EP 39 Opium Case Study
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Welcome, premium subscribers! Thank you for subscribing. I appreciate you very much. TLDR below. This is not financial advice.
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What is the OPIUM network?
The opium network is a derivative protocol where you can create different kinds of derivative products. You can use different protocols to help match orders or use protocols as a liquidity pool to be issuing different kind of option products. As always, it is decentralised.
There are an on-chain trade and an off-chain match. Off-chain matches people and trade together. You match buyers and sellers and on-chain is where you execute and do settlement. It is a lot more expensive to do everything on-chain so the kind of matching that doesn't need so much transparency because the execution will be done on-chain.
Products for Opium Protocol
Credit default swap
Interest rate swap
Futures options
Binary options
There are a lot of different financial products that derive their value from some underlying asset and in general, these are derivatives so you get to trade these. This protocol is done specifically for that.
Mechanism Design: Governance
Governance Token: $OPIUM Token
The governance token is $OPIUM. $OPIUM takes up about 60% of the total token supply and this 60% is distributed to active users. If you are an active user, you get to claim some of these $OPIUM that give you access to governance and different rewards when you are staking. It has a governance function. The platform earns 10% in platform fees. In the governance model, it uses an Aragon DAO. Governance is pretty robust because you have a DAO to govern it and the protocol receives 10% of the fees earned.
In the opium network, the users holding the $OPIUM have access to make decisions and to do any governance decisions or any resolution that may come up. They are entitled to do that and in governance, you can change the different parameters as Opium which uses Aragon’s DAO which is a decentralised autonomous organisation. It allows different people to come in to participate in voting and make decisions collaboratively. They can decide the different parameters in the mechanism itself because these are derivative products in a decentralised way using tokens to incentivise people's behaviours and it can be quite complicated.
Derivate products are complicated. If you want to build governance into these complicated products you have to understand to what extent can you let these different people vote on these products. Governance is basically is the entitlement that they can make such decisions. If you give them too many decisions to make you allow them to completely change the different model and structure and the whole mechanism where the protocol will work then it is not going to be fair for other people who came into the system later. Or you can have big players or bad actors coming in to completely change the system to benefit them because they hold lots of $OPIUM.
Decision Making
$OPIUM holders can change parameters via governance:
Providing order book liquidity for the derivatives market
Writing up CDSs and options
Increasing the Total Value Locked in Opium Protocol
Designing relevant (high-demanded) financial derivative products on Opium
Incentivise liquidity providers to 3rd party pools/projects that are useful for Opium Ecosystem (e.g. Derivatives as collateral, Balancer pools with $OPIUM)
Participants in the vote will be rewarded for their vote. Opium has also set aside a Governance reserve fund for governance.
Pricing Model
Let us say there is a user that bets that price is going up by 15% and you have another user on the other side that bets that it will go down by 15% and we are trading the product $ETH. $ETH right now is $1000,. If someone bets that it is going up then they are risking $150 and if someone bets that it is going down they are risking $150 because these two people are betting the same percentage of 15% they pair with each other.
Let us say this agreement lasts for five months and during this time we are going to put that $150 into the pool and you'll have $300 in total. Five months later we realized that the value actually rose by 5%. If I'm the person who bet that it will actually increase and appreciate then I will get my 15% back which is the initial amount that I put in plus this 5% because I got it right whereas on the other hand the person gets 15% back but loses that 5% because the person is wrong and this is how the options contract is being settled.
Every time there is a settlement or every time there are transactions going on you have to pay a premium to be able to engage in the trade and of all these different transactions going on 10% goes into the protocol and the protocol is basically owned by people who have the OPIUM tokens.
Mechanism Design: Non-Financial Incentives
Voting Protocol
In Non-financial incentives, we are looking at the other less tangible financial things with $OPIUM: 1 $OPIUM token equals one vote and how $OPIUM are being allocated is that you have an allocation schedule.
It is an exponential curve what it does is that the longer you allow your $OPIUM to be in the system and you don't claim the $OPIUM as soon as possible then you are entitled to more $OPIUM. It is a very interesting game theory perspective because everyone wants to exit earlier. After all, if you exit earlier fewer people are exiting then you can sell your open tokens at a high price at the same time you also want to stay longer because if you are the last one standing then you can get 300 times the token in the initial token that has been sold and if you compare 300 times the amount of tokens versus selling one token at 300 times the value then it is a very interesting game theory structure of how do you want to play the tokens and what would be the good middle point of where you want to sell the tokens and how often you want to keep the token in this bonding curve.
