It has been over 5 months since I, as well as Nicholas Krapels, finished the last comparison article on Decentralized Options Platforms, which I called “The next big DeFi opportunity.” DeFi is moving incredibly fast and much has changed during the past few months. Prices for nearly all DeFi assets, including our own FinNexus (FNX) token, peaked at the end of August. While the SUSHI drama surely stopped the price momentum of the industry, it did not dampen the development momentum of DeFi projects. If anything, we’ve seen bigger, bolder announcements of far more ambitious projects than the old DeFi Summer food tokens, which were not much more than a single-asset rewards token contract that emitted emoji-backed cryptocurrency. APY.finance, Barnbridge and Hegic have all made their mark on the DeFi industry. Each in their own way represents significant strides in providing a robust, composable suite of DeFi base-layer protocols.
However, the pace and growth of development in the DeFi options industry has moved to the forefront of the DeFi industry. New DeFi options models and projects pop up with increasing regularity. Therefore, at the request of readers, and also for general educational purposes for DeFi users, this article will serve as an update of the previous comparison analysis published by CoinMonks. It is recommended to go through the previous article before jumping too deep into this update.
The DeFi options platforms below are listed in no particular order.
(The table is made on 25 Nov 2020)
Hegic is the star platform of all the decentralized options marketplaces in the past few months. It successfully completed the $HEGIC token sale in September 2020, using a unique IBCO mechanism. The Hegic v888 model, which went live on October 10, 2020, represented a landmark shift for the Hegic protocol. Previously, liquidity pools were separated into put and call pools, with DAI serving as collateral for the ETH put pool and ETH itself serving as collateral in the ETH call pool. The v888 model completely changed the role of liquidity pools into bidirectional pools, which allowed ETH to serve as collateral for both ETH calls and puts. The novel mechanism also made it easier to start up a liquidity pool for WBTC calls and puts. Also, the introduction of the $HEGIC token made it possible to incent these liquidity pools with something more than just the profits and losses from the pools themselves. With generous liquidity mining rewards and active community involvement from pseudonymous lead solo developer 0MOLLY WINTERMUT3, the Hegic protocol has seen over $75 million locked in its two collateral pools in less than 2 months since launching v888.
IBCO stands for Initial Bonding Curve Offering. The Hegic team deployed a linear bonding curve via smart contract that guaranteed the same settlement price for all offering participants. This mechanism provides a price floor for the token and linearly also linearly increases the token price in tandem with the number of participants. The aim of the bonding curve offering was to prevent the front-running issues that are prevalent in most initial Uniswap offerings.
This token sale was quite a success with 31,000 ETH raised during this IBCO process.
Though Molly’s team remains anonymous, the naming of v888 might give away their origin (just a wild guess). With the mainnet debut of this new version of Hegic on October 10, the basic pooled liquidity model remained from previous versions of the protocol, but there were some dramatic changes to the mechanisms which govern how those liquidity pools operate.
Here is a rundown of the basic differences.
Hegic v888 has a dual pool model. The previous DAI and ETH pools were terminated while new ETH and WBTC liquidity pools were created.
Both ETH and WBTC options are included in v888 while previously only ETH options were available.
The Hegic liquidity pools are now bidirectional, which means that the writing of both puts and calls can be powered by the same pool, with WBTC and ETH as underlying assets respectively. Previous versions of the protocol allowed ETH puts to be backed by the DAI pool, and ETH calls to be backed by the ETH pool.
Very attractive mining rewards, denominated in rHEGIC, a token that can later be converted into HEGIC, are promised for providing liquidity to the collateral pools.
Options do not have to be physically settled as in the last version of Hegic. WBTC and ETH now serve as the basic currency for cash settlement.
According to DeFipulse, the TVL in Hegic v888 has been rising dramatically since its birthday.
Moreover, until 18th Nov 2020, 880 options were traded and the total trading volume reached $38,000,000 USD. Indeed, Hegic’s first month was a bit of “hedge magic.”
More information can be found on the Hegic dashboard here on Dune analytics.
