How to earn on Options in a decentralized way
Derivatives such as Options allow you to make unlimited profits while limiting possible losses. As one of the most complex financial instruments, Options are also one of the most popular earning tools in any market. In one of our previous articles, we described all the benefits of Options trading, types of Options, and some basic trading strategies.
In today’s article, we will discuss decentralized Options trading protocols and describe the main features and opportunities that decentralized markets offer to their users.
Features of Decentralized Options Markets
As the DeFi ecosystem and the amount of locked funds grows, its members increasingly need decentralized mechanisms to manage their risks.
Options trading tools entered the crypto space quite recently. Major exchanges such as Binance, OKEx, and BitMEX have platforms for retail investors with Options trading tools. Deribit and FTX also offer Options products to their users. In terms of people’s money and new financial opportunities, the main drawbacks are the mandatory KYC procedures and the necessity to trust a third party with one’s funds.
Building decentralized solutions for Options trading and hedging risks is key to attracting new users and cash flow to DeFi. Innovative approaches and smart contract possibilities will allow any user to access a wide range of financial instruments and yield additional profits.
Hegic is an on-chain protocol for Options trading, built and launched in the Ethereum network. The platform uses hedging contracts — these are Ethereum-based contracts that hold liquidity in a non-custodial manner, sell contracts to holders, and distribute rewards to liquidity providers. Hedge contracts are used to protect the value of the assets over a period of time. The decentralized approach is ensured and guaranteed by the liquidity locked in contracts and time stamps.
Hegic’s unique feature lies in the fact that hedge contracts transfer the risk of losing funds from one particular seller to all liquidity providers. In other words, the risk of losing funds is reduced while ensuring the profitability of all liquidity providers.
The cost of Options contracts at Hegic is higher than the alternative platforms offer due to the utilization of so-called American Options instead of European Options. This approach is beneficial to Hegic users as it allows them to execute the contracts at any time instead of waiting for their expiration.
ETH and WBTC Options trading is available on the platform, with time frames ranging from 1 day to 4 weeks. To sell Options, you must enter the ETH or DAI pool, where ETH is used to sell Call Options, and DAI is for selling Put Options. Hegic allows Options to be created at any, even obscure, strike price, making the market more flexible for Options buyers, thus reducing this parameter for Options sellers. At the same time, it increases the cost of buying an Option but offers higher returns for sellers