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Squeeth Primer: a guide to understanding Opyn’s implementation of Squeeth

(Acknowledgements: Zubin Koticha, Andrew Leone, Alexis Gauba, Joe Clark, Tammy Fisher for feedback, revisions, and being frens)

Squeeth Cat riding courageously into DeFi’s derivatives landscape on top of Uni v3

Introduction

Squeeth (squared ETH) is a new financial derivative invented by the Research Team at Opyn (Zubin Koticha, Andrew Leone, Alexis Gauba, Aparna Krishnan), Dave White, and Dan Robinson. Squeeth is the first Power Perpetual and gives traders perpetual exposure to ETH².

Mechanism-wise, Squeeth functions similar to a perpetual swap, tracking the index of ETH² rather than ETH. It provides global options-like exposure (pure convexity, pure gamma) without the need for either strikes or expiries, effectively consolidating much of the options market liquidity into a single ERC20 token.

In short, Squeeth makes options perpetual and is a very effective hedge for Uniswap LPs, all ETH/USD options, and anything that has a curved payoff.

Different Ways To Squeeth:

Long Squeeth

  • Long Squeeth is a leveraged position with unlimited ETH² upside, protected downside, and no liquidations. Long Squeeth offers pure convexity (ETH² payoff), giving it a more favorable payoff than 2x leverage. Compared to a 2x leveraged position, Squeeth will make more when ETH goes up and lose less when ETH goes down, but funding rates are expected to be higher due to exposure to pure convexity. Long Squeeth holders pay a funding rate for this position.

Short Squeeth

  • Short Squeeth is a short ETH² position, collateralized with ETH. Traders earn a funding rate for taking on this position, paid by long Squeeth holders. Short Squeeth positions can be liquidated. A user’s exposure to the price of ETH depends on the amount of collateral they have deposited, as well as if they own the collateral or have borrowed it with stablecoins elsewhere.

Automated Squeeth Strategies (🐂🦀🐻)

  • Squeeth strategies are a collection of automated yield strategies for different market conditions that allow users to earn funding, paid by the daily funding rate of Squeeth buyers. Users simply deposit ETH and the contract automatically manages the strategy.
  • The Crab Strategy will be the first Squeeth Strategy to launch.

Uniswap v3 SQTH-ETH Liquidity Providers

  • Liquidity providers earn LP fees for providing SQTH-ETH liquidity. LPing in the SQTH-ETH pool is similar to being long ETH^1.5, which is constantly rebalanced or continuous ETH 1.5x leverage. Users can mint or buy Squeeth and deposit Squeeth + ETH into the Uniswap V3 SQTH-ETH Pool. (Users who buy Squeeth and LP will pay funding which will result in the price of oSQTH trending downwards over time absent appreciation in the price of ETH)

Hedging Uniswap LPs with Squeeth

  • Constant function markets like Uniswap are notoriously difficult to hedge. However, it’s now possible to accurately hedge any non-linear exposure with a linear instrument (futures) and a quadratic instrument (Squeeth). Squeeth enables hedging Uniswap v3 LPs with almost no impermanent loss.

Hedging All ETH/USD Options with Squeeth

  • Options are difficult to hedge because the value of an option is a curved (i.e. convex) function of price. Squeeth is a hedging instrument for 𝑎𝑙𝑙 ETH/USD options. This is because it’s strike-less and expiry-less.

Using the Price of Squeeth as a Volatility Oracle

  • The price of Squeeth can be used as a volatility oracle; a predictor of how much volatility we expect in ETH over the short term. Using the price of Squeeth as a volatility oracle is more effective than any on-chain oracle for ETH volatility because it is directly tradable, and better than any individual option because it is not specific to a particular strike or expiry.

DeFi Protocols & Developers: Opyn’s goal is to enable any team to utilize Squeeth’s infrastructure

  • Teams offering yield strategies can build vaults that offer regular yield that is not subsidized by liquidity mining
  • Active Uniswap v3 liquidity managers can LP in the SQTH-ETH pool. This is similar to being long ETH^1.5, which is constantly rebalanced or continuous ETH 1.5x leverage
  • Arb bot devs can take advantage of of high or low funding across the Squeeth ecosystem
  • Lending protocols can use SQTH-ETH LPs as collateral for loans

Comparisons: Squeeth, Options, Perpetual Swaps

Long Payoff Comparisons: Squeeth, Options, Perpetual Swaps

Compared to options, Squeeth has several key advantages:

