Against the background of the growth of the market in 2020-2021, the cryptocurrency options sector has strengthened, where the main activity falls on the centralized deribit exchange.
DeFi is one of the main drivers of the development of the crypto industry. It is not surprising that against the background of the boom in this segment, decentralized options are gaining popularity, publicly available and not involving KYCprocedures. Projects like Hegic and Opyn have proven that even such complex financial instruments are in demand.
Cryplogger understood the features of decentralized options, found out the reasons for their growing popularity, and also learned about the pitfalls of these difficult, but interesting and promising financial instruments.
- Against the background of the rapid growth of DeFi, quite advanced financial instruments are gaining popularity – decentralized options.
- The segment is still small, but it is developing quite quickly. Hegic, Opyn and other projects are gradually increasing TVL,improving user interfaces.
- Increasing the liquidity of DeFi options is facilitated by integration with various projects, liquidity mining programs, the development of second-level solutions and tightening regulation in relation to centralized analogues.
Why do we need DeFi options?
Options have long been one of the main pillars of the traditional financial system. These derivatives provide investors with the opportunity to bet on the future dynamics of assets and hedge price risks, effectively using capital.
The chart below shows a real rise in aggregate open interest in options, which peaked in the spring of 2021. This was followed by a decline in activity and a gradual recovery that began in late June.
Also noticeable is the clear dominance of Deribit, from which LedgerX, FTX and CME are significantly lagging behind.
Due to the global trend towards tighter regulation, Deribit was forced in May 2020 to restrict access to the platform for users from some countries, including Japan. Later, the exchange introduced mandatory customer verification.
Probably, thanks to these measures, traders paid attention to options in the DeFi segment. These on-call protocols provide similar capabilities to traditional counterparts, while being publicly available (permissionless) and non-castodial.
There are two types of option contracts: put and call. Put contracts entitle holders to sell the underlying asset at a fixed price in the future. In turn, calls allow you to buy an asset at a certain price.
An example of the simplest option on-term contract: the user creates a call to buy 1 ETH for 4000 Dai on January 1, 2023. This process involves three steps:
- the user deposits 1 ETH in a smart contract;
- smart contract issues 1 call option;
- upon the expiration date – January 1, 2023 – the token holder can send 4000 Dai to the smart contract and withdraw 1 ETH.
Even such a simple scheme may seem complicated to many, especially in comparison with more understandable liquidity pools and landing services. The latter, due to their ease of use, can attract significant funds. Prominent examples of this are Uniswap and Aave, whose TVL numbers in the billions.
Creating efficient optional protocols with an intuitive interface is not an easy task for developers. The complexity of the architecture of such platforms is associated with serious risks for market participants.
In May, the Opyn platform lost $ 371,000 due to the vulnerability of the project’s internal token. Attackers conducted a double-spending attack on Ethereum put options, gaining access to the collateral funds of users who sold contracts. To avoid further losses, Opyn developers withdrew 572,165 USDC from their own smart contract, and also removed the possibility of buying oTokens.
Recently, bridget Harris, an analyst at venture capital firm Divergence Ventures, took advantage of the exploit that arose during the May airdrop of the Ribbon project, receiving more than $ 2.4 million in RBN tokens.
The fact that the segment is still only at the initial stages of development is evidenced by the figures. For example, the TVL of the major Hegic on-line options protocol is $ 21 million, Opyn’s figure is $ 127 million (DeFi Pulse data as of 10.10.2021). The amounts are incommensurably small in comparison with the indicators of the leading AMMplatforms or landing protocols. The revolutions in comparison with centralized analogues are also insignificant.
It is important to mention other inherent characteristics of options, which are associated with many difficulties and risks. First, these contracts are not indefinite — they must be constantly created and executed.
Options involve asymmetrical conditions and, accordingly, risks for the buyer and seller. For example, the holder of a call option risks only the premium paid for the contract. The risk of the seller of a short call is unlimited, and the profit potential is limited by the premium from the sale of the contract.
At the heart of many onchain options platforms(Hedget, Opyn v2)is the order book. This is a model understandable to many, but for effective work it needs market makers who provide sufficient liquidity.
