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Ep 40 Potion case study
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TLDR below. This is not financial advice.
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Potion is quite a new protocol and it doesn't have any tokens yet. This is interesting because you realise that asometimes, these protocols do not really need the tokens. Tokens could come in at a later stage when it starts generating value and you can socialise the value gains to all these different stakeholders. But the first thing or the most important thing in your protocol especially in finance or in DeFi is really to build the right kind of algorithms and this is what potion is doing really good.
I want to talk about this because it does not have a token. But there are still economic mechanisms and incentives to discuss. It doesn't always need to have a token.
1. Recap: Put Options as Insurance
The put option is where you get to sell your asset at a fixed price or an agreed-upon price. This is good because if the prices drop too low then you can have a put option at the price that you're comfortable with.
For example, we're talking about ethereum being $1700. You put a put option that allows you to sell it at $1700. Let's say ethereum falls to $900. With this option, it allows you to sell it at $1700. That is how you get to use put contracts as insurance.
This is a good way to mitigate risks as buyers and this is good because the space is very volatile and when we create products we want to look at how to structure different things to make sure that buyers are protected and more buyers can come into space and grow the DeFi ecosystem.
2. Problems with Existing Options
Unscalable Liquidity Architecture: You can create option products but you can't exactly trade them in the secondary market and this is a good problem to have because then it really suggests a more mature secondary market and we're not at that stage yet in the DeFi space so that is something to look forward to and worth innovating in this space.
Limited Market Availability: Options or Derivatives are not very easy products so there are still some limitations to liquidity or trying to get more people into space.
Unreliable Pricing: This is interesting because a lot of options models that we use is the Black-Scholes model which is not exactly the best and there are a lot of problems with that especially when we're looking at very risky and volatile products and the Black-Scholes model doesn't really help to aggregate this kind of information.
European Options: A lot of the options that we talked about so far are all European pricing and European Options mean that you can only execute them when they expire but one of the benefits of options is that you can execute them anytime you want. This is the American style of options.
What Else Did You Miss?
Mechanism Design: Governance
Mechanism Design: Bargaining (Pricing)
Token Design: Financial Incentives
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TLDR: Potion Protocol is currently in the development phase, with simple product structures making it accessible to everyone. Innovation comes in the pricing of option premium to really reflect the volatility of the underlying asset.
Get smart: Pricing based on actual volatility/risk creates fairness for both buyers and sellers.
We also covered Why DeFi Is More A Ponzi Scam on Tuesday. Upgrade to premium for just $10 to get access to all premium content.
Ps: Order the textbook "Economics and Math of Token Engineering and DeFi" today!