  • No strikes, no expiries
  • No liquidity fragmentation
  • No need to “roll” positions, avoiding risks and costs such as gas and spreads paid to market makers
  • Constant gamma (curvature of payoff)

Compared to perpetual swaps, Squeeth has several key advantages:

  • No liquidations on the long side
  • Compared to a 2x leveraged position, Squeeth will make more when ETH goes up and lose less when ETH goes down (funding rates for Squeeth are expected to be higher due to exposure to pure convexity)
  • The main difference between Squeeth and perpetual protocols is that Squeeth is a leveraged position (ETH² payoff) that is a fungible ERC20 token, enabling it to be traded separately (in uniswap pools, for example, or as collateral for loans). This composability is a major advantage to Squeeth’s design

Squeeth Mental Models:

  • Squeeth makes options perpetual
  • Squeeth allows you to hedge Uniswap v3 LPs with almost no impermanent loss
  • Squeeth effectively takes options & removes strikes and expiries to create a single ERC20 representing the entire options chain
  • Squeeth is a hedging instrument for 𝑎𝑙𝑙 ETH/USD options. This is because it’s strike-less and expiry-less
  • LPing in the SQTH-ETH pool is similar to being long ETH^ 1.5, which is constantly rebalanced or continuous ETH 1.5x leverage
  • The price of Squeeth can be used as a volatility oracle, a predictor of how much volatility the market expects in ETH over the short term
  • Squeeth can be thought of as offering pure convexity. It has constant gamma exposure, so it offers consistent optionality regardless of the price of ETH
  • Short Squeeth and Automated Squeeth Strategies offer regular yield that is not subsidized by liquidity mining
  • The Crab Strategy is a classic ‘short volatility’ position

Evolution of the concept: Everlasting Options → Power Perpetuals → “Squeeth”

Regular options have many strikes and expiries, and if you want to trade them consistently long term, this takes time, introduces risk, and gets expensive from spreads paid to market makers and gas costs on Ethereum.

The concept of Everlasting Options removes expiries completely from regular options. Since multiple expiries are no longer required, liquidity will be less fragmented. However, there are still multiple everlasting options for different strikes. This means there will still be liquidity fragmented across different portfolios of options contracts and traders will still have to decide between multiple strikes.

Power Perpetuals solve this and are a more specific implementation of Everlasting Options without strike prices. A Power Perpetual is a perpetual derivative indexed to a power of the price of an underlying asset, such as ETH. For any power p, the ETH^p power perpetual is kept in line with a funding fee paid at regular intervals (vs. premiums in options). Quadratic Power Perpetuals such as Squeeth give global options-like exposure (pure convexity, pure gamma) without the need for either strikes or expiries, having the ability to consolidate much of options market liquidity into a single instrument such as an ERC20.

Squeeth (squared ETH) is a Power Perpetual that tracks the price of ETH². This functions similar to a perpetual swap where you are targeting ETH² rather than ETH. Long Squeeth gives traders a leveraged position with unlimited ETH² upside, protected downside, and no liquidations. Squeeth buyers pay a funding rate for this position. In contrast, short Squeeth is a short ETH² position, collateralized with ETH. Traders earn a funding rate for taking on this position, paid by long Squeeth holders.

Squeeth is the first quadratic Power Perpetual in the history of DeFi and traditional finance.

Trading Squeeth in Practice

To recap: traders can buy or sell Squeeth, which gives perpetual exposure to ETH².

  • Buy Squeeth: ETH² upside exposure, pay a daily funding rate, no liquidations
  • Sell Squeeth: ETH² downside exposure, receive a daily funding rate, can be liquidated

Important Squeeth characteristics to understand:

