This article builds off of previous DeFi options categorization work, please check out this article released on December 1, 2020.
Similar to traditional markets, the DeFi landscape has experienced fragmentation, especially when it comes to cryptocurrency options. At SIREN Markets, we have been working on our v2 for trading options, and in the course of our development process, we have conducted substantial in-depth research into the field of available DeFi options protocols.
If you’re interested in learning more about the DeFi options landscape, read on for an in-depth analysis of the available protocols.
In traditional finance markets (TradFi), options are generally priced using the Black-Scholes model. The model assumes a liquid options market in order to calibrate the volatility surface which is a three-dimensional plot that shows the volatility level for different options with various expiries and strikes on a specific underlier. Further the volatility surface is used as model input to correctly price options.
Another well-known model is the Binomial Options Pricing Model (BOPM) used to price American-style options which may be exercised before their expiration date, unlike the European-style option that can be exercised only at expiry or Bermudan-style option which is exercisable on predefined dates.
Crypto option protocols do not follow the same rules as TradFi options. Decentralizing a protocol and making all operations occur on-chain comes with significant technical limitations that must be overcome by the protocol designers, for example:
- Expensive fees (otherwise known as “Gas”) make frequent trading prohibitive.
- Underlying returns in the markets are not normally distributed causing issues in calibrating volatility surface that can be used to correctly price the options.
- DeFi markets are not efficient yet, breaching one of the key assumptions of the Black Scholes model of a liquid and efficient market. The root cause of this is much information relating to cryptocurrency distribution being opaque or not well understood by the new TradFi investors who are switching from old school or traditional markets to the crypto sphere.
- The volatility factor and risk-free rate on cryptocurrency assets are not easily available as the option market is still in its growth phase. At the same time it is hard to predict because of lack of sufficient liquidity, making the option pricing difficult.
- Traditional options trading requires complex calculations to estimate prices and buy/sell amounts correctly. But as we’ve seen recently with the spike in gas prices, there is a difficult tradeoff between efficient pricing and low transaction fees that option protocol designers need to choose between. On the other hand, more calculations performed on-chain can further increase the gas costs but could enhance users’ confidence in the protocol as one that is truly decentralized.
- Finally, every information oracle used is another vector that affects pricing models. Option protocols are fundamentally limited by the quality and availability of their oracles which means that the crypto option market cannot exist without a reliable price feed.
The highlighted information uncertainty and technical limitations present unique challenges to DeFi option protocols. Nevertheless, different protocols in the DeFi landscape have approached these problems diversely with varying benefits and drawbacks. Investigation of these various projects are presented below:
Siren Markets 🧜
SIREN Markets (‘SIREN’) is a decentralized application used for creating, trading, and redeeming fully-collateralized option contracts for any ERC20 token on Ethereum.
SIREN is a fully collateralized options platform and the protocol does not require any oracles for settlement. Under this design, both the long and short sides of the contract are tokenized, which allows option buyers and sellers/writers to easily move in and out of their positions at any time.
The buyer side is represented by a bToken and the writer side is represented by a wToken. Tokenizing both sides of the contract enables the creation of a secondary market for short and long exposures. SIREN uses an on-chain Black-Scholes approximation to price options.
bTokens allow holders to buy (for calls) or sell (for puts) the underlying asset at a predetermined strike. wTokens allow holders to withdraw collateral if the option has not been exercised or withdraw the payment from an exercised option contract after maturity.
Becoming a writer is as simple as providing liquidity to a SirenSwap AMM. This liquidity is pooled with other liquidity providers, and when an option buyer purchases a bToken through the SirenSwap AMM, this liquidity is used to underwrite the option. The AMM sends bToken to the option buyer, and wToken to the AMM pool.
SirenSwap AMM uses a combination of constant-product bonding curve and options minting to trade bTokens and wTokens. The SirenSwap AMM does not require any asset in the pool other than bTokens and wTokens so users can trade them against the collateral asset.
The governance token for Siren Markets is called SI. The SI token will soon allow holders to participate in the decision-making of the protocol, including the creation of options markets, incentive programs, and more. When fees are enabled on the platform, transaction fees will accrue to SI token holders.
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Check out the docs here: https://docs.sirenmarkets.com/
Opyn(v1) was the first DeFi options platform with AMM liquidity from Uniswap and it uses a 0x orderbook in v2.
