The OLM Experience for Liquidity Providers
Options Liquidity Mining is our latest product that enables projects to mint customizable ERC-20 call options as incentives for a variety of use cases. If you’re wondering why the project you’re LPing for is transitioning to OLM, this post will delve into the specifics including OLM’s mechanics, benefits, and the shift it brings to liquidity provision.
What are oTokens for LPs?
oTokens function as ERC-20 option tokens, primarily call options for incentives. Instead of directly claiming a liquid token, you receive the option to exercise within the eligibility window of the oToken and obtain a payout asset at a discount. In this process, the project issuing the oTokens receives the quote asset, bolstering its treasury and creating long-term value for its community and participants.
How does this change the LP Experience?
The role of liquidity providing undergoes a transformation that introduces a new layer of engagement and value realization. The shift from solely receiving liquid tokens as rewards to receiving options as rewards alters how LPs interact with their provided assets by requiring them to be more active.
To illustrate, it’s beneficial to conceptualize traditional liquidity incentives as oTokens with a $0 strike price and an infinite eligibility window, in contrast to the structure of oTokens with a fixed strike price and a defined eligibility window. Even further, the reward window for both mechanics is temporary as liquidity provision is temporary.
This new dynamic brings three considerations into play for LPs engaging with oTokens:
- Payout Token and Price: LPs need to consider the payout token they’ll receive upon exercising the oToken and its current market price. Assuming the options are American-style, the value of an oToken when received is at least the current market price minus strike price. If the strike price is above the current market price, it isn’t valuable to exercise at that moment. However, it isn’t worth zero since the market price could still go up before expiry. This understanding ensures that LPs are informed about the value they stand to gain from the exercise.
- Quote Token and Strike: LPs must be aware of the quote token required for exercising the oToken and the fixed strike price associated with it. This element defines the exchange ratio between the quote token provided and the payout token received.
- Eligibility Window: LPs need to be familiar with the eligibility window during which they can exercise the oToken. This aspect provides LPs with the context of when their opportunity to exercise will be available and when it will expire.
Note: We anticipate that most protocols will implement American-style options, but the contracts support any eligibility window.
How to Receive and Exercise oTokens
Receiving oTokens is a seamless transition for LPs. To begin, you’ll need to acquire the specific assets required for liquidity provision, which will vary based on the preference of the oToken issuer. Typically, this will be native tokens paired with base assets such as ETH, USDC, DAI, and others. Once you’ve obtained the necessary assets, proceed to provide liquidity as usual and oTokens will be emitted as rewards. Simple right?
When it comes to exercising oTokens, users can follow the steps below:
- Check Key Parameters: Prior to proceeding, make sure to review certain parameters as mentioned in the prior section. This includes the expiry date, eligibility window, epoch length, and strike price associated with the specific oToken you hold.
- Initiate Exercise: If all parameters align and you decide to proceed, you can initiate the exercise of your oTokens. This process allows you to convert your oTokens into the underlying assets they represent. In most cases, this action will be carried out on the issuer’s UI.
Risk Considerations and Nuances
- Impermanent Loss (IL) and Market Conditions: Being a liquidity provider is not risk-free. A major risk is IL, which represents the divergence between the outcome of holding paired assets separately versus providing them to a liquidity pool. In general, IL tends to be lower when the relative prices of the supplied tokens remain stable, and higher when they experience significant fluctuations. Although liquidity mining rewards attempt to compensate for this risk, it might not fully mitigate it during periods of heightened market volatility. Another consideration is that oTokens vary in value as the underlying payout and quote tokens change in value. If the payout token price drops below the fixed strike price, it likely doesn’t make sense to exercise the option at that time as we mentioned previously.
- Understanding of Configurations per OLM Program: New oTokens are issued per epoch to update the strike price and expiry of the tokens, ensuring that the rewards maintain value over time. Projects will vary their epoch durations to balance freshness of oToken configurations with limiting the number of tokens users need to manage and exercise. In traditional liquidity mining, rewards exist indefinitely until they are claimed. However, oTokens have expiries and value can be lost if rewards remain unclaimed past the expiry. In fact, new oTokens cannot be minted after the token expires so users will not receive anything if they wait too long. This is why it’s crucial to check the eligibility window of an OLM contract to make sure there is enough time to realize the value of the rewards.
Bond Protocol is the permissionless on-chain bond marketplace. Our mission is to power sustainable treasury growth and support protocols to acquire strategic assets, including their own liquidity.