  • Index price: the Squeeth index price is ETH²
  • Mark price: Mark is the current trading price of Squeeth
  • Funding rate: payments made by long Squeeth traders to short Squeeth traders based on the disparity between the Index Price (ETH²) and the Mark Price (current trading price of Squeeth), regularly (Mark — Index). Funding rate is set through demand and supply for the contract, which will determine the distance between the index price (ETH²) and the mark price (Squeeth price). Note, the funding rate for Squeeth is almost always expected to be positive due to long Squeeth’s convexity premium, however it is possible to be negative (i.e. shorts pay longs if the rate is negative).
  • In-kind Funding: Funding is not paid directly, but occurs through a continuous change in the value of the contract. It’s as if you are selling some of your position every day to pay funding. For example, if you are long Squeeth and you buy $1,000 worth of Squeeth exposure, funding will be deducted from your initial $1,000 oSQTH position. Funding happens every time the contract is touched (it is continuous)
  • oSQTH: oSQTH is the Squeeth ERC20 token and the price of your position that reflects the impact of daily funding since the contract was created
  • Normalization factor: a variable that adjusts the value of your position by the impact of daily funding. For Squeeth buyers, the normalization factor causes a user’s oSQTH value to slowly decline relative to the Index Price (ETH²) due to in-kind funding. For Squeeth sellers (someone who has minted squeeth), the normalization factor reduces the amount of debt owed for a short Squeeth position due to in-kind funding received.

Long Squeeth

Long Squeeth gives traders a leveraged position with unlimited ETH² upside, protected downside, and no liquidations. If you go long Squeeth, you always hold a position similar to an at the money call option except you have constant gamma exposure. This functions similar to a perpetual swap where you are targeting ETH² rather than ETH.

The ideal market condition to hold Squeeth is when a trader has conviction in the upward price movement of ETH in the short to mid-term. Holding a Long Squeeth position for an extended period (> 1 year), during which ETH trades sideways or goes down in value, will likely cause a loss in ETH² exposure of the Long Squeeth position due to in-kind funding paid to Short Squeeth sellers.

To open a long Squeeth position (buy Squeeth), a trader can use ETH to buy Squeeth on Uniswap. The amount of exposure to ETH² is directly related to the amount of ETH a trader uses to buy Squeeth (oSQTH is the Squeeth ERC20 token).

A hypothetical long Squeeth payoff can be visualized this way:

The impact of funding over time (oSQTH in USD)

The graph above shows the impact of a hypothetical constant funding rate for a long Squeeth position from November 2020 to November 2021.

To explain the concept of long Squeeth in action, let’s break down this example scenario:

On November 1st 2020, Alexis sees that ETH is trading at $450. She believes that the price of ETH will be significantly higher in the medium-term and decides to go long Squeeth to express this belief in the market. Alexis pays 10 ETH to buy 222 oSQTH, worth $4,500 of Squeeth exposure. (Each oSQTH is approximately 1/10000 of Mark Price)

November 1st 2020: Alexis’ ETH entry price is $450.

  • ETH Price: $450
  • Index Price (ETH²); $202,500
  • oSQTH balance: 222 oSQTH (4500/202500 * 10000 = 222.22 oSQTH)
  • Value of Squeeth exposure (oSQTH): $4,500

Fortunately for Alexis, while the price of ETH fluctuated over the following 12 months, her market outlook was correct (ETH continued to rise) and on November 1st, 2021, ETH traded at $4,300. She is satisfied with the price run, but anticipates the market cooling off or trading sideways so she exits her Long Squeeth position (oSQTH) with ETH at $4,300 to avoid paying more funding.

November 1st 2021: Alexis’ ETH exit price is $4,300

  • ETH Price: $4,300 (~10x)
  • Index Price (ETH²); $18,490,000 (~90x)
  • oSQTH balance: 222 oSQTH
  • Value of Squeeth exposure (oSQTH, less in-kind funding): $225,000 (~50x)

Alexis’ position has increased from $4,500 to $225,000

Over the year where ETH has gone up by 10x, oSQTH has gone up by 50x but ETH² has gone up by 90x. The difference is the impact of funding costs.

Risks: Of course, due to leverage, if ETH goes down, Alexis would also lose some of her initial investment. However she would lose less than the equivalent 2x leveraged perp due to the convex payoff curve of Squeeth, setting aside funding. With Squeeth Alexis also avoids the possibility of being liquidated, unlike 2x leveraged perps.

Leverage Without Liquidations on the Long Side

Long Squeeth gives traders a leveraged position with unlimited ETH² upside, protected downside, and no liquidations. Leverage (ETH² payoff) comes from being long convexity, and the reason long positions can’t be liquidated is due to in-kind funding.

