Oddz Protocol: Understanding how the Liquidity Pool works
In our earlier pieces, we discussed how Oddz is a game changer in the on-chain derivatives trading space allowing users to employ innovative attributes for seamless trades. We also dived into the nuances of how Oddz distinguishes itself from the existing players in the DeFi derivatives landscape. Some of its striking features include transparent premium discovery mechanisms, customized trades, and budget-friendly fraction trades.
Today, we will discuss in detail the functionality of the Oddz Liquidity Pool for platform traders, which is actively contributing to bringing DeFi to mainstream adoption.
The Liquidity Pool phenomena for Option Traders
In the simplest sense, Liquidity pools are aggregate pools of tokens or crypto assets locked in by the liquidity providers to provide liquidity to the decentralized platforms. In the traditional financial landscape, where the order book model is employed to execute trades, Liquidity pools utilize the AMM to execute seamless trades.
The Oddz Protocol enables traders to buy calls and put options in a decentralized and hassle-free manner. It employs a unique automated market-making mechanism to drive liquidity to the platform. Under the AMM model, it replaces option writers with liquidity providers who are incentivised for infusing liquidity in the Oddz platform to promote seamless option trading.
Unlike the traditional derivative trading scenario where option writers actively participate in creating a contractual agreement, Oddz works innovatively. They are replaced by liquidity providers who actively participate in the options trading process by locking their crypto assets to provide adequate liquidity to the platform. The liquidity pool constitutes USD pegged stable coins deployed by the LPs. The utilization of the over-collateralization ratio for purchasing options ensures proper safety for option buyers due to the underlying asset volatility and also maximizes liquidity utilization. The liquidity providers are rewarded with the premium paid by the option buyers.
The usual flow functions as liquidity providers lock their assets into the liquidity pool. When the option is bought or exercised, the liquidity provider records the pool’s share in tandem with the total utility in the ecosystem. The profit and losses are generated on the execution of the options trades and are distributed between the liquidity providers, which is evident in the operational flow.
Realizing the profit and losses on the Oddz platform
The realization of profits and losses occurs in two scenarios when the options are burned. Firstly when the option is exercised and secondly when the option is out of money at the expiry period.
Suppose an option is purchased, the liquidity provider will receive the premium amount multiplied by the share of the liquidity in the total utility ecosystem. In cases of losses to the liquidity pool due to the execution of options, each of the liquidity providers will be earmarked. While in the call option, it is equivalent to the strike price in USD whereas, in the put option, it is capped via maximum collateralization. The amount of USD outflow multiplied by the share of the liquidity provider in the total utility ecosystem acts as the loss for the liquidity providers. Reinforcing the fact that the net gains will always be equal to profits — losses.
Withdrawal of funds from the Liquidity pools
The withdrawal of the funds from the liquidity pools is dependent on the liquidity utilized by the pools along with the buffer. The liquidity providers have the complete freedom to extract liquidity from the platform. However, if the LP’s extract the liquidity before the threshold period of 14 days, the premium is distributed amongst the liquidity providers who have stayed along longer, providing liquidity to the platform.
When the assets are transferred to the liquidity pool, the Oddz platform issues oUSD tokens commencing with 0% on the starting day. Once the trade is executed and the P/L index goes up, the gains or losses are distributed with the exercising of options.
The Oddz liquidation mechanism promotes the distribution of premium to liquidity providers. With the current framework, it is evident that Oddz capitalizes on option buyers’ trading fees and liquidity providers participating on the platform.
Ready to experience the world of derivatives trading by participating in liquidity pools?
Oddz provides an intuitive interface and lucrative incentivization structure to participate as a liquidity provider. As we near our test net launch, we will be bringing a series of educational pieces that will help our community to understand the nuances of how the Oddz platform works and the participation process. Until then, stay tuned as we bring you the latest updates. In case of questions or queries, reach us out at info@oddz.fi.
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