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For LPs: Changes in Siren Lemuria

Illustration by Christine Flotzer

Siren Lemuria, the latest version of the Siren DeFi options trading protocol, will be released this month. In advance of launch we are sharing a two-part series of deep-dive articles on the technical improvements coming with Siren. See the Lemuria launch announcement for a high-level overview of the major protocol improvements and Part 1 of this series on changes for traders.

Upgrading Lyonesse to Lemuria

Siren Lemuria replaces the previous protocol version, Siren Lyonesse. Lyonesse launched in August 2021 and was already a significant improvement over the first version of Siren, which was launched on Ethereum Mainnet in March 2021.

One of the major improvements in Lyonesse was the move to Polygon, which allowed the protocol to execute more computation on chain due to Polygon’s faster execution time and lower gas fees.

The release of Siren Lemuria builds on the groundwork laid by the previous version to significantly improve the Siren protocol for all our users. This post focuses on modification that benefit Liquidity Providers (LPs), while our previous post examined modifications that benefit options traders.

Sticky Price Impact Discourages Scalping

The Siren Automated Market Maker (AMM) is designed primarily to enable options buyers to take leveraged exposure without the risk of liquidations over a medium-term duration. The AMM has always included the concept of price impact, which increases the price of an option proportionate to the size of the trade. This price impact discourages short-term scalping by adding a spread to each trade, which earns additional yield for LPs.

However, in Siren Lyonesse the price impact caused by a single trade had very little effect on the pricing of subsequent trades. This structure gave traders an incentive to split a single large trade in many smaller trades to circumvent the price impact of a large trade. Here is an example of a bot that systematically took advantage of this flaw to scalp the AMM, avoiding the price impact by splitting larger trades into >20 smaller ones.

Circumventing price impact in this way reduced the revenue paid to the AMM, which directly reduces the yields passed on to LPs.

Options trades circumventing price impact

Lemuria addresses this oversight by adding the concept of Dynamic Implied Volatility, whereby each trade’s price impact carries to the subsequent trade. This feature also enables market-driven price discovery for each option by assigning a separate implied volatility to each series that is influenced by both the historical volatility and the trading activity. This consistent application of price impact boosts the bottom line for LPs in Siren AMM pools.

Reducing Variability in LP APYs by Reducing Pool Exposure; Simpler Capital Management

In Siren AMM, options traders can only sell options back to the AMM that they previously purchased from the AMM. This restriction, that options sellers must first be options buyers, guarantees net positive trading flow for the AMM; i.e. the Siren AMM can’t buy more options than it sold. However, in previous versions of Siren LPs still occasionally experienced net long exposure.

wTokens and bTokens

Whenever an option is purchased by a trader, the Siren AMM takes a unit of underlying collateral, for example UNI, and locks it into a contract, and creates two tokens, a bToken (buyer token) and a wToken (writer token). The bToken goes to the option buyer, and represents their long exposure to the options contract. The wTokens represent the short side of the options contract. When an option is sold back, the options buyer sells the bToken to the AMM, which then gets paired with a wToken to unlock the UNI used to collateralize the option. That UNI stays in the AMM pool and becomes available to collateralize another options contract.

Reducing Long Exposure for Less Yield Variability

In previous versions of Siren, if a large LP withdrew their share from the pool, they would take short options tokens (wTokens) with them. If traders subsequently sold their long options tokens (bTokens) to the pool, there wouldn’t be enough short tokens to offset the long exposure. Holding bTokens for extended periods of time left the pool long on theta (time decay), which is undesirable given that we want LPs to always be selling theta, not buying it.

We observed this behavior in production several times, and it resulted in pool under-performance and lower LP yields.

In the new Siren Lemuria release, this issue is addressed via a wTokenVault contract that prevents wTokens from ever leaving the AMM. Instead of withdrawing wTokens, LPs will now receive a receipt that represents their collateral still held in the AMM as wTokens. This fix means that wTokens will stay in the pool and will continuously be used to close out options contracts, reducing the long exposure held by the AMM. Eliminating long exposure means reducing pool under-performance and more consistent APYs for LPs.

Simpler LP Capital Management

In addition to giving better returns, this change also lets LPs manage their capital by expiration date. Previously, LPs that withdrew their wTokens from the AMM had to manage capital held in each options series independently. Now, LP capital will be grouped by expiration date, which will simplify the capital management experience for LPs.

Siren DOV for More Trading Volume

An additional feature that is launching with Siren Lemuria is our DeFi Options Vault (DOV). At the moment, the primary way that users interact with the Siren protocol is through the Siren retail trading app, but in the future Siren will be used as an operating protocol for many different use cases.

For retail trading, the Siren AMM quotes pricing derived from the on-chain Black-Scholes model. With Siren DOV, the AMM can also accept external quotes from market makers and institutions, effectively creating a Siren Structured Product Vault.

The DOV feature has been running weekly options sales since January and has allowed Siren to significantly increase trading volume and usage rate of TVL, which in turn boosts the APY received by LPs. Wholesale options buying is how Ribbon Finance and other projects have risen to prominence over the last few months, and now Siren has the capability to drive similar volume. For more information on DOVs, see this post by QCP Capital.

The volume of trading through Siren DOV is currently limited only by the TVL available in Siren pools, and with the launch of Siren Lemuria we have the capacity to significantly expand the capital in the project, and thereby returns for LPs and traders alike.

Lemuria Coming Soon

Thank you for joining us on our journey through the deep sea to launch the latest version of Siren! We’re very proud of all of our contributors’ hard work, and we’re looking forward to sharing the new version of the protocol with the world very soon.

As always, join us in our discord to discuss Siren, options, and how together we can change the shape of DeFi and the world.

Keep swimming!

Team Siren 🧜‍♀️

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Siren is elevating the experience of cryptocurrency traders and yield farmers by bringing battle-tested financial primitives to the world of DeFi.

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Siren

Siren

A distributed protocol for creating, trading, and redeeming fully-collateralized options contracts for any ERC-20 token on Ethereum.

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