Bitcoin Volatility, Skew, and Options Pricing, Part 3

Recently Deribit, the leading cryptocurrency options exchange introduced a new service - crypto-based USD loans. Here is a blog post that describes existing marketplace for crypto-based loans, and the loan service that they are offering. The service is radically different from existing services, as it relies on hedging.

As described in that blog post I linked above, existing services rely on getting a collateral much higher than the value of the loan, to compensate for the high risk of volatility of crypto. For example, lender may require a 50% loan to value ratio, lending 0.50 per 1.00 of crypto collateral. This is obviously not very efficient use of capital, and still does not protect the lender if value of collateral falls below 50%.

Deribit will be using a combination of over-collateralized lending as above and hedging to provide better rates. For example they may offer 75% loan to value ratio, lending 0.75 for 1.00 of crypto collateral, but hedge their remaining risk by purchasing puts. If the value of collateral declines, the combination of reserve and long put option will protect them from loss.

Why is this important? The answer, in one word would be - SKEW. Crypto lending is a growing market with demand exceeding the supply. If Deribit's lending service will take off, it will create a strong, systematic buying pressure on puts, raising the left skew. I wrote before that markets treat BTC as a speculative asset, with call skew. In a year from now we may see a more symmetric skew behavior in BTC.

Such change may provide an opportunity for an interesting trade - to substitute BTC deltas with a long near ATM call and short OTM put, to capitalize on skew differential.