Structure Finance presents Volatility Staking Without Options
Harvesting volatility risk premium (VRP) is a common long-term strategy for investors in most asset classes because market participants are willing to overpay for protection.
Current high yields in crypto are due to the immaturity of the crypto ecosystem. Staking and lending yields will be lower as the crypto world matures and funding becomes more abundant. Yield staking opportunities will dry out should we see another “crypto-winter”. Volatility risk premium harvesting is a mature approach to generating income on your holdings. VRP harvesting has been around for decades in traditional financial markets.
Volatility income does not depend on the inefficiency of the market but rather is a form of “insurance selling”. Traditional financial markets have popular products for VRP harvesting like variance and volatility swaps that do not require trading options and delta-hedging. No such DeFi products exist yet in the crypto space even though implied volatility is rich and ripe for VRP harvesting.
Instead of trying to replicate products from traditional finance, we have created a DeFi specific paradigm for VRP harvesting. Volatility Income Pools (VIP) generate income via volatility risk premium harvesting on a much more frequent scale than option selling.
Volatility Income Pools (VIP)
VIP is a system of two capital pools to bet on realized volatility of crypto without trading options. Invest in FLOW pool to harvest volatility risk premium (systematic overpricing of financial insurance) if you expect crypto to just move sideways. Invest in LEAP pool if you expect large moves or need to hedge exposure (for example, impermanent loss on a DEX). These pools accrue volatility-linked income daily or hourly (our current live beta accrues hourly but the upcoming VIP 2.0 will be accruing daily), but investors can keep crypto there for as long as they like.
Any Coin, Any Chain
VIP is by design perfectly adapted for consistent multi-chain deployment. Arbitrage ensures consistency between VIP instances across different chains. Development and deployment for different chains are straightforward — currently, we are running a beta instance of hourly VIP-BTCUSDT on BSC Mainnet.
By its nature, VIP can be linked to the price of any coin. We already have it working on a BTCUSDT and any developed coins like BTC or ETH are very easy. However, it can be easily linked to alt-coins or even project tokens, as long as there are volatility sellers and volatility buyers.
FLOW pool is for investors who expect absolute return over the next day to be muted.
LEAP pool is for investors who bet on a large absolute move over the next day.
At the end of each day, FLOW and LEAP pools exchange a fixed percent fee for an absolute percent change in underlying crypto over that day
Every period we calculate the absolute percentage change of the underlying crypto
ABSOLUTE RETURN = ABS( crypto price now / crypto price 1 day ago — 1.0 )
This is what FLOW pool is going to pay to the leap pool.
FLOW to LEAP = ABSOLUTE RETURN * FLOW starting balance
In exchange, LEAP pool pays a premium rate.
LEAP to FLOW = premium rate * LEAP starting balance
In addition, both pools are charged a small liquidity fee. The smart contract uses this fee to buy STF and hold it in reserve.
At the end of the period, the amounts in the two pools are adjusted by the payments
FLOW end balance = FLOW starting balance + LEAP to FLOW — FLOW to LEAP — liquidity fee
LEAP end balance = LEAP starting balance + FLOW to LEAP — LEAP to FLOW — liquidity fee
Take VIP BTC as an example which is linked to a daily USDT/BTC exchange rate.
FLOW starting balance = 10 BTC
LEAP starting balance = 1 BTC
USDT/BTC starting price = 50,000
USDT/BTC end price = 51,000
premium rate = 50%
liquidity fee = 0.1%
Absolute percentage change of USD/BTC over the day
ABSOLUTE RETURN = ABS( 51,000 / 50,000–1.0 ) = 2.0%
Payments between the pools at the end of the day
FLOW to LEAP = ABSOLUTE RETURN * FLOW starting balance = 10 * 2.0% = 0.2 BTC
LEAP to FLOW = premium rate * LEAP starting balance = 1 * 50% = 0.5 BTC
Balances at the end of the day
FLOW end balance = 10 + LEAP to FLOW — FLOW to LEAP — liquidity fee = 10.29 BTC
LEAP end balance = 1 + FLOW to LEAP — LEAP to FLOW — liquidity fee = 0.699 BTC
VIP Is Trading Options Without Trading Options
Each VIP period is essentially a straddle option trade between FLOW (option sellers) and LEAP (option buyers). Straddle since the absolute change of the underlying that’s paid by the FLOW pool is a straddle option with a notional value equal to the size of FLOW pool at the beginning of the period. The premium for this straddle is the fixed payment by the LEAP pool times the size of the LEAP pool at the beginning of the period. So the actual price of the straddle per unit of underlying, straddle price is determined by the ratio of funds in the pool:
STRADDLE PRICE = premium rate * LEAP balance / FLOW balance
Crypto volatility is very expensive across all expirations since there is high demand for options but not enough option sellers. However, crypto volatility for short-dated options is especially rich. A backtest for the performance of the FLOW pool of VIP-BTC daily (not-compounded) accrued several hundred percent over the last year.
Live beta of a similar VIP instance (hourly, though) has accrued 78% over the first two months, albeit with a little bit more volatility.
What’s next for VIP?
Next week we are releasing VIP 2.0 which will have daily observations and right away will have instances for BTC, ETH, and our own token, STF. Keep your ears open for the announcements and reward programs!
We are also working with several other smart chain projects to get VIP running on their platforms. In addition, we would like to hear which coins you would like us to add next.