What is convexity? In simple terms:

Squeeth has convexity because the relationship between the price of the underlying asset (ETH) and the value of Squeeth is not linear. In options land, this translates to the concept of gamma. Compared to a normal 2x leveraged payoff:

  • the more the price of ETH moves in your favor, the more money Squeeth will make you
  • the more the price of ETH moves against you, the less money Squeeth will cost you
Squeeth’s Convex Payoff vs “Normal” 2x Leverage Payoff

An even broader interpretation is that convexity in Squeeth leads to asymmetric payoffs — higher upside, lower downside compared to perp swaps (explained in the graph above). Asymmetry is what sets Squeeth (and options) apart from other financial products.

Of course, because convexity is more favorable, long Squeeth holders will pay a funding rate that is expected to be higher than funding for long perp swaps.

Recap: While using leverage with perpetual swaps exposes traders to liquidation risk, you cannot be liquidated if you buy Squeeth. However, it’s important to remember that Squeeth is ideal for short to medium-term trades. Due to in-kind funding, if you hold Squeeth for a really long time (> 1 year), the funding rate reduces the amount of Squeeth exposure from the time of initial deposit.

Funding Rates: How Squeeth Tracks the Index Price (ETH²)

We say that Squeeth tracks rather than equals ETH² because longs pay a funding rate to shorts to maintain the position. This is similar to funding payments for perpetual futures, except that there is no direct (cash) payment. Instead, changes in the relative price of a user’s Squeeth position (oSQTH) and ETH² give the same effect. This is in-kind funding.

In-kind funding works like the interest payment of a cToken in the Compound protocol or a zero coupon bond. There is no direct payment from long to short positions, but there is an exchange of value through the relative price of a user’s Squeeth position (oSQTH) and ETH² (in the same way as there is a change in the value of a cToken to represent interest payments).

  • For Squeeth buyers, oSQTH value slowly declines relative to the Index Price (ETH²)
  • For Squeeth sellers, oSQTH debt adjusts down

In other words, if you buy Squeeth, in-kind funding is paid out of your position. If you sell Squeeth, the amount of debt you owe adjusts down due to funding payments received.

The ultimate impact is the same as if we had cash funding. In-kind funding is used because it doesn’t require extra machinery on the token to pay or receive funding. In particular, it means the entire Squeeth contract fits into a standard ERC20 contract.

The Normalization Factor in the Squeeth Mechanism

Under the hood, the funding rate (i.e. in-kind funding) is implemented by a single variable called the normalization factor. The normalization factor is a global variable that reduces the relative value of a user’s long Squeeth position by adjusting down the debt owed by a short Squeeth position, i.e. someone who is short:

(value of debt in ETH) = (original debt amount) * (normalization factor)* (ETH price)

The equation above details how the value of Squeeth debt adjusts down with the normalization factor. For example, if a trader borrows one unit of Squeeth and the normalization factor changes from 1 to 0.99 over a week, this is equivalent to receiving 1% funding. If it decreases to 0.97 after another week, this is equivalent to receiving 2% funding over that week. Changes in the normalization factor between two points in time represent the funding rate paid or received to hold a Squeeth position (oSQTH).

It’s expected that funding will be paid from longs to shorts, so this normalization factor will decrease over time, reducing the relative price of oSQTH and making the debt cheaper to repay.

oSQTH vs Squeeth

We call the ERC20 token that is minted oSQTH. The price of this token reflects accumulated funding from the time the contract is created. For comparisons to ETH² we adjust for the impact of the normalization factor and scale by 10,000 to put the number in more natural units:

squeeth price = 10,000*(oSQTH price in USD)/(normalization factor)

The value of Squeeth will be close to ETH², while the value of oSQTH will be proportionately smaller over time.

To visualize the normalization factor and compare the price value of oSQTH to ETH² over time, let’s revisit the long Squeeth example from the previous section. The figure below shows the impact of a hypothetical constant funding rate for Squeeth from November 2020 to November 2021. The cumulative funding is around 50%, which is reflected in the final difference between ETH² and oSQTH.

The impact of funding over time (oSQTH in USD)

Over the year, ETH has gone up by 10x, Squeeth has gone up by 50x but ETH² has gone up by 90x. The difference is the impact of funding costs.

For a more detailed look at Squeeth funding, variance, and implied volatility, please see Joe Clark’s Squeeth Insides Volume 1: Funding and Volatility paper.

Short Squeeth

Short Squeeth is a short ETH² position, collateralized with ETH. Traders earn a funding rate for taking on this position, paid by long Squeeth holders. If you short Squeeth, you hold a position similar to always selling an at the money straddle, where you have constant negative gamma exposure. This functions exactly like a perpetual swap, where you target ETH² rather than ETH. Short Squeeth positions have the possibility of being partially or completely liquidated.

