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Ep 38 Hegic case study
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TLDR below. This is not financial advice.
This month's theme: options
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Hegic is a peer-to-pool option trading protocol that allows users to trade in options in a decentralised way.
Hegic works quite simply with the participation of two components, writers and buyers:
Buyers: who need to call or put option on Hegic. Buyers can customise parameters of Options such as expiry date, strike price.
Writers: Who sell call or put options to make a premium and to become a writer on Hegic users simply need to provide liquidity to the Hegic Pool.
1. Objectives of HEGIC
One of the objectives of any business is to earn revenue otherwise you won't start a company.
In HEGIC, liquidity providers are basically option sellers. Previously, you could only be an option seller if you had a lot of capital. If I have a little money, I can't exactly have the same benefit. Instead, we can pool all this liquidity together and provide a way for users to be hedging or speculating on the assets that are available. Then we can distribute the benefit to the liquidity providers and users, so this is a value add to liquidity providers. There's a new avenue or a new source of income from becoming a liquidity provider which is your premiums.
There is also a value add to users because now there's more options and alternatives to be finding the best avenue and to get returns or profits and this is very useful because in economics every time there is an increase in opportunities or alternatives available then there is a marginal increase.
2. How HEGIC works
In general think of it as something similar to Uniswap. In Uniswap your pool will be something like let's say ETH and USDC for example. In HEGIC you just have one asset let's say ETH. You add liquidity into the pool and what we want to do is to get all these little smaller guys with some capital put them all together.
With Uniswap people can trade and exchange so if I have ETH and I want to change it for USDC or if I’ve USDC and want to change it to ETH. I don't have to go around asking people and then pool together the exchanges from every little guy. Instead, I put all the things inside a pool and then we just trade.
With HEGIC it's also similar because we pool all the ETH together and instead of trade and exchange we issue option contracts.
We can do both call options and put options so let’s say we are the seller because we have enough liquidity and enough assets available to be selling call options and put options. Buyers pay the premium to the liquidity pool and whoever that provides liquidity gets to have a share of this premium. Similarly in Uniswap when you trade and exchange you have to pay transaction fees which goes back to liquidity pool.
3. Economics Design of HEGIC
When settling the contract, which is not an obligation, you can choose to execute it or not. If you choose to execute it then you want to settle the contract.
Let's say a buyer buys a call option and he wants to buy ETH at whatever price so this is a call option contract. He wants to settle so that means he's going to buy ETH from the liquidity pool and every time this transaction happens you have to pay a fee and this fee is based on ETH.
The liquidity pool is based in ETH so this is where HEGIC comes in because here people are staking and every time you make payments, you have to pay one percent settlement fee to these stakers and stakers will also get HEGIC tokens and this is one of the ways HEGIC token works.
It is the rules for the entire system minus token so the mechanism design of HEGIC is basically the different rules of the game.
In governance, we're talking about changing parameters so things like changing the contract rates or changing the settlement size fee which is right now at one percent or you could change the kind of assets.
The system works in pricing your HEGIC so HEGIC price is determined by the supply and the HEGIC supply is a very straight line with a gradient of zero point eight zeros. 1 ETH so that means for every ETH that is added into the system through liquidity pools it will be the area under the graph and you will be minting the amount of HEGIC supply and the price of the HEGIC tokens will be determined so that means for every ETH added the price of HEGIC increases and this is bonding curves.
The token policy is kind of like monetary policy so one thing that we usually talk about is inflation and we have three phases of inflation in HEGIC. Phase one is if the trading volume exceeds 100 million, phase 2 is if the volume exceeds 1 billion and phase 3 is where the volume exceeds 10 billion then you will have inflation of HEGIC tokens to the users or the stakers so the rate for the first one is 14.17% the second is 2.77% and the third is 2.09%.
When HEGIC has trading volume up to a certain amount it means that there is an economic value of up to a minimum of 100 million dollars worth of trade which is people buying and selling option contracts and when this value is justified by people trading then that means there's the economic value being incurred and what is done now is to turn this economic value to HEGIC tokens as an inflationary asset to give and return them to users and you have that for all the different phases 100 million, 1 billion and 10 billion.
In traditional finance, one of the most important pieces of derivative products can be mentioned is options.
A simple option is a contract that allows a holder to exercise a call or put option at a predetermined price in the future with the main purpose of minimising the risk (hedging) or speculation.
Hegic was one of the first protocols to develop options in the DeFi space, Hegic's products are well received, as evidenced by TVL reaching over $45M. However, the daily transaction volume on the protocol remains volatile, averaging $2M per day.
Listen on podcast if you prefer audio version.
HEGIC is an options protocol in the DeFi space. It has grown tremendously and there's huge growth in the space as the derivatives market continues to mature.
Ps: Order the textbook "Economics and Math of Token Engineering and DeFi" today!