Price in Opyn is how much premium user pays for buying 1 oToken of puts and calls. Opyn v1 works in a way where option prices are determined by market forces (0x) and it is a two-way marketplace that exists where you can buy options or sell them, not just sell to close out for intrinsic value.
Without the option, it’s all about impermanent-loss vs fee-income, but with the option, it is about impermanent loss that can be hedged so it is about option-cost vs fee-income. Fee-income is relatively predictable by looking at pool utilization on Opyn just by analyzing trade volume/liquidity trend as compared to sudden price changes which are equal to the impermanent loss.
The cost of the option (time-price) comes as an offset so the baseline starts from negative. In Opyn, you are trying to earn fees from LP-ing. If the fee outperforms the option cost then it’s a good deal.
Opyn v1 was fully collateralized in a strike for puts and underlying asset for calls, so naked options (uncapped) can be written and purchased. Physically settled options will continue to be supported through v1 for the ‘long tail’ of options.
In Opyn v2, there are lower margin requirements and initially, a max loss will be required for spreads and less than a max loss will be required for naked options. Furthermore, yield and governance collateral token earning will be enabled to be claimed by sellers. In addition, v2 brings a governance functionality for future decentralization.
Hegic is an American-style, cash-settled options protocol that uses a peer-to-pool options model in its protocol that connects option buyers and writers. Pooled liquidity is great because it aggregates liquidity from all market participants automatically. Writers on Hegic, who sell their call or put options to make a premium need to provide liquidity to the Hegic pool. Therefore, liquidity Providers in Hegic are option writers and the pool provides collateral for many different options at the same time. Anyone that wants to come to Hegic to be a liquidity provider (LP) can deposit to Hegic and take on their pro-rata exposure to contract writing based on their share of the total writer liquidity. Furthermore, the option is written only when it is purchased.
Hegic provides buyers a large amount of flexibility in terms of choosing their underlying asset, duration and strike price. The prices are algorithmically determined based on the chosen contract characteristics. The price of an option is determined using a Black-Scholes approximation and uses skew.com to incorporate implied volatility (IV) into option prices. However, Hegic does not apply any additional price correction for market dynamics such as supply and demand and this lack of price correction means that under certain extreme changes in the underlying asset price, a Hegic pool may run out of collateral. Nevertheless, Hegic has a pooled LP model that sells options to buyers at any arbitrary strike. Hegic pools overprice non-ATM options which leave buyers with a bad deal, but it is worth keeping in mind that any AMM using the common Black-Scholes approximation is going to do the same. Unless buyers are buying ATM options, buyers on Hegic are overpaying the true Black-Scholes derived price.
The native token for Hegic is called HEGIC. The HEGIC token has a right to claim a share of the protocol fees (1% of all options volume traded on Hegic). Fees on Hegic are paid in the option’s underlying asset and this means that takers receive yield from the underlying asset.
Potion is a newcomer to space and is a one-sided option AMM which provides protections against the impermanent loss because of the high price volatility in the crypto market. In other words it works like insurance to protect the position and reduce the probability of extreme losses at the same time keeping the upside potential there. Nevertheless, it is worth highlighting that this “insurance” doesn’ mean that the holders will not incur losses in a volatile environment but it will rather work as a reduction of probability of such large losses over time.
Potion provides buyers a large amount of choice in terms of choosing their underlying asset, duration, and strike price and then users are quoted with an algorithmically determined price based on those input variables. The Potion AMM is a distributed bonding curve or multiple bonding curves per LP. The team links utilization to premium and it uses Kelly Criterion which makes the order size the bet size. Then it provides feedback regarding the correct premium size that would give the appropriate odds for the bet size. Finally, it puts the information on a bonding curve.
The Potion team is composed of technical talents who thought that LPs were taking on more risk than they are understanding. Their AMM uses reverse Kelly Criterion and they plan to account for supply and demand. Potion initially focused on survival rates from LPs and their goal is to provide comfort to LPs that they won’t go bankrupt at any time. Potion hopes to provide choice and diversity for end-users and enables users to create customized options and pick any strike and expiry.
FinNexus offers a lot of flexibility and choice to its users. It is a peer-to-pool options model that offers pooled liquidity and lower risks to LPs, thus increasing liquidity is an important focus. FinNexus applies the Black-Scholes model in option pricing. Furthermore, IV is their most important parameter that is fed into their protocol and the volatility surface is calibrated for different strikes and maturities.