At the recommended collateralization ratio of 200%, the ideal market condition to short Squeeth is when there is conviction the market is overpricing volatility and the price of ETH will trade sideways. It’s expected that Squeeth holders will pay Squeeth sellers a higher funding rate than perp holders to compensate Squeeth sellers for being short convexity.

Because short Squeeth positions are collateralized with ETH, decreases in the price of ETH do not result in an ETH² payoff at the recommended collateralization ratio of 200%. The amount of exposure to ETH is directly related to the collateralization ratio of the position and whether or not the collateral was borrowed with stablecoins elsewhere. The maximum amount you can lose with a short Squeeth position is the amount of collateral used to mint and sell Squeeth, minus the premium received from selling.

To open a short Squeeth position (sell Squeeth), a trader can put down ETH collateral to mint and sell Squeeth on Uniswap. For Squeeth sellers, oSQTH represents the debt owed by a short Squeeth position.

A hypothetical short Squeeth payoff can be visualized below:

Hypothetical Cumulative Return From Holding a Short Squeeth Position With 2x Collateral

The graph above shows a hypothetical cumulative return from holding a short Squeeth position with 2x collateral from January 3, 2021 to April 1, 2021 — a period when the price of ETH rose from $975 to $1,967 (+101% increase).

Important characteristics to understand:

  • The return of Squeeth itself is not path dependent. In other words, the return over a period can be determined by the start and end values (squared price at the end less squared price at the start)
  • Squeeth returns including collateral returns are path dependent. In other words, PnL for two examples using the same entry and exit prices can vary significantly based on how volatile the price is over the period.
  • The path dependence of short squeeth arises because we have to change the collateral amount each day to keep a constant 2x collateral ratio
  • The total return of short Squeeth including collateral can be broken down into four components for each day that the position is held: 1) Squeeth return based on change in ETH price, 2) Squeeth return based on squared change in ETH price, 3) Collateral return based on change in ETH price, 4) Funding costs
  • Holding exactly 2x collateral at the start of each day means the Squeeth returns from changes in eth price and collateral returns exactly cancel out, leaving only squared changes in eth price and funding costs
  • The figure above shows these two primal forces battling for supremacy: variance (squared eth returns — blue line) and funding (red line)
  • The blue line measures how much volatility there has been. If there are a lot of large daily moves, regardless of the start and end price, the blue line will be lower. In other words, if volatility is high then the blue line would be much lower (steeper negative slope), and if volatility is low then the blue line will be closer to 0 (flatter slope).
  • This is called a short volatility position because the return is lower if the volatility of the price is higher.

To illustrate the concept of short Squeeth in action, let’s break down this example scenario:

On January 3, 2021, Joe sees that ETH is trading at $975. He believes the market is overpricing volatility and that the price of ETH will trade relatively sideways in the short to medium-term, so he decides to short Squeeth and hold 200% collateral. He recognizes it’s fine if the price of ETH increases, as long as there are no large spikes in the price of ETH. Joe uses 20 ETH to mint & sell Squeeth.

May January 3, 2021: Joe’s ETH entry price is $975.

  • ETH Price: $975
  • Index Price (ETH²); $950,625
  • Collateralization Ratio: 200%
  • Collateral Amount: 20 ETH (Full Collateral value $19,500, Notional Squeeth Exposure $9,750)
  • Hypothetical funding rate: .49% (randomly chosen to illustrate a hypothetical cumulative return)

As you can see above, at a 200% collateralization ratio Joe has approximately 1.025% of a full Squeeth (~$9,750 in Notional Squeeth Exposure, the Index Price (ETH²) is $950,625)

Now let’s break down each short Squeeth return component on a daily basis to explain Joe’s cumulative return:

Short Delta (∆ ETH)² Return

From Jan 3 to Jan 4, the price of ETH increased from $974.97 to $1,042.40 (∆ ETH = $67.43). The (∆ ETH)² return is $4,546.80. Since Joe has approximately 1.025% of a full Squeeth (ETH²), his daily short Delta (∆ ETH)² return is -($46.6).

Short Funding Received

Our hypothetical daily funding rate is .49%. To determine the daily funding received, square the ETH price and multiply it by the funding rate (ETH is $1,042.40 on Jan 4, so ($1,042.40)² * .49% = $5324.32). Since Joe has approximately 1.025% of a full Squeeth (ETH²), his daily funding received is $53.64.

