Early DeFi was like a gold rush in the west, full of opportunities and risks. One of the biggest risks is the hacked risk of smart contracts, which may result in the total loss of user assets; and the black swan risk of mortgaged assets (such as ETH), which will cause heavy losses to users. Although DeFi can bring good benefits, these potential risks also make DeFi controversial.
DeFi needs to explore social scalability
In previous articles, Blue Fox Notes focused more on the scalability of technology. Due to the consensus needs of the blockchain itself, there are natural limits to its throughput and speed, but this article focuses more on social scalability Sex. If we solve the problem of technical scalability, such as through layer 2 and sharding, are users willing to use it? DeFi also needs to address security issues. Obviously, multiple risk events in DeFi in the past have had a negative impact on DeFi’s social scalability. So, is there any way to solve these problems?
One of the most important is the insurance mechanism, which can reassure people participating in DeFi. At the same time, this insurance is best to meet the characteristics of the crypto community without trust, to reduce the friction costs of human negotiation, such as the need to define the nature of the risk (liquidity risk, hacker risk, etc.). Only simple, without trust can bring DeFi a smoother experience and provide DeFi with social scalability. Blue Fox notes today introduced Opyn, which is an agreement to solve the above problems, trying to bring risk hedging to the DeFi field. So, what is Opyn? To put it more obscurely, it is a convex agreement. To put it more simply, it is an option agreement that does not require custody, and it is also an insurance agreement that does not require a license. There are three main entities on Opyn, one option seller, one option buyer, and option arbitrageur. Different subjects have different purposes, and together form an option market, and the formation of this option market can help DeFi users protect their asset value.
Opyn’s rapid growth Opyn: DeFi users provide insurance services DeFi’s insurance services are different from Nexus Mutual’s insurance services, Nexus Mutual is a mutual insurance platform based on Ethereum, Opyn mainly provides insurance services for users through put options. There are currently two main categories: one is ETH’s protective put options, and the other is the insurance of Compound stored funds (USDC and DAI).
Opyn’s ETH protective put option and Compound storage asset insurance ETH’s protective put option are equivalent to insurance against the price of ETH. As shown above, as of the writing of the Blue Fox notes, there are four types of protective put options for ETH on Opyn. For example, the exercise deadline is 16:00 GMT+8 points on June 19, 2020, and the ETH put option with an exercise price of 240 USDC. The protective price of 1ETH at the time of writing the Blue Fox note is $8.3896, which is relatively expensive. The reason is that the time is longer, at that time there are two weeks before the exercise, and the second is that the transaction price is close to the spot price. The option prices that are close to the expiration time and far from the transaction price are relatively cheap. As shown in the figure below, in less than an hour, as the price of ETH rose slightly, the option oETH fell slightly.
If the option buyer Xiaolan buys the above-mentioned put option of 1ETH, then before the expiration of 16:00 Beijing time on June 19, 2020, if the price of 1ETH falls to US$210 and the user exercises, the oETH option buyer can follow the The price of 240USDC sells 1ETH, thus making a profit. In this way, options buyer Xiaolan does not have to worry about the decline in the price of ETH. In addition, if Xiaolan believes that the ETH price will not fall below 240USDC before expiration, then he can also sell his oETH options to others in advance.
Opyn: Revenue opportunities for option sellers
I just looked at Opyn from the perspective of option buyers, so where did the options come from? Who will bear the conversion obligation when exercising. This requires the seller of Opyn options. Interestingly, this expiration exercise does not require permission and trust, and the smart contract ensures that when the option expires, the buyer can complete the transaction at the originally agreed transaction price. Why can it be achieved?
First, Opyn’s options are generated by the seller through mortgage assets, which is similar to the mechanism of Maker generating Dai. By collateralizing USDC, oETH options can be generated. If an option seller Xiaohu wants to participate in the above mentioned transaction price of 240USDC and the expiration time is 16:00 GMT+8 ETH put option product on June 19, 2020, she only needs to mortgage the corresponding USDC, You can generate corresponding oETH options. Once exercised, the buyer can exchange at the price of 1ETH 240USDC. The converted USDC comes from the mortgaged asset when the seller generates oETH. So why are Opyn’s option sellers willing to bear the obligation of exchange? Because option sellers received protective fees in advance. As in the above product, only 1ETH is protected, and the buyer pays a fee of 7.2 USD. The seller of put options believes that the price of ETH before expiration at 16:00 GMT+8 on June 19, 2020 may not be lower than 240USDC. If the price is not less than 240 USDC, the buyer will not exercise, then the option seller is equivalent to earning 1ETH 7.2 US dollars in fees.
