Bitcoin Variance Swaps

By Carol Alexander

Published May 28, 2021; Republished By SSE September 6, 2022

Bitcoin variance swaps have been traded on-chain for nearly two years. Here is the smart contract code for doing so. However, these products are incredibly risky. The figure above shows the pay-off to $1 notional on a 30-day bitcoin variance swap, with a fair-value swap rate based on CryptoCompare's BVIN index. Unlike equity variance swaps, the variance risk premium can be very large when negative, which is good for the variance swap issuers, but their downside risk when the preimum jumps to excessively high positive values is difficult to forecast and to hedge using bitcoin options.

The methodology for the BVIN index is similar to the CBOE's VIX formula, but being based on Deribit option prices we need a complex data filtering mechanism, because of the issuance of 3-week options which have low trading volumes for several days after issue. The exact methodology is decribed in detail here. The graph below shows the BVIN index in percentage points (green, left-hand scale) and the bitcoin price in US dollars (red, right-hand scale).

The first part of my QuantMinds in Focus talk discusses options-based bitcoin volatility trading. Then I talk about optimal delta hedging of bitcoin options, and the information one can derive from various buying-pressure metrics built from 1-minute data on all Deribit options (on these topics, two discussion papers are in preparation). You can read more about fair-value swap rates for bitcoin variance swpas of different maturities, with different monitoring frequencies for the realised volatility, and about the determinants of the corresponding bitcoin vaiance risk premium here.