Collateral Return

From Jan 3 to Jan 4, the price of ETH increased from $974.97 to $1,042.40 ($67.43 difference). Since Joe deposited 20 ETH as collateral, his collateral return is $1,348.60.

Cumulative Short Squeeth Return: Jan 3 to Jan 4

At a 200% collateralization ratio, the total PnL for Joe is (see Squeeth WhitePaper for a detailed breakdown)

-(eth price change)² + funding

So, from Jan 3 to Jan 4, Joe has earned a return of -($45.46) + $53.24 = $7.78.

More daily return figures for this example:

Daily Short Squeeth Returns at 200% Collateralization Ratio

Fortunately for Joe, although the market didn’t exactly trade sideways from January 3, 2021 to April 1, 2021, there were no large spikes in the price of ETH as it moved higher from $975 to $1,967. The cumulative funding earned from shorting Squeeth (red line) outweighed the losses from the squared price changes (blue line), resulting in a positive cumulative short Squeeth return (yellow line). Despite the price of ETH increasing 101% over a 3 month period, the market was overpricing volatility and the “premium funding” earned from being short convexity resulted in a positive cumulative return of 50.84%. Joe is satisfied with the the funding earned, but anticipates ETH breaking out, so he exits his short Squeeth position with ETH at $1,967 to realize his gains.

Hypothetical Cumulative Return From Holding a Short Squeeth Position With 2x Collateral

Hypothetical Cumulative Return Variables:

  • Implied Volatility: 133.73%
  • Realized Volatility: 109.13% (the standard deviation of daily eth price returns annualized)
  • Funding Rate: .49% (daily funding is (implied volatility)²/365 = 0.49%)

Hypothetical Cumulative Return Output:

  • Short Side $ Return: -$2,922,300.06
  • Dollar Funding : $1,090,070.34
  • Sum of squared price changes: $606,802.62
  • Dollar Collateral Return: $1,936,270.92
  • Total $ Return: $483,267.72
  • Total % Return: 50.8400%

To emphasize that Squeeth returns are path dependent, the chart below shows an example using the same entry and exit prices, but with extreme ETH price volatility between Jan 24 and Feb 7. You can see that the return profile varies significantly based on differing daily volatility levels of ETH.

Hypothetical Short Squeeth Cumulative Returns Emphasizing High ETH price Volatility (Jan 24 - Feb 7)

Risks: Large daily moves in the ETH price become much larger when they are squared, as we see in the second chart. Sustained periods of high volatility will make the blue line very negative as the large squared returns add up. If the ETH price is increasing, Joe will need to top up his collateral to avoid being liquidated. If the ETH price decreases, the value of Joe’s collateral will decrease, though this will be offset by reduced exposure to short Squeeth. Joe is a vol trader now, he needs to think of everything squared!

Since selling Squeeth exposes a trader to liquidation risk, it’s important to monitor the liquidation price set by the minimum collateralization threshold (150%).

Automated Squeeth Strategies 🐂🦀🐻

By pairing long ETH with short Squeeth, we get REALLY cool automated strategies to generate yield from Squeeth buyers.

Squeeth strategies are a collection of automated yield strategies for different market conditions (🐂🦀🐻) that allow users to earn funding, paid by the daily funding rate of Squeeth buyers. Users simply deposit ETH and the contract automatically manages the strategy.

The first Automated Squeeth Strategy to launch will be the Crab Strategy 🦀

Opyn’s goal is to enable any team to utilize squeeth’s infrastructure. There will be a few Opyn foundational strategies (Crab: neutral exposure to eth, Bull: positive exposure to eth , Bear: negative exposure to eth), but integration teams can adjust any parameter of the trading strategy to create their own strategies or build their own novel strategy with different mechanism, triggers, etc. (more details below)

Crab Strategy 🦀 [Launches January 24]

The Crab Strategy allows depositors to collect funding without being short ETH. The vault pairs short Squeeth with long ETH to create a position with an approximate delta of 0 to the price of ETH. This is a classic ‘short volatility’ strategy.

The Crab Strategy is similar to selling a continuous straddle that resets periodically to be at-the-money. The strategy is profitable between rebalances as long as ETH moves less than an amount that is based on the funding received from the short Squeeth position (approximately 6% in either direction in a single day, subject to volatility). In other words, the crab strategy takes the view that volatility is high. If ETH goes up or down less than the amount of implied volatility, the strategy makes money. The strategy rebalances daily, or upon a large move in the price of ETH, to be delta neutral by buying or selling ETH vs. Squeeth.

