Perpetual Options for DeFi
It is no secret that the on-chain options market is illiquid despite the many benefits options offer. On the demand side, options provide asymmetric upside to the buyer. Gamma exposure is embedded in the contract, but their complexity makes them arguably harder to trade. While institutions appreciate hyper-customizability in the derivatives that they buy or sell. The average DeFi user just wants simplified exposure to leverage and the hedging properties of an option. Unlike in a perpetual future, the leverage a trader takes on does not change as the value of the underlier increases or decreases. Meaning the amount of leverage a trader takes out at the beginning stays constant. As such, traders would not have to manage their leverage directly as prices move.
On the supply side, market-making on-chain options entails unappealing collateral requirements, multiple strikes, and specialized knowledge to price the premium on an option. Making the process of providing liquidity quite challenging for all but a handful of sophisticated institutions.
In response, the researchers at Paradigm and Opyn pioneered the power perpetual. A way to make call options perpetual and on-chain friendly. Unique to the perpetual call option is the rolling over of the expiry and squared exposure on the underlying asset. So if the price moves up by 2X, then your gains increase by 4X. Or if the price increases by 4X, your gains increase by 16X. Giving buyers constant gamma exposure in DeFi with no liquidation risk.
“Rolling over” refers to an everlasting option that has no expiry. With the option to exercise at some price continuing in perpetuity. As such the pricing relates to a funding rate commonly found in perpetual futures. However, the funding is defined by the [mark — payoff] instead of [mark — index]
As the figure below indicates, the perpetual call option is a hybridization of a call option and perpetual future payoff.
Squeeth, has been the most recognized implementation of the perpetual call option. Yet despite its prominence, it has failed to reach critical mass. Daily volumes are sparse and the funding rate makes it unfeasible for the majority of buyers.
Taking the most recent annualized funding rate, a long ETH buyer would pay 124.31% of their principal to a short seller.
We argue the reason for this lack of success is not in the actual intent of the product but in its implementation. Squeeth which is minted over an RFQ/orderbook system requires sophisticated market makers to price the instrument and provide liquidity. Moreover, for every buyer there needs to be an equally willing short seller. But liquidation risk, complexity, collateral requirement, and payoff profile make this unappealing for shorts.
To solve this, Numoen has constructed a specialized AMM from the payoff of a perpetual call option. So although Squeeth provides unlimited upside whereas Numoen does not. Making this tradeoff enables anyone to provide liquidity to a perpetual call option. All by renting their liquidity to Numoen’s pricing algorithm. No need to bootstrap liquidity on an external market (as is the case with oSQTH) or take a short. No liquidations. And no oracle manipulation.
Best of all, the protocol runs completely on-chain and creates instantaneous liquidity on any underlying asset, not just ETH.