There are also option platforms based on liquidity pools – for example, Hegic and Finnexus. Advantages of this model:
- the ability to easily attract liquidity to ensure the effective operation of the platform;
- flexibility: option buyers can set their own insurance prices and expiration dates;
- providing liquidity on a continuous basis (this means that LP does not need to close positions and move to another pool with the expiration date).
However, pricing on such platforms is not carried out through AMM, as on Uniswap, but algorithmically using the Black-Scholes model. In the context of the latter, the value of an option is determined by taking into account the value of the underlying asset, the stamp price, the duration of the contract (expiration date) and the implied volatility. Data on the latter parameter can be queried from centralized exchanges like Deribit through oracles, which can be the object of attacks and manipulations.
Hegic
Hegic is an on-call protocol that allows you to buy call and put options of the American style of execution based on ETH and WBTC. Users can also sell contracts, acting as liquidity providers.
The non-castodial platform created by the developer Molly Wintermute does not imply the passage of KYC. The service began operations in February 2020.
In September of the same year, the HEGIC token was issued. It became the centerpiece of a new version of the protocol, Hegic v888, which began operations a month later. The token can be blocked by lots for staking, used to receive commissions, as well as for on-term management of the platform.
Participants of this AMM platform can customize the parameters of options, setting the insurance price and expiration date. Option prices are calculated automatically, immediately after setting their parameters.
Each user can purchase options from liquidity pools. However, the maximum limit for buying contracts from pools is limited to 80% of the total amount of funds blocked in them.
Steaking remuneration is received by the owners of lots of 888,000 HEGIC (approximately $ 150,000 at the exchange rate on 10.10.2021). In total, no more than 3000 such lots can be created. However, there is the possibility of delegated staking with smaller amounts, provided by the HegicStakingservice.
To start trading options on Hegic, you need to go to the platform and click Launch Hegic.
After that, you need to connect to the platform through a Web3 wallet like MetaMask.
Then you can choose the type of option – call or put based on ETH or WBTC. It is also possible to set the term of the option(Period). Strike Price indicates the current market price, and the calculation is carried out in the USDC stablecoin. Price to Break-even — break-even price at the specified parameters of the option.
Below on the page there is a calculator showing the amount of net profit if the price of ETH or WBTC reaches a certain mark during the contract retention period.
The project’s blog on Medium says that only one on-line transaction is enough to start “gas-free” trading on the platform. However, to do this, the minimum trade size must be 10 ETH or 1 WBTC.
After confirming the transaction, the user will receive an ERC-721 token associated with the option he created.
The execution fee is 1% of the contract size. It is received by HEGIC stakeholders, and other commissions go to liquidity providers.
External price data is obtained by the protocol using Chainlink oracles.
From October 10 to January 10, the total trading volume on Hegic reached $ 168 million. The protocol issued 3530 contracts for 1094 unique addresses. The average contract size was $47,700.
Hegic’s success in the DeFi segment has attracted the attention of third-party protocol developers. For example, the zLOT staking service appeared. It lowers the threshold for entering HEGIC staking by combining the assets of small investors into lots.
Users can deposit HEGIC in zLOT. After that, zHEGIC tokens are issued for them. In the process of withdrawing Hegic’s native assets, zHEGIC coins are burned.
The project also provides for the ZLOT management token, which can be blocked for staking, as well as used for voting for changes to various protocol parameters.
Opyn
No less popular among DeFi apologists is the Opynproject. It was founded by graduates of the University of California at Berkeley Aparna Krishnan, Zubin Koticha and Alexis Gauba.
Built on the basis of Convexity Protocol, the platform attracted $ 2.16 million in seed investments from Dragonfly Capital in the summer of 2020.
Despite the losses incurred as a result of the hack, the project raised $ 6.7 million in the next year during a series A funding round from Paradigm, Synthetix co-founder Kane Warwick and head of the Aave DeFi project Stani Kulechow.
