Friktion Research
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Friktion Research

Zap: Bear Market Survival

Published: 05/15/2022 |By: Friktion Research Contributors

This post will cover volatility market observations, protocol performance(+forward strategies), and an auction recap.

This week crypto markets experienced an unprecedented level of downside volatility in a series of events catalyzed by a bank run on UST, the native algorithmic stablecoin of the Terra (LUNA) ecosystem. Market participants watched as a $20bn asset capitulated to <$2bn within the span of days, dragging the entire ecosystem with it.

Founder’s Note: Most importantly this has damaged the livelihood of many in our community and close friends — having been an early user of Terra DeFi it has been challenging to watch — however, Terra’s active developer and community support are great lessons we can learn from. If you’re coming from the Terra ecosystem and would like any support getting back on your feet — we’re here to help. ~Uddhav and Alex

Crypto volatility markets

As UST began losing peg on Monday, LUNA fell nearly -50% within the 14 hours, compounding the peg instability, dragging correlations along with them on SOL, BTC, and ETH. BTC saw lows <$27k, ETH $1800, SOL $40. Given a rapid shift in sentiment and broader crypto market instability as the UST reserve depleted, volatility markets reacted severely down the curve. BTC ATM 7day IV, a proxy for short dated options pricing, rallied from 70vol to 150vol, hitting levels last seen in May ’21 (Chart 1). Bitcoin volatility term structure flipped to steep backwardation (Chart 4: T and T-7day BTC Vol).

Chart 1: Bitcoin Volatility (Source:
Chart 2 & 3: Bitcoin skew and volatility term structure pre- and post-crash (Source:
Chart 4 & 5: Ethereum & Solana volatility term structure pre- and post-crash (Source:

Solana volatility (using ATM 7day IV as a proxy) strengthened from 80vol to 240 vol during the week, with skew (negative skew = more put premium at the same delta) also falling heavily as the spot market sold off.

Chart 6 & 7: Solana IV and Skew (Source:

Traditional markets remained weak following the prior week’s FOMC, leaving SPY/QQQ down -5% week-over-week. Cryptoasset correlations with public equity markets weakened during this period. As seen in Chart 9, equity volatility (using VIX futures curve as proxy) also flipped from mild contango to backwardation during this period (May 4 vs 14th):

Chart 8 & 9: Traditional markets (Source: Vixcentral)

Impacts on Friktion Volts

As a protocol, first order effects include sunsetting the LUNA (Volt#01) and UST (Volt#02) Volts, meaning they are now in Withdrawal Only mode. As UST started to lose peg on Monday, we ran checks to ensure that settlement pricing would be in order, which made the asset appear more like a quanto than an option. The settlement formula included the LUNA/USD (for calls) and LUNA/USD*UST/USD (for puts). Since Friktion’s options strategies do not utilize leverage, there was no risk of platform insolvency (losses are capped at total principal deposited).

Volt#01 Performance

Volt#01, Friktion’s call option overwriting strategy, continues to perform in this bear market. This strategy takes advantage of overpriced upside volatility to continue to collect premiums as prices fall. As mentioned before, put skew strengthened this week, but notably SOL call vol traded >150vol this epoch. Note this strategy is more bear market resilient than Volt#02.

Below is a comparison between the yield of being in Volt#01 inception to date and holding a long spot position (Charts 11–13):

Charts 11–13: Friktion Volt#01 performance vs long spot (Source: Friktion Research)

Volt#02 Performance

With assets experiencing >30% declines in the course of a week (>210vol!), Volt#02 options went ITM resulting in a drawdown of principal. Below is a comparison of the performance of Volt#02 inception to date vs holding a long spot position (Charts 8–10):

Charts 8–10: Friktion Volt#02 performance vs long spot (Source: Friktion Research)

Volt#03 Performance


While the market went risk off, Friktion’s Volt#04, a basis strategy, was steadily rebalancing into a long basis position, with an inflow of ~$6 million USDC into the strategy. This position/PnL can be easily tracked here. Currently the Volt earns profit in negative funding rate environments.

During this period, BTC/ETH funding went negative but have since normalized while alt L1s like SOL are still negative. .

Below are the historical hourly funding rates for SOL on Mango compared to an aggregation of multiple CEXs’ during the week:

Charts 14 & 15: SOL funding rates on Mango Markets and CEXs (Source: Mango, Coinalyze)

Protocol improvements and responses

Through the unprecedented market turbulence, Volts performed in expectation with the strategy’s intended payoff and protocol parameters. In the instance of the LUNA expiry price near $0, the premium remaining in the pool was not converted from USDC to LUNA, and will be distributed to depositors in lieu. We have identified a number of implementation that can provide downside protection for Volt#02 in turbulent market conditions. These include a credit (put) spread Volt which would buy a further OTM put along with the current sale of a put in order to cap the downside loss, particularly effective in situations like we saw this week. Additionally, we’re developing on a Long Volatility Volt which would use a combination of principal + yield generated from low-risk stablecoin strategies (such as basis or lending, preferably delta-netural) to continuously purchase downside tail hedges instruments such as options or power perps. This will also be a big step in fully decentralizing Friktion auctions and will provide a Volt for participants to access the exposure and pricing of option buyers of Volt#01 and #02. As a result, we expect this will unlock deeper liquidity in the long-term for Friktion’s Volts.

Auction Recap

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