Hegic uses a peer-to-pool options model in its protocol. The liquidity pools are the counterparties to all the options, with any variety of terms, written from that pool. Liquidity is collectively shared with all the buyers, with zero price slippage. This model also provides more flexibility for the option writers. Please read the last article for a deeper understanding of the benefits.
Hegic v888 uses bidirectional liquidity pools. Previously, put and call pools were separated, ensuring that options written from the pool were always fully collateralized and physically settled. However, in this old model, the liquidity provider for each different pool faced one-sided risks. For example, the DAI pool could only write put options. Therefore, liquidity providers were more likely to lose money when the market moves to the downside because all of the options written from the pool would be in the money. In other words, maintaining separate pools meant that the risks were only partially diversified, hurting the risk-adjusted returns of the liquidity providers. Smart liquidity providers could of course hedge against these one-sided risks, but that kind of protective diversity was not baked into the protocol as it is in v888.
With bidirectional pools in Hegic v888, puts and calls are simultaneously powered by the same pool. If puts lose money, calls will be in profit. This bidirectionality mitigates the risks of a pool with only a single type of options because it further diversifies risk.
Moreover, Hegic token holders earn attractive staking rewards and pool contributors earn are incented with generous liquidity mining rewards. Options buyers also enjoy rewards from Hegic that are a bit like rebates. Please refer to the Hegic docs or its website for more details.
In the previous Hegic model, the pool’s logic was built on the physical settlement of options, which left no worries about whether or not a pool may ever be undercollateralized. However, in v888, the case is different. The pools are bidirectional and can write calls and puts.
Let’s take the v888 ETH pool, for example. For writing call options, it is no problem, as the pool is comprised solely of ETH and can therefore always deliver when call option holders exercise their options, no matter how the market price moves. In other words, the provided collateral for the liquidity, since it is denominated in ETH, also appreciates as the ETH price grows.
But for put options, bidirectionality can be a problem. Puts give option holders the rights to sell ETH at a certain USD price, like protection or insurance. In Hegic’s model, if an option holder exercises a put, the pool needs to deliver the difference between the market price and the strike price, which is calculated in USD but delivered with ETH tokens. In v888, this is called cash settlement of options. In prior versions of the Hegic protocol, it was physically settled.
Now suppose the ETH price drops by 30% in a week. The value of ETH in the pool also decreases by 30%, which undermines the pool’s capability of performance. In extreme cases, if there are full of at-the-money (ATM) 4-week puts against the pool and the ETH market price drops 50% in this 4-week period, the pool will be drained. If it drops more than 50%, the pool will be incapable to perform.
For now, Hegic does not specify the current collateral ratio requirement in their documents, but it would be safer to keep the collateral ratio higher than 100% or make it dynamic according to the market conditions.
· Option Pricing
Hegic applies a special and simplified pricing model for pricing options, different from the traditional ones, and the implied volatility (IV) is manually updated with reference to skew.com.
The protocol specifies 1-month ATM IVs. Each time this parameter changes -10% or +10% on Skew.com, the IV parameter is manually adjusted in the Hegic smart contracts. Moreover, Hegic v888 charges an additional 1% fee on the purchasing of options, which all gets distributed to staking lots holders.
These two mechanisms result in a relatively higher price for options compared with other platforms, especially the out-the-money (OTM) options, despite the fact that they are being compensated with transaction mining rebates. Arbitrage opportunities between Hegic and other options venues could arise if the market becomes more crowded.
· Risks in the pool
As there is no price slippage in option pricing, the ideal put-call balance can be hard to be maintained.
For example, on 21st Nov 2020, in the ETH pool, there are about 75% ETH calls in the total options volume. This 1:3 put/call ratio makes the pool’s risks highly biased. The case is similar in the WBTC pool. The pool participants may have to manually hedge against the potential risks for a dramatic market rise, even being a pool contributor. However, the potential loss as a liquidity provider to the pool is well compensated by mining incentives.
Hegic is now the troop leader in decentralized options, with the highest market capitalization and total value locked (TVL). There is great potential in the decentralized options market and it is just getting started.