This strategy is short Squeeth, which is how yield is earned. At each rebalance, the strategy is also long an amount of ETH that cancels out the Squeeth exposure to the price of ETH, leading to an approximate delta of 0 to the price of ETH. The strategy rebalances on a time-based or price threshold to maintain this 0 delta exposure, meaning the positions frequently reset to having 0 ETH exposure. The Crab Strategy has constant negative gamma exposure.

Crab Strategy Payoff Profile

If the Crab Strategy falls below the safe collateralization threshold (150%), the strategy is at risk of liquidation. Rebalancing based on large ETH price changes helps prevent a liquidation from occurring. If ETH moves more than an amount that is based on the funding received from the short Squeeth position (approximately 6% in either direction in a single day, subject to volatility) the strategy is unprofitable. In other words, the Crab Strategy takes the view that volatility is high. If ETH goes up or down more than the amount of implied volatility, the strategy loses money. If the Squeeth premium to ETH increases, the strategy will incur a loss because it will be more expensive to close the position.

ETH Bull Yield Strategy 🐂 [Coming Soon]

The Bull strategy rebalances on a time-based or a price threshold to maintain a 1 delta exposure, meaning that the Bull strategy has constant exposure to long 1 ETH while earning funding. The strategy has constant negative gamma exposure.

ETH Bear Yield Strategy 🐻 [Coming Soon]

The Bear strategy rebalances on a time-based or a price threshold to maintain a -1 delta exposure, meaning that the strategy has constant exposure to short 1 ETH while earning funding. The strategy has constant negative gamma exposure.

Uniswap v3 SQTH-ETH Liquidity Providers

Liquidity providers earn LP fees for providing SQTH-ETH liquidity. LPing in the SQTH-ETH pool is similar to being long ETH¹.5, which is constantly rebalanced or continuous ETH 1.5x leverage. Users can mint or buy Squeeth and deposit Squeeth + ETH into the Uniswap V3 SQTH-ETH Pool. (Users who buy Squeeth and LP will pay funding which will result in the price of oSQTH trending downwards over time absent appreciation in the price of ETH)

Hedging Uniswap LPs with Squeeth

Constant function markets like Uniswap are notoriously difficult to hedge. However, it’s now possible to accurately hedge any non-linear exposure with a linear instrument (futures) and a quadratic instrument (Squeeth). Squeeth enables hedging Uniswap v3 LPs with almost no impermanent loss.

Uniswap LP hedged with Squeeth

For a full discussion, see Joe Clark’s Hedging Uniswap v3 LPs with Squeeth paper.

Hedging All ETH/USD Options with Squeeth

Options are difficult to hedge because the value of an option is a curved function of price. Hedging options with futures (delta hedging) is never exactly right because the amount of the hedge changes with the asset price. Squeeth is an easy-to-use quadratic contract that can be used as a hedging instrument for 𝑎𝑙𝑙 ETH/USD options. This is because it’s strike-less and expiry-less

Hedging a call option with Squeeth

For a full discussion, see Joe Clark’s Hedging Options with Squeeth paper.

Using the Price of Squeeth as a Volatility Oracle

The price of Squeeth can be used as a volatility oracle; a predictor of how much volatility we expect in ETH over the short term. This index is similar to the VIX price, which is a market priced based measure of volatility for US equities. Using the price of Squeeth as a volatility oracle is more effective than any on-chain oracle for ETH volatility because it is directly tradable, and better than any individual option because it is not specific to a particular strike or expiry.

For a more detailed look at Squeeth funding, variance, and implied volatility, please see Joe Clark’s Squeeth Insides Volume 1: Funding and Volatility paper.

Building on Top of Squeeth 🏗️

Opyn’s goal is to enable any protocol or developer to utilize Squeeth’s infrastructure. Squeeth has many powerful use cases and we want to make it as easy as possible for teams to integrate with Squeeth’s core contracts. If you’re a developer or a builder, let’s build the Squeethcosystem together! Reach out if you’re a:

  • Team building active or passive yield strategies
  • Active Uniswap v3 liquidity manager
  • Arb bot devs or quant traders
  • Lending protocol
  • Creative builder with your own idea

For Automated Squeeth Strategies, there will be a few Opyn foundational strategies (Crab: neutral exposure to ETH, Bull: positive exposure to ETH , Bear: negative exposure to ETH), but integration teams can adjust any parameter of the trading strategy to create their own strategies or build their own novel strategy with different mechanism, triggers, etc.

