Ep 37 Crypto Options comparison

Crypto Options differences

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TLDR below. This is not financial advice.

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Why do we use DeFi Options?

1. One is to hedge against the price movement. When prices move a lot, you want to protect yourself. So you buy a put option if prices fall if you are an investor.

2. You can also use it to bet against the market or bet with the market so you could use options to speculate in the market. A call option if the market goes up.

3. You could be a seller and earn revenue from selling options. That is easily available in the DeFi protocols.

Difference between DeFi options and CeFi options

• Products Available: In general CeFi options are still very much focused on just the top two crypto asset products. Bitcoin and Ethereum. With DeFi, it allows you to expand to a lot of the other crypto-assets easily. Currently, most of the DeFi option protocols are focused on Ethereum but that's just to test it out and because everyone has Ethereum. It's easy to get demand. But it would not be difficult to switch to different kinds of crypto assets or DeFi assets.

• Incentivisation method: The DeFi protocols have a token. These tokens incentivise people to become liquidity providers or users. This is quite different from just the traditional CeFi options protocol. With CeFi you've got a market buyer and a market seller who come together to trade. They execute the trade whereas with DeFi it adds a completely different layer because there are tokens involved.

• Revenue split When you purchase options you have to pay a premium and this premium usually goes to the seller but in DeFi or with tokens involved you could split them into more creative and interesting ways so you could split them in more than one piece.

• Creation: Option contracts are created by the protocol and it's more or less standardised and you get to choose different kinds of customisation.

• Trading: You can either trade the contract as it is with all the different specifications or you could trade the tokens that represent the contract in one way or another. There are a lot of different mechanisms involved and no single standardised mechanism.

• Settlement: Most of these DeFi option protocols are doing the European options so it settles at the expiry date and this is where automation can come in because if it allows you to make money as an option buyer then it will execute it immediately and then you just settle.

• Market makers: There are different types of market makers. You have the liquidity providers, option sellers, stakers and you have different types of people in the space more than just option sellers or the contract creators.

• Asset types: In CeFi usually it's bitcoin and ethereum and you might have some other stuff on FTX. DeFi protocols have a lot of different asset types depending on what the liquidity is for these asset types.

• Tokens: DeFi protocols have tokens and these tokens could be revenue-generating or they could exist to represent some other asset.

HEGIC

With Hegic, users pool their assets together and lock their funds in the liquidity pool. This pool is the market maker. When an option buyer buys a contract, the option is created using the Black-Scholes model. The underlying assets will come from the liquidity pool.

I pool the risk together with all the ETH in a liquidity pool.

Execution

1. Oracle price feed: Get the value of the underlying asset (ETH).

2. Premium payable: Buyer pays a premium to buy an option. The price is determined by the Black-Scholes model.

3. Premium received: This premium will be received by the liquidity pool so everyone in the pool will receive a portion of the premium. This is in ETH.

4. Executing contract: When a buyer executes the contract, they have to pay a fee of 1% of the value of the contract in ETH.

5. Stakers: the 1% goes to the staking slots, which are the people who will stake Hegic tokens to get this ETH.

In Hegic individuals could be liquidity providers or they could be in the staking slot or be in both. They get to earn ETH and HEGIC. This is the token model and Hegic is created as a way to reward users in the system.

They have a limited amount of staking slots and you have to have a limited amount of Hegic tokens to be staking. Hegic has been used as a profit-sharing system because it's not fair if only the liquidity providers are earning fees. You could also be earning fees by staking in the system and get to earn the settlement fee as well so you can earn fees in two ways. You can think about the premium at 100% so usually, it's 100% for CeFi but with Hegic it does something like maybe 5% to the community and 95% to sellers (just for example).

Why do we want to reward the community?

1. Share revenue with everyone in the ecosystem in a decentralised system

2. There are a lot of other external parties that are helping to promote this ecosystem like people on Twitter or the believers in the project who are not risk-averse to be staking ETH as liquidity providers or they don't have enough ETH to be liquidity providers. But they can still earn and be part of this decentralised ecosystem by staking HEGIC tokens and earning from the HEGIC token ecosystem.