Since a brief introduction in our previous article, FinNexus has made great progress. The FinNexus Protocol for Options (FPO) v1.0 is officially online here. The neatest aspect is that it is a Dual Dapp that exists on both Ethereum and Wanchain. If you have both Metamask and Wanmask installed, you can access both chains from the same website! More information can be found on the FinNexus Documentation site.
FPO v1.0 is a decentralized peer-to-pool options model, built with pooled liquidity. Like Hegic, the beauty of pooled liquidity is that it accumulates liquidity from all market participants simultaneously and automatically. The risks and premiums are also shared equally across the entire group of liquidity providers so that no individual participant is at high risk and all participants can share in the rewards.
FinNexus calls FPO the Universal Options Platform. It is called that because the pools can support any underlying asset on any base layer blockchain.
The unique characteristics of FPO v1.0 are described here:
It may collaborate with different chains. Now FPO is live on Ethereum and Wanchain with a joint interface. Later it may come to Elrond, Kardiachain and more.
FPO v1.0 enables the creation and trading of options from any type of underlying asset based on the collateral held in liquidity pools. Now, FPO v1.0 supports BTC, ETH, MKR, LINK, SNX options. The underlier may not even be limited to crypto-assets. Real-world financial assets like gold, petrol, stocks, or indexes can easily be integrated. Really, since FinNexus partnered with Chainlink, if they have a price feed for it, FinNexus can include it in our options liquidity pool.
The choice given to the option buyers is very flexible and can be tailored to his/her needs.
MASP stands for Multi-Asset-Single-Pool model, and it is the core mechanism and innovation in the FPO platform. Multi-Asset means that FPO is supportive of multiple assets as the underliers of options, as well as the ones contributing to the collateral. Single-pool represents that the options live are powered by joint liquidity, which doesn’t necessarily mean that there is only one liquidity pool. There are currently two pools on Ethereum, a USDC pool, and an FNX pool. There is also one WAN/FNX hybrid pool on Wanchain, dually backing the issued options.
Below is the example of the MASP mechanism in the USDC pool on Ethereum:
Options in FPO v1.0 are priced according to the Black-Scholes Option Pricing Model. When buying options on FPO v1.0, they are priced by the Black-Scholes formula implanted in the smart contracts. Key parameters for pricing options include the underlying asset price feeds such as BTC/USD, ETH/USD, LINK/USD, MKR/ETH, and SNX/USD. Most critical to these calculations is a source for IV. In contrast to Hegic which requires manual input based on skew.com data, FPO uses live feeds from Deribit to provide these crucial data points to the FPO v1.0 smart contracts. In another differentiator with Hegic, an adjustment coefficient is added to the pricing formula to make the pool more balanced with regard to risk.
Also, with the USDC pool, options are traded and settled in a stable coin, which is much closer to options traders’ transaction convention and easier to collaborate with different yield chasing strategies, whose financial performance is usually measured in USD.
In addition to the basic introduction of the FinNexus Protocol for Options (FPO) model, there are several mechanisms elaborately designed for security purposes. The following points underline the security mechanisms embedded in FPO, which is an important point to consider these days in the DeFi world.
Minimum Collateral Requirement. FinNexus introduces the Minimum Collateral Ratio (MCR) requirement for the pool. It is an innovative mechanism designed to control the size of the pool’s total options exposure. The MCR ensures that the options are always over-collateralized.
Pricing Adjustment Coefficient. FinNexus introduces a pricing adjustment coefficient to mitigate the concentration by adding a coefficient for pricing options. It automatically discourages the purchase of options that are already over-weighted in the pool. In a nutshell, if there are more calls than puts, calls are more expensive, and vice versa.
One-hour Chill Time. To protect against possible flash loan exploits in FPO v1.0, a special mechanism called ‘Chill Time’ is designed, during which the options buyers cannot sell or exercise the options, and the pool participants cannot withdraw their assets out of the pool. ‘Chill Time’ is set to be one hour.