Example parameters for adjusting Automated Squeeth Strategies could be: how often the strategy trades / hedge frequency, how much of its delta does it trade, auction params, etc.). Could also have some signal based trading strategies too (if RV*1.5<IV, sell squeeth, trade in or out depending on IV vs market, or similar ideas).

Squeeth Risks

Liquidation Risk

Can I be liquidated if I buy Squeeth (go long Squeeth)?

No. Long Squeeth is a leveraged position with unlimited ETH² upside, protected downside, and no liquidations. However, funding is paid in-kind (as a percentage of the Squeeth holder’s position), so timing matters significantly. Because funding is taken from a trader’s position, the amount of ETH² exposure will decrease over time. For this reason, traders should assess the holding period of their long Squeeth position and recognize its payoff will depend on ETH’s daily price movement and the ongoing impact of in-kind funding during the period the position is open.

Can I be liquidated if I sell Squeeth (go short Squeeth)?

Yes. If short Squeeth positions fall below the safe collateralization threshold (150%), they are at risk of liquidation. Downside risk for short Squeeth positions is limited to the amount of collateral used to mint Squeeth (and sell it). The suggested collateralization ratio for short Squeeth positions is 200%.

Uniswap TWAP Risk

What are the risks associated with Uniswap v3 GMA TWAP?

Squeeth uses the Uniswap v3 GMA (geometric moving average) TWAP of the more liquid ETH-USDC or ETH-DAI pool to make it harder to manipulate an oracle price. However, there are still risks if the liquidity is low enough in the more liquid of the two pools to manipulate the oracle price. The main risk associated with a manipulated oracle price is that a trader could create a vault that is underwater, enabling her to mint Squeeth that’s not fully backed and immediately sell the Squeeth position for more money than originally deposited. Other risks from a manipulated TWAP oracle price are forced liquidations or attempting to make Squeeth funding too high or too low.

What measures is Opyn taking to combat oracle manipulation?

To combat the possibility of a Uniswap v3 GMA TWAP oracle manipulation, Opyn uses the more liquid of the ETH-USDC or ETH-DAI pool and sets a TWAP period long enough to combat economically viable manipulation attempts.

For more details on methods to combat Uniswap v3 TWAP oracle manipulation, see Euler’s paper here.

Smart Contract Risks

Have Squeeth contracts been audited?

Yes, Squeeth smart contracts have been audited by Trail of Bits, Akira, Sherlock, and have been peer reviewed. Additionally, Opyn has partnered with Sherlock’s to provide $10M smart contract coverage and a $1M ImmuneFi bug bounty. However, Squeeth is an experimental technology. We encourage extreme caution when interacting with all smart contracts, including Squeeth. Only use funds you can afford to lose. See the Opyn Terms of Service for a full list of risks and waivers associated with smart contract risks.

DeFi User Procedural Risk

What are DeFi procedural risks associated with using Squeeth?

Beyond the risks outlined above, DeFi users take on procedural risk associated with their use of apps and private keys that might put their assets at risk. Using certain wallets or maintaining weak authentication methods can put your holdings at risk. Please use caution and best practices when utilizing your assets across DeFi in general.

Squeeth Cat Being Squishy (inspired by the only gif that appears when you search “Squeeth”)

Power Perpetuals are still in their infancy, but we have been studying them in depth since their inception (July 9, 2021!) and remain extremely excited about their potential.

If you are as intrigued by this new primitive as we are, we would love to hear from you. You can join the Opyn Discord, email us squeeth@opyn.co or DM Opyn or Dave White on Twitter.

Disclaimer: This post is for general information purposes only. It’s also just an elaborate plan to get people to say a funny word. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. It should not be relied upon for accounting, legal or tax advice or investment recommendations. This post reflects the current opinions of the authors and is not made on behalf of Opyn or its affiliates and does not necessarily reflect the opinions of Opyn, its affiliates or individuals associated with Opyn. The opinions reflected herein are subject to change without being updated.

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Opyn is building DeFi-native derivatives and options infrastructure. Inventors of Squeeth @ opyn.co

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