Pitch Lake and L2 Tokens
With the announcement/airdrop of the Optimism chain native token — $OP, we want to explain why L2s such as Optimism are perfectly suited to benefit from Oiler’s upcoming Pitch Lake product.
While Optimism has not explicitly stated that their protocol transaction fees will be charged in $OP tokens, we predict that this may happen in the future. In fact, there have been several proposals posted on the Optimism governance forum to do this [link 1][link 2][link 3].
We can see other L2s such as Polygon charge tx fees using their chain’s native tokens, such as $MATIC.
This is important because every single Optimism transaction is submitted to L1, however it is not executed on the L1 EVM. This means that in order for the chain to operate, the Optimism chain operator must pay for each of these transactions to be posted to L1.
This is an important observation because Optimism will incur expenditures for all transactions they must post to L1, in Ethereum’s native token — $ETH, while charging transaction fees on their chain in their native token — $OP.
As we can see, Optimism will likely incur what in traditional finance is called foreign exchange risk. Foreign exchange risk is a term which refers to the losses trade participants may incur due to the volatility of the native currencies of those involved in trade.
Consider a Canadian automotive part supplier who supplies car parts to an American car manufacturer. The Canadian part supplier sells parts needed by the American car manufacturer in Canadian Dollars, thus the American manufacturer must account for the currency fluctuations between the Canadian Dollar and the United States Dollar. From the US car companies perspective, anytime the Canadian dollar weakens, their car production costs decrease. However, when the Canadian dollar strengthens, their car production costs increase as well. At a small scale, currency fluctuations may not always be significant. However, as the size of production increases, this fluctuation may introduce significant risk to the American car manufacturers operations if left unhedged. For this reason, when manufacturers produce at scale, they look for ways to hedge foreign exchange risk using derivatives markets.
Market participants can hedge foreign exchange risk in various ways. Futures contracts can be used to buy or sell an asset for a predetermined price sometime in the future. Options are a commonly used financial derivative product to hedge the volatility of an underlying asset.
The decision to charge tx fees on the Optimism chain using $OP tokens would carry some risk because operators will be incurring expenses in ETH (when posting tx’s to L1), while receiving $OP tokens to cover this expense. We cannot make an assumption that the value dynamic between Ethereum and the Optimism token will remain stable. This will lead to operators overcharging chain participants in order to cover the volatility risk involved in their operations.
Exposure to basefee volatility will not only be applicable to Optimism. We believe that more L2s will launch their own chain native gas tokens in the future and will all be looking to hedge their risk. We are not the only ones who think this will happen [link 4].
Our Solution
Is it possible for Optimism and other L2 chain operators to hedge this risk? Yes. Soon.
Oiler Networks upcoming Pitch Lake DeFi Vaults will provide all those with exposure to basefee volatility a way to hedge this risk. Traders will be able to get basefee exposure using capped collateralized options, which will be auto-generated by vaults every month and sold via gnosis batch auctions. There will be multiple vaults available, each being tailored to different risk appetites of traders.
Market participants who deposit money into vaults will be effectively writing PUT or CALL options. Those that buy these options hedge themselves against basefee volatility in the future. Furthermore, option holders will be able to trade these options on any secondary marketplace they choose.
We have designed Pitch Lake to be oracleless — meaning it does not use oracles. This characteristic is very significant because oracles are oftentimes the most vulnerable part of any protocol. We believe that all data that was ever present onchain should not be accessed using oracles as it introduces unnecessary risk. Pitch Lake uses Fossil to fetch all the data it needs directly from the chain, ensuring that contract pricing is always correct.
Since someone could technically manipulate basefee by driving it up near expiry, we use Fossil to compute TWAPs over days, weeks, or even months (based on a vault’s parameters). Fossil is able to average basefee data found in thousands of blocks cheaply on Starknet.
All options have cash settlement in ETH. Settlement occurs at the same time for all vault participants, meaning that when someone triggers settlement, the payout amount (or loss) per option is fixed.
New options are minted and sold through a Gnosis Batch Auction — a fair method for price discovery. We set a reserve price such that options are not sold below their predicted valuation which we calculate with black-scholes.
If L2s began using Pitch Lake to hedge their exposure to basefee volatility, they would be able to offer their users predictable tx fees since they would no longer have to overcharge to compensate for their tokens price volatility.
For more technical information about Pitch Lake, please refer to our recently published paper.
Legal Notice:
This article and any information contained in it is subject to the Oiler Legal Notice available at https://docs.oiler.network/oiler-network/token/legal-notice-and-risk-disclosure-statement. Please carefully review the Legal Notice as it contains important legal information, risk disclosure statement, limitations and restrictions relating to the information that we provide, third-party resources and forward-looking statements.