Moving Average IV and IV Surface Mapping. FinNexus applies the average IV from the most liquid options on the market, which is 1 day, 2 days, and 7 days at-the-money IV, and feeds it into FPO v1.0 by an hourly moving average. The protocol then uses this data point as the ‘Anchor IV’ for the DeFi options market. Based on this Anchor IV, FPO v1.0 applies the Stochastic Volatility Inspired (SVI) parameterization model and derives the volatility matrix or volatility surface.
FPO was launched on Ethereum on 4th November and on Wanchain on 11th November. So far FPO has seen a maximum of $1.7 million of TVL in its smart contracts.
FinNexus is a rising star in the decentralized options market. Its FPO is a decentralized peer-to-pool options model, similar to Hegic, but with some distinctive characteristics. Its universal design makes it promising to include any crypto-assets or even real-world assets in its decentralized options model. The potential of collaboration with other projects and market strategies can be quite exciting. The pricing mechanism coded is more dynamic and can auto-balance the risk in the pool. Plus, FinNexus has a relatively low market cap.
Since our last discussion, the basics of Opyn and its Convexity Protocol remain unchanged. The variety of its product offerings have substantially improved, however. Whereas previously users could only by ETH puts, these days users have a selection of 7 ETH puts and 2 ETH calls, as well as a choice of DPI, WBTC, UNI, and YFI options.
According to defipulse, the TVL in OPYN is shown as follows since Aug 2020.
Opyn options are American type, which means they can be sold or exercised at any time before expiration. The point of American options is that they give holders more flexibility in hedging. In some scenarios, it is more profitable to sell a put option than it is to exercise it. The put option rises in value as the value of your holdings in the underlying asset falls, allowing you to sell it and reduce the downside risk in your overall portfolio.
An exciting development for the OPYN team is that they are close to launching OPYN v2. There will be some distinct updates in OPYN v2, though some features have yet to be finalized. I will highlight some of those advancements here.
Auto-exercise ITM options upon expiry. Opyn options can be settled upon expiration time, automatically.
Collaterals are kept in Margin Vaults. This mechanism allows Opyn to maintain all the collateral necessary to fully back their call and put spreads based on the maximum potential loss. It is more capital efficient and flexible when complicated options combination strategies are employed.
More margin flexibility. Future updates may allow for flexible margins and liquidations. Again, it will be more capital efficient.
Diversification of collateral. Using yielding or interest-bearing tokens as collateral allows options sellers to maintain 2 sources of return. They can earn interest, as well as any mined governance tokens, while simultaneously earning from selling options premiums. Opyn v2 will allow yielding assets like Compound cTokens to be posted as collateral for options (e.g. cUSDC for ETHUSDC puts). Sellers would earn interest and COMP for their collateral. Longing in-the-money (ITM) options can be settled in cTokens and unwrapped to the underlying asset, given adequate liquidity. For options buyers, option premiums are likely to be lower for options with yielding collateral compared to options backed by non-yielding assets.
Transiently Undercollateralized Vaults. It may allow for more complex interactions with higher capital efficiency. It could be something like flash transactions in options.
Curiously, despite the roaring success of DeFi protocol tokens since this summer, there is currently no protocol token for Opyn.
Opyn is the first project in decentralized options with automated market maker (AMM) liquidity from Uniswap. Opyn options are tokenized and can be easily combined with various strategies, both for buying and selling options. Different from the peer-to-pool model of Hegic and FinNexus, where options sellers only work passively in the liquidity pool, Opyn option sellers and writers can sell options on their own terms. The upgrades of Opyn v2 are expected soon and may offer some fresh innovation to the space.
As introduced in our previous article, Opium is building a derivatives protocol that has broader dreams. Opium is not just limited to options.
Opium is known for its variety of option products. Opium has Options on Gas price, which allows users to hedge the Ethereum gas price. Opium has a variety of ZEPO, a European style zero strike call option on different underlying assets with the strike price set at zero, replicating the underlying crypto assets. In traditional finance, a European call option with a strike price of zero is usually traded in places where there may be obstacles pertaining to the transfer of the assets. The purchaser of the option will definitely exercise it, so it is the same as owning the underlying asset and the seller has full offsetting participation in the underlier’s price.