In 2019, Opyn was one of the first to offer decentralized options to the market. The first version of the protocol allows you to create American options in the form of oTokens, 100% secured by the underlying asset.
The second version of the protocol has a number of innovative features, including auto-fulfillment and flash release. The latter is based on the concept of flash loans.
Oracles are used to determine the execution price. Each contract is issued as an ERC-20 standard token and therefore becomes available for trading on any DEX.
Features of Opyn v2 open up the possibility of implementing spread strategies, when one option position can serve as collateral for another. For example, when buying a put option with a relatively high shock price and then using it as collateral to sell a put with a lower hit.
Support for flash issuance and spread strategies is designed to increase the capital efficiency of trading operations. In addition to this, in June, the developers introduced the possibility of partial security for contracts.
Oracles from Chainlink are responsible for price data and liquidation.
The Gamma Protocol used in Opyn v2 was audited by OpenZeppelinand its formal verification was made by the Certora team.
According to information on the project’s website, Opyn’s turnover since its inception has exceeded $ 1.95 billion, and a total of 38,779 transactions have been executed. Such impressive indicators are largely achieved due to integrations with Ribbon Finance, Opeth, Gamma Portal, Fontis Finance, Optional Finance, Ziku Finance and other projects.
Other projects
Primitive is a decentralized American options platform that uses tokenized long and short positions. Call contracts are executed in the underlying asset (wrapped in ETH or SUSHI), puts in the Dai stablecoin.
Siren Protocol — initially, the project was launched as an AMM platform with bTokens and wTokens tokens. When a trader buys an option from a pool, its collateral is used to release a pair of assets. In this case, bTokens are sent to the buyer, and wTokens remain in the pool.
This approach is similar to Hegic and FinNexus. The difference is that options are tokenized and pools are “one-way.” For example, for a call option based on WBTC, the collateral asset may be “bitcoin on ether”.
Subsequently, the platform underwent significant changes. The second version of the protocol launched in August implements: the transition to European options, settlements in the stablecoin, polygon support. The user interface has also been significantly redesigned.
Auctus is a Flash-enabled DeFi protocol that also runs on Arbitrum and Binance Smart Chain. Users can trade options in the basic and advanced interface modes, create contracts with different execution prices and duration, as well as the opportunity to act as a liquidity provider.
On Auctus, market participants have access to quite complex automated strategies. For example:
- The user deposits USDC in the Vault.
- USDC is issued as a loan on the Curve platform. The user receives CRV tokens, which are sold for the automatic purchase of ETH-based call contracts.
- If on the expiration date the call is “in the money”, the contract is executed automatically – the trader receives a profit.
This year, the project plans to launch an on-line control system, the central element of which will be the AUCtoken.
Premia is a decentralized marketplace with the ability to issue contracts with various parameters and steak a native token. The second version of the protocol with a completely redesigned interface is being prepared for launch.
Antimatter – the project positions itself as “Uniswap for options”, providing perpetual financial instruments based on various networks – Ethereum, Binance Smart Chain, Arbitrum, Avalanche, Fantom, Near and Solana. The site talks about the possibility of issuing NFT, backed up by various underlying assets.
Findings
Decentralized options are quite complex, but interesting tools. They open up new strategies for advanced investors, and wide opportunities for integrations for projects.
The landscape of this still very young and small segment is changing rapidly. Developers are actively working on improving platforms and creating projects with new features.
The creator of the DeFi project yEarn Finance, André Cronier, called Hegic “a really wonderful technology.” The positive feedback resulted in a partnership to create binary options using yEarn vaults.
Developer Molly Wintermute is working on a Whiteheart-based on-chain hedging protocol. The solution is designed to automatically buy put options “in the money” on behalf of users when they acquire assets on decentralized exchanges.
The interfaces of some projects can hardly be called user-friendly. It is also obvious that many services lack liquidity.
Decentralized options mark a natural stage in the development of the crypto industry and DeFi. The introduction of second-tier solutions and the support of new ecosystems such as Polygon, Avalanche and Solana can serve as powerful drivers for the development of option protocols, increasing their liquidity, as well as integration with other projects of “financial Lego”.
