Fuelling the Volatility Engine
The volatility engine is picking up steam. The recent protocol upgrade and the 3,000,000 OP token grant won by the Lyra DAO present an opportunity for the protocol to ramp up growth. This blog will recap the launch, and make some suggestions about how to supercharge the options trading experience and advance the protocol into a new era.
Avalon Recap
It’s been 3 weeks since we launched Avalon (the most recent protocol upgrade) with 0 DAO-funded incentives for LPing and trading. How’s it been going?
- The pool has attracted $3.1m in ETH Vault liquidity
- $13.1m notional volume has traded
- $50,000 in fees have been generated
- LPs have already made 2.1% returns on their capital (36% returns annualized — although it’s too early to make this extrapolation)
- Pool utilization is consistently pushing 100%
In plain English: with no token incentives, thus far the protocol has generated high returns on capital deposited to the market-making vaults. Crucially, these returns are market neutral. The PNL chart has consistently ground up and to the right, regardless of whether ETH was falling or rising. If the AMM continues to generate yield at even a quarter of the pace it currently is, it would be a monumental result. There are a couple of important caveats here:
- It’s only been 3 weeks! The AMM will need months to establish a *real* track record, and whilst variance to delta swings has been muted by hedging, we need to observe the AMMs performance in a variety of market conditions before drawing conclusions with any confidence
- The pool is operating at a fairly small scale (with ~$3m in liquidity), and fees and slippage are relatively high. Therefore it’s likely that the profile of traders and fee percentages materially change as liquidity and volumes grow
Even with these in mind, it’s been about as good a start for the AMM as we could’ve hoped for. We’ve barely scratched the surface of options AMM design, and there is a clear path to 10x this performance with capital efficiency/quantitative upgrades.
What’s Next?
A multitude of LEAPs covering the Avalon rollout were approved around a month ago. However, the decision to rollout was delayed by significant market volatility leading to synth liquidity concerns. Those concerns have now mostly subsided, and I believe now is the time to press on with a steady rollout of the features described in LEAP 26. The state of play for Lyra is:
- We have a product that traders love: version 1 saw $500m+ notional volume with 73% month-on-month active trader retention (30D Ending Users — 30D New Users) / 30D Beginning Users). Once users began trading on Lyra, they didn’t stop.
- With 0 trading incentives, LPs are printing fees: generating ~$50,000 in 3 weeks off of ~$2.7m in working capital. Vault PNL is closely tracking fees generated, which indicates that these fees (so far) are being generated profitably.
- All of these numbers have been achieved with 0 token emissions directed to the core protocol, which indicates that they are sustainable.
- A market-leading integrator experience with a streamlined SDK and grants program allowing for rapid composability
- A number of integrator protocols (e.g. Polynomial, Brahma, dHedge, Fuerte) waiting in the wings for Lyra liquidity to increase so they can execute their strategies with the AMM.
- Real-time statistics, analytics, and monitoring for LPs/traders
These are early days, however, and until the market-making vault establishes the aforementioned track record over a longer time horizon, vault incentives will be required to keep pace with trader demand. We must now build off the foundation that has been established by growing TVL until pool utilization stabilizes closer to the 60–70% mark. Here’s how I think we should proceed:
- Migrate LYRA security module on L1 to LYRA staking rewards on Optimism
- Distribute OP token grants as rewards for LPs, using boosting mechanics from staked LYRA proposed in LEAP 26
- Commence LYRA locking and staking on Optimism for a low amount of staking rewards (at most the current rewards accruing to the Security Module stakers)
- Maintain the USDC Security Module (on L1) and the LYRA-ETH LP programs, with the potential to boost LYRA-ETH LP rewards with OP shortly
Market maker vault OP rewards should start small and gradually increase until pool utilization hovers around 60–70%. The council should work with the community in discord over the coming week or two to determine the exact number of tokens to emit.
After consulting with the product and engineering teams, it is feasible that the above programs could be launched on August 3. Note that the rewards will initially be calculated via a public, off-chain script, as stipulated in LEAP-26.
The Goal
I believe that Avalon is the best options trading product DeFi has seen. We need to ensure that we scale liquidity in keeping with the overwhelming demand the protocol is seeing from traders and integrators, and in doing so solidify Lyra’s place as the market leader.
However, Avalon is a capital-hungry system: the AMM fully collateralizes each option it sells. This might not be an issue if it continues to generate fees per $ of deposits at the current rate, but I believe that it’s likely the yield compresses significantly as more capital enters the system and trading volumes grow. That’s why the CC’s are hard at work engineering a system that can increase the AMM’s capital efficiency by an order of magnitude and open the possibility to support institutional scale. In the meantime, the community’s focus should be on leveraging the power of Avalon to build an organic, sustainable foundation of Lyra-native traders and integrators. All incentive programs should be constructed with this in mind.
As far as I’m concerned, there’s a wide open spot next to the Uniswaps and AAVEs of the world for whichever options protocol manages to crack the nut. The lane is wide open, and I know that Avalon is a product capable of taking it. If the council, community, and CC’s get the next few months right in terms of incentives, awareness, and narrative, I have no doubt that it will.