FinNexus has two pools on Ethereum with FNX and USDC/USDT as collaterals. Options are purchased and settled in the related collateral asset. Another one of FinNexus offerings is the MASP which stands for Multi-Asset-Single Pool, this allows for hybrid assets as collateral. MASP enables collateral like USDC/USDT stable coin pool. MASP allows for unlimited types of assets to be included. Settlement for MASP acts like conventional trading in that settlement takes place in stablecoins. FinNexus also offers mining and staking.
FinNexus offers lots of diversity in terms of underlying assets. Therefore, LPs’ risks are more diversified thanks to the variety of underlying combined with the in-house risk adjustment parameters which act as an AMM mechanism and helps to balance the put and call distribution within the pool.
Another FinNexus product offering is FinNexus Protocol for Options (FPO). FPO is a cross-chain permission-less protocol for options and is also called The Universal Options Platform that has launched on Binance Smart Chain, Wanchain, and Ethereum.
Ribbon Finance have introduce a novel financial structured product to the Defi Options landscape. They offers high yields on ETH through an automated option strategy with their Vault Products. They use Opyn’s oTokens for their options-writing strategies.
This makes it easier compared to individual option trades whilst still being rewarded with upside gains. Recently they also launched their Ribbon Governance ($RBN) to further decentralize their protocol.
Charm is simplifying the option pools and is summing options to easily calculate values and is focusing on trying to grow the base options layer. The prices on Charm are driven by supply and demand allowing price discovery. It has also a very interesting AMM design that can trade multiple strikes but not ideal when you have to manually roll post-expiration.
Charm is working on a vault where LPs can deposit and it will automatically roll over liquidity to the next pool. In Charms view, risks for a passive LP are higher because there are more strikes so hedging relationships are trickier. At the same time, however, trading volumes are also more likely to be higher because more options are available and the slippage is lower due to the AMM design. Some other pools are safer (i.e. Primitive) but the yields are substantially lower because of the lack of liquidity. Therefore, very often there is a trade-off between LP investment and associated risk.
Finally, the fee for Charm is only 1% notional and there are no extra fees to close a position or for settlement.
Primitive has two tokens a LONG option and a SHORT option ERC20. It requires 100% collateralization to create options. When an option is created, one receives the Long and Short tokens which can be sold to have exposure against the option. Liquidity is added through Uniswap and is applied for the transaction of option tokens.
Opium offers a variety of option products and is a platform for both options and other derivatives. It has built products with a variety of underliers, such as COMP, YFI, NXM, BAL, and more. Furthermore, the Opium exchange enables the trading of Opium products and provides liquidity to users.
Opium also forged the trails of Credit Default Swaps (CDS) in collaboration with Aave in August 2020, which protects against the default of a borrower. It has developed a CDS Contract on USDT/USDC and WBTC/BTC price depreciation. In addition to CDS, Opium launched the first IRS product as well.
Hedget is a peer-to-peer decentralized options model with full collateralization and it supports European style options which means that the option can only be settled at the time of expiry. Hedget protocol token is called HGET which is the governance and utility token for Hedget and is issued on the Ethereum network as an ERC-20 contract. Hedget is built for Binance Smart Chain as well as Ethereum where Chromia is being incorporated as a Layer 2 enhancement for the Ethereum platform.
ACO — Auctus Options, is a decentralized non-custodial options protocol that is tokenized with orderbook liquidity. It creates liquidity pools for writers and these writers receive premiums automatically by selling covered options. ACO hopes to create custom liquidity pools for its users who chose minimum IV, which is adjusted based on the utilization rate of the pool.
An interesting component of ACO is its flash exercise feature. Flash exercise allows users to cover the cost of exercising their ACO options using Uniswap V2 flash swaps leaving users with final profits. For traders who want to get exposure with fewer funds, flash exercise allows users to exercise profitable options contracts in a single transaction even if users do not have the funds available to buy/sell the asset before maturity.
Finally, ACO introduced vault strategies for its users.
A message from SIREN
As always, thank you to all land walkers for joining us on our journey to bring the SIREN Markets to the world. We hope this survey of the various DeFi options protocols has sparked your interest in option protocols. And if you’re already familiar with them, we hope you’ve gained a clearer understanding of the ‘options’ available to you :).
🧜♀️ 🔱 💖
SIREN is a decentralized platform for trading cryptocurrency options designed for the sophisticated degen. As a trader, come participate in market upside while limiting your risk by buying options on your favorite DeFi tokens. As an LP, come pool your favorite DeFi assets to passively earn rewards when people bet on the markets.