Moreover, Opium has developed products on options with different underlying assets, like BAL, BZRX, COMP, NXM, YFI, etc. It has also made some trials on exotic options like binary options on COMP, which is a cash-or-nothing binary option. The seller pays some fixed amount of cash if the option expires ITM while the buyer pays the agreed premium to the seller. The Opium exchange is the venue to trade these option products and it provides an order book liquidity for the users. The concern is that the liquidity is not deep enough at present.
In Aug 2020, Opium launched the First Credit Default Swap (CDS) product in DeFi, in collaboration with Aave. A CDS is a kind of insurance product, and a financial derivative that provides protection against the default of the borrower. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in case the borrower defaults.
It works as follows:
Opium also developed a CDS Contract on WBTC/BTC and USDT/USDC price depreciation. The CDS products are tradable on Opium Exchange, with an order book liquidity.
Interest rate swaps are one of the most important and biggest derivative markets in the world. According to the introduction, SWAP.RATE is a platform where you can hedge against or take advantage of the interest rate fluctuations in DeFi lending and borrowing. For the first time, decentralized Interest rate swap (IRS), one of the most widely used financial derivatives, is introduced in DeFi. An IRS is a contract in which one stream of future interest payments is exchanged for another based on the specified principal amount.
For example, by using an IRS, users can fix your floating rate on the deposit or loan. IRS, like a special insurance contract, will pay out the difference between the promised fixed rate and the realized rate at the time of maturity.
On SWAP.RATE, you can either choose to pay floating and receive fixed rate, or pay fixed and receive floating rate. As the liquidity gets deeper, Opium Team will introduce a live swap curve. IRS is a powerful and big derivative market in traditional finance. We’re glad that Opium is introducing it to DeFi.
There is currently no protocol token for Opium.
Opium is a decentralized derivative protocol, not just for options. It developed options with various underlying assets as ETH GAS, BAL, BZRX, COMP, NXM, YFI, etc. as well as ZEPO and binary options. It launched the first decentralized CDS and IRS products. Opium derivatives’ liquidity is based on order books. It is interesting to see how these innovations will grow.
ACO is a decentralized non-custodial options protocol that allows users to trustlessly trade, mint, and exercise call and put options. ACO protocol tokenizes put and call options contracts creating ERC20 tokens which users can send, trade, or even integrate ACO Tokens into other DeFi projects. ACO has made many innovations since our introductory piece and officially rebranded to Auctus in November 2020.
Auctus enhanced the UXUI to a simpler and clear one. While for advanced traders, one can always go to the advanced interface. There is a toggle in the upper right corner.
Auctus made some trials on options with SNX and YFI in late August 2020, and with SUSHI in September 2020. However, these days only WBTC and ETH options are live on its platform.
Apart from order book liquidity, Auctus enhanced its protocol by introducing pooled liquidity, currently in beta version in November 2020. Liquidity providers may receive premiums by automatically selling covered options.
As mentioned here, Auctus’s goal is to allow the creation of custom-tailored liquidity pools, meaning option writers can decide which range of strike prices and expiration dates they are willing to mint and sell, as well as decide what is the minimum implied volatility (IV) they are willing to sell. IV is adjusted based on the utilization rate of the pool.
From the UI on 19th November 2020, Auctus maintains 4 pools as puts and calls in ETH-USDC and WBTC-USDC pairs, to work as the seller of options, with a strike price range and expiration range. The pools are controlled with more limitations and renewed from time to time. The pooled liquidity finally goes to market for the current basic mode users, and later it may be included in the order books. Therefore, the Auctus pooled liquidity model works differently than Hegic and FinNexus’ pooled liquidity model.
In November 2020, Auctus introduced the first Vault strategies on the market.
Vaults represent a passive-investing strategy that combines interest-earning protocols and options. Some vaults offer capital protection and so can be adapted to all risk profiles. While some vaults offer principal protection, they still face the risks of smart contracts. Vaults benefit users by socializing gas costs and automating allocation strategies.