Value Accrual and flow

The value of accrual is really as an entire ecosystem and the value flow comes from having a lot of options being executed so think of these external promoters as influencers. These influencers are not going to be buyers or sellers, which is where they can't earn any money but they are promoting the platform. They get to have some tokens and they stake these tokens in the ecosystem and earn some fees from transactions.

Opium

Opium is a different kind of options protocol. If I have ETH and I'll put all of my ETH into liquidity pool and earn a premium from all these different options contracts being bought, then I have to put 100% of my stake in the liquidity pool.

With opium, it's quite different because I'm only putting the amount of assets that I have at risk.

Instead of one big liquidity pool, we have individual sellers and buyer. Think of this as something like tinder where your buyers and sellers tell their orders and then the orders will be matched in one big order sheet. Once they're matched, you have the matchmaker that says buyer one and seller one are matched and buyer two and seller two are matched. The match goes into a smart contract.

The contract input: oracle to find the price of the underlying

The contract output: figure out how much to pay and at the end you get

Contract creation: the opium minter which mints your contract and each options contract is quite specific because you have different expiry date, different strike price and a lot of different kind of elements.

They are unique, so the contract becomes an ERC721, which is a non-fungible token. The contact can then be traded and from now to expiry.

Contract Creation

Let's say as a seller I say ETH price goes down by 15% and for it to match, someone has to bet that ETH price will go up by 15%. What the system does is to match the person who says 15% with the other person who says 15%.

We put in 15% each. A total of 30% of ETH will be locked in the contract.

Settlement

Let's say at settlement the prices go down by 10% so this is where the smart contract comes in and determines how much to payout. The total amount that we have inside the system is 30%.

When prices go down by 10% and as a seller, you bet that price goes down by 15%. So you get back 15% (original) + 10% (your bet). The other party get back 15% (original) - 10% (his bet).

Value Accrual

Every time there is a trade occurring, you pay a premium. 90% goes to sellers and 10% goes to the entire ecosystem. The value accrual is from the system being used more often as more the execution and matches more the people purchasing options and hence more revenue is generated which can be redistributed to users.

Opyn

Instead of creating their own bonding curve, they use the Uniswap bonding curve and it's kind of like Maker DAO where you have collaterals in a liquidity pool or a vault.

Then, you mint oTokens to represent the ownership in the vault. These tokens can be traded accordingly. oTokens are created based on the expiry, strike price and all the other things. oTokens now represent the options contract in the system and buyers get to pay a premium when they buy these tokens. In this scenario the oTokens are very different from the Hegic and Opium tokens because all tokens are just a representation of the collaterals in the vault so they're not exactly revenue-generating and there's no profit-sharing mechanism in this opyn model.

DeFi Options Comparison

Token use case

HEGIC is for staking, governance and reward. OPIUM is an NFT. OPYN is a representation of the collaterals in the vault or the liquidity pool.

Token value accrual

In HEGIC and OPIUM it's the premiums available when things are being paid but with OPYN it just represents the collaterals.

Contract creation

HEGIC and OPYN use Black-Scholes formula which is the general theoretical formula for pricing options. With OPIUM it's more of a bilateral risk pairing so if both of us are interested in 15% and either the prices go up or go down then we will come into an agreement together and that's how we are paired.

How the options are traded

There is no way to trade the options with HEGIC. The option is created and it waits until expiry and then gets executed whether you want to execute it or not but it's not being traded.

With OPIUM the way it's traded is that the option is now an ERC 721 non-fungible token that can be traded in the secondary market and in the platform itself they have a secondary market where you could trade the 721.

Lastly, for OPYN all the options become standardised into oTokens which are available on Uniswap so you can trade the o tokens and they are all fungible with each other.

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TLDR:

There is no generic model for DeFi options. They can be used in a few ways, as insurance, to speculate in the market or to earn. Each model is different and thus where innovation lies!

Ps: Order the textbook "Economics and Math of Token Engineering and DeFi" today!