Crypto Options Market Has Become More 'Interdealer' Since FTX's Blowup: Paradigm

The collapse of Sam-Bankman Fried's digital assets exchange, FTX, has had industry-wide ramifications, one of them being market makers increasing their share of crypto options trading volumes.

As of Friday, the notional value of the month-to-date interdealer flow on the institutional-grade, over-the-counter (OTC) communications platform Paradigm was $633 million, or 43.5% of the total crypto options trading volume of $1,455 million. That's the highest since at least January this year.

"More buy-side takers (hedge funds/family offices/HNW) are sitting on the sidelines, and a higher proportion of Paradigm volumes is occurring between market makers," Paradigm tweeted, adding that the options market fells more "interdealer" than before FTX's meltdown.

An options trade is said to be an interdealer trade when both the price taker and the price maker are market-making firms, that is entities with a contractual obligation to maintain a healthy level of liquidity on an exchange.

Price makers create orders and wait for them to be filled. In other words, they bring liquidity to the market. Takers remove liquidity from the market by taking available orders.

The crypto market, like traditional finance, comprises the "buy-side" and the "sell-side." The buy-side invests in assets and includes pension funds, mutual funds, institutional investors, hedge funds and retail investors. The sell-side, which includes commercial banks, investment banks, market makers, stockbrokers and other entities, is concerned with creating, promoting and issuing traded securities.

While Paradigm is an OTC communications platform, its fortunes are closely tied to Deribit, the world's leading centralized crypto options exchange by trading volumes and open positions. Trades facilitated by Paradigm are automatically executed, margined and cleared at Deribit.

Interdealer flows or trading between market makers now account for a higher-than-usual share of the total trading volume.

The interdealer flow as the percentage of total volume on Paradigm has jumped to 43.5% in December from 30.4% in November.

"This can chalk up to buy-side clients closing books for the year, and still only halfway through the month, but a jump this high suggests a structural change," Amberdata's weekly options analytics note published Sunday, said.

One possible structural change might be attributed to the high degree of uncertainty the collapse of FTX has injected into the market and the unwillingness among retail and investors to keep coins/funds on centralized exchanges.

FTX filed for bankruptcy on Nov. 11, setting off a chain reaction that took down industry heavyweights like crypto lender BlockFi and brought extra scrutiny on leading exchange Binance and some of the oldest digital assets institutions, like Grayscale. Grayscale is owned by Digital Currency Group, which is also the parent of CoinDesk.

"The main takeaway is that the supply-demand picture between the number of market-makers and the number of active-takers adding risk has definitely shifted more toward the supply of makers and less demand from takers," Joe Kruy, head of institutional coverage at Paradigm, said in a Youtube interview early this month.

According to Kruy, the situation is likely to persist. "Given the recent events, people are going to be sitting on their hands, waiting to see what happens. There is still potentially a lot of bodies that have yet to rise to the surface," Kruy said.