStop and whatnot but this was happening at the level of the entire US stock market. Um and it is you know you can really have a big outsiz impact if you have size going into these options and the markets do do that but at the end of the day markets

are weighing machines right so like uh what goes up must come back down um if someone's putting that impact in and you know the the fundamentals aren't aren't coming up with it it does kind of go down but it does reduce you know spreads trading execution quality um reduces volatility in the market over time and that makes everything tighter as well. So it generally improves liquidity across the board um and makes it more investable for some people when they can put these hedges on. So um in that sense yes but like I I think the overall impact is you know a little more muted than that.

>> Okay. Okay. But nonetheless a a rich healthy options market does create a healthier market structure which makes the market itself more palatable more accessible more interesting to a wider set of market participants. And that's bullish. >> Absolutely. Yeah. >> Cool. All right. Options are bullish. Nick, Nick, thanks for coming on the show. Uh what should listeners know about uh Derive in the short term? You got, like I said, we have V3 coming. Uh what if they want to learn more about Derive or if there's anywhere you want to point them to, where should they go?

>> Yeah, our Twitter is derivexyz and then uh derive.xyz is the site. Um, and you can pretty much find everything about what we're doing uh there. You know, we publish everything. Um, and we do some analysis and market updates and things like that, too. So, hopefully that's helpful and useful for for for some of your listeners. >> Cool. Nick, we'll get all those stuff all that stuff in the show notes. Thanks for coming on the show today. >> Thanks for having me on. This is great. >> Bankization, y'all know the deal. Crypto is risky, but not risky enough. The institutions have landed, so we are going even further west. This is the frontier. It's not for everyone, but we are glad you are with us on the bankless journey. Thanks a lot.