The first Vault on Auctus is 3POOL-ETHCALL. it provides ETH exposure with principal protection. The yields generated from farmed CRV governance tokens are automatically used to purchase ETH call options.
Later it may launch other vaults like bullish or bearish strategies or IL hedging strategies.
Auctus options are tokenized with an order book liquidity. Yet it creates liquidity pools for writers, who will receive premiums by automatically selling covered options. Interestingly, Auctus is creating Vaults with different strategies, and its options are highly involved. Options can be powerful tools in various investment strategies, for insuring and speculating. Let’s wait and see what these vaults will deliver and how options will work in tandem with the vaults.
Primitive is making progress these past months. Previously, Primitive had some quite unique ideas regarding the Utilization Ratio of a liquidity pool as a proxy for IV, as we introduced in the last article. That was Primitive’s first prototype model. Apparently, that innovative idea has been abandoned. IV is a tough nut to crack, but it is the key to unlocking an effective decentralized options marketplace. In October 2020, Primitive launched its new interface and options model on Ethereum’s Rinkeby testnet.
The updated testnet model of Primitive seems a bit similar to Opyn. It is testing the option instrument itself with two fungible tokens: a LONG option and SHORT option ERC20. Creating options requires the underlying assets to be deposited, which means each option is 100% collateralized. When an option is created, the party initiating the transaction will receive the Long and Short tokens. The party can then sell either of the tokens (or even both) to have only single exposure against the option (Long or Short).
Uniswap liquidity will be applied for the transaction of the option tokens. It is planned that in a later Phase, the Uniswap pool will be replaced by a ‘better pool mechanism’ for trading options. Maybe some innovative ways to tackle the time decay and Impermanent Loss problems. The Primitive model and documents are still under construction, and it will be interesting to find out what Primitive will bring to the DeFi market.
Currently, Primitive does not have a platform token.
Hedget is a new decentralized platform that came onto the scene in August 2020 after raising $500,000 in seed funding. In September 2020, it completed a public token sale and got listed on multiple exchanges. Hedget is currently under development with an alpha demo available now at hedget.com. But you need to stake HGET tokens in order to participate.
According to the Hedget website, it applies a Chromia-based L2 solution that handles trades, tracks ownership of contracts and facilitates the communication necessary to perform settlement through Ethereum smart contracts. Also, Hedget announced that it would utilize Binance Smart Chain for a version of the Hedget platform which works with assets on Binance Decentralized Exchange.
Though Hedget’s product is not on the market yet, according to their product structure, it is most likely a peer-to-peer decentralized options model with full collateralization. It will support European-style options, which means that the option can only be settled at the time of expiry. Options are likely to be tokenized and transacted in Hedget’s trading venue.
PowerTrade is a Bitcoin option trading platform and it is offering a mobile-first trading experience. PowerTrade raised $4.7 million in September 2020 in a private token presale round. Later in the same month, it made the PowerTrade Fuel (PTF) token launch and listed on multiple exchanges. Currently, the PowerTrade team is testing an internal alpha on testnet, which is running trades on the exchange testnet. The platform is coming in Q4 2020, according to the team.
We haven’t heard much from Pods in the recent few months, since our last introduction, but it is actively enlarging its team. Their platform is still in the testing period and hopefully, it can deliver something interesting and different to the market.
There is currently no protocol token for Pods.
This concludes our wrap-up of the decentralized options market as we head into December 2020. In the DeFi industry, projects and codes change extremely fast. By the time I update this article again in a few months’ time, Andre Cronje will most likely have launched three new projects and YFI will have absorbed fully half of all DeFi platforms.
From a 30,000-foot view, however, sometimes it is easier to see where an industry niche is going. As a result, keeping track of these 9 DeFi options platforms, and others as they come online, will be most interesting to observe. Each platform is slightly different from the other. But the collection of innovative ideas pushes the entire space forward.
It is a joy to be involved in the development of the protocol future.