(The annualized return of option sellers can reach 108.94%)
In the face of high returns, option sellers are willing to generate oETH options. However, it should be noted that if the price is lower than 240 USDC, especially below 231.79 USDC, then the option seller may incur a loss, the degree of loss depends on the decline in the ETH price during this period, if it is during the 3.12 black swan period , ETH fell below $100, which would be a very big loss. For buyers, the price of ETH can be protected at $240. The risk of these declines will eventually be calculated into the price of the option. The longer the time to exercise the option and the closer the transaction price is to the underlying price, the higher the protective fee and the more expensive the option.
Opyn: Opportunities for arbitrageurs
Since Opyn’s option products are also ERC20 tokens, these tokens can be traded on DEX (such as Uniswap, Balancer). Due to the existence of a secondary market, as the option exercise time approaches and the underlying price rises and falls, the option price will change, and people will trade options based on their own judgment, thereby generating arbitrage opportunities. Initially, the price of options was set by Opyn, but as arbitrageurs entered, options gradually formed market prices. For oETH options, the price is related to the volatility of ETH and the remaining time of the expiration time of ETH exercise. For example, some users can buy options on Opyn and then sell arbitrage based on price changes. For example, in the figure below, a user bought a protective put option for 1.5ETH and spent a total of 12.6412USDC and sold it when the ETH price was close to the option transaction price. A total of 15.28USDC was sold for less than 10 hours , About 20% profit. Of course, the price of the option will change with the change of the underlying asset price, and there are risks here.
Since Opyn option products are ERC20 tokens, with the participation of arbitrageurs, the option market has begun to have a certain liquidity, which in turn has promoted the active participation of option buyers and sellers.
Options and DeFi’s Social Scalability
In the DeFi insurance market, in addition to Opyn, there is Nexus Mutual, but the mechanism of Nexus Mutual is different from Opyn. Nexus Mutual has strict limits on the amount of insurance, and the scope of its insurance also has certain limits. For example, it mainly prevents the risks caused by hacking, but does not provide services for liquidity and other risks. In addition, in the event of a claim, personnel participation is required, and it is necessary to distinguish between code errors and hacking, etc. Due to human participation, this will result in higher execution costs. Because Opyn adopts the option model, its protective put options can provide objective insurance services, regardless of the reasons for the assets (hacking or market crash, etc.), they can provide protection. At the same time, because the option model has objective exercise standards, option buyers can exercise their rights as long as they meet the conditions. Both parties do not need to consider insurance fraud or the complicated affairs of human claims and fraud evaluation, which can save costs. Of course, Nexus Mutual is also very important for the development of DeFi. As a mutual insurance, it is also an important attempt for the development of DeFi. As of the time of writing the blue fox note, Nexus Mutual’s current total active insurance reached 16326.15 ETH, and Opyn’s current option insurance service Nor can it fully cover the services of Nexus Mutual.
A user once provided Opyn with nearly $70,000 in pledged funds on Nexus Mutual (the pledge deadline is December 26, 2019), and then some users purchased a one-month insurance for Opyn in Nexus Mutual with an insurance amount of 2.5 Ten thousand US dollars, which is equivalent to providing insurance services to Opyn users through Nexus Mutual, to achieve reinsurance of insurance business. In the traditional financial market, which market has the most liquidity? Derivatives market. In the derivatives market, which asset type has the largest trading volume? Options. The annual trading volume of options reaches hundreds of billions of dollars. The good liquidity of options provides market participants with services of hedging, financial insurance, and leverage. For DeFi to achieve social scalability and move towards a larger population, options are a critical part because it can provide participants with insurance services and can control the participants’ maximum losses. Opyn is an option agreement that can provide insurance services in the field of DeFi. Opyn is just the beginning, there will be more projects devoted to this option area that does not require hosting and does not require permission and does not trust, providing DeFi users with a richer risk hedging and insurance services. The option service will gradually become a very important Lego building block in the DeFi field, and then promote the prosperity of DeFi.
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Risk warning: All articles in Blue Fox Notes can not be used as investment advice or recommendation. Investment is risky. Investment should consider personal risk tolerance. It is recommended to conduct an in-depth investigation of the project and carefully make your own investment decisions.