This bonding curve is really the $OPIUM governance allocation bonding curve or distribution bonding curve where all the $OPIUM will be kept in this bonding curve and the later you want to take your $OPIUM out the more $OPIUM you can get and let us say an individual has a total of 100 tokens and the person decides to take out initially like five tokens. They don't get access to these remaining 95 tokens that were originally awarded to this individual because they decided to liquidate early and these 95 tokens are then given out to any individual that stays for the entire 100 tokens plus the extra 95 tokens. It is kind of like taxation or punishment for people who left early. That is the mechanism for non-financial incentives.
Mechanism Design: Structure
Bargaining
Bargaining is the rules where buyers and sellers will bargain and agree on a price and the structure of this entire system. It is also community information, and of course, we are talking about oracles here. With bargaining how it works is that the protocol doesn't decide how much money things are and the protocol basically allows people to make a decision off-chain
If I'm betting that $ETH is going up by 15% and if someone is betting that $ETH is going down by 15% then when you put that in order book off-chain it is more like a matching system, 15% up and 15% down match the net is zero.
To increase liquidity in the protocol, $OPIUM also uses its own hummingbird bot to match liquidity in CeFi like Deribit. Matching CeFi (for depth) and DeFi (for innovation) is indeed a novel idea to merge the best of both worlds.
Community information
Community information is where you get oracles. In this situation, you have oracles in two ways the first one is where they use Chainlink to get the price of underlying. Let us say the price of $ETH is the asset we want to trade then we are betting it either goes up by 15% or it goes down by 15% so how do we know the price of $ETH as you can't hire someone to be checking all the time and keep updating so you get an oracle to tell you this is what I've sent to all the different exchanges and this is the price I'm getting back.
Smart Contract
The smart contract will provide settlement when the options contract or the bet 15% up or 15% down has reached the expiry of five months that we mentioned before. It has a total of 30% in the pool and so somebody wins 20% and someone gets 10% and the total is still 30% and so the smart contract will calculate that and issue 20% to the person who bet it right and for the person who bet it wrong it will be reduced by 5%.
Token Design
Token Policy
$OPIUM is the utility token where you have governance and where you can stake and then you can also get OPIUM rewards. The total amount of $OPIUM to users will be 60% of 100 million tokens that they are issuing. The way it is being structured or being distributed to people. That is about 10% inflation in year one because they are basically issuing out to the different user. With the bonding curve and governance, the users are less incentivised to want to liquidate now because the longer they hold the more value or rewards they can get in terms of $OPIUM. If they liquidate early they have the penalty to pay. $OPIUM accrues value because the platform collects 10% of whatever revenue the platform is generating so there is some form of monetary value to the token itself.
Financial Incentives
Staking $OPIUM: You can receive returns with $OPIUM by staking on the network and participate in the protocol.
Trading derivative assets: If you could bet that ETH is going up by 15% and you can only settle this at expiry which is 5 months. What you can do instead is that you can trade this asset. Maybe this asset is worth $100 and you sell it for $90 because there are still 4 months to expiry and you don't want to wait for 4 months so you want to take that $90 first and sell this asset.
Architecture
The architecture is interesting because what they have done is to create this thing called ERC-721o. It is a new standard that combines ERC-20 which is tradable and fungible with ERC-721 which is non-fungible. It means that puts ERC-20 tokens inside and creates this portfolio which is very unique on its own and you can turn this into an NFT or a non-fungible token and this is called ERC-721.
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TLDR:
Financial derivatives are an important component of the financial markets, as they enable risk management. The decentralised derivatives market is expected to grow exponentially with DeFi's growth and, as a result, a widespread and robust financial infrastructure is required.
Opium is a financial protocol for decentralised financial derivative products. Opium Protocol is completely based on open-source software and smart contracts. In addition to conforming to values from the DeFi space and possibly incorporating DeFi currency market and protocols, the Opium Protocol is designed to also incorporate into the traditional financial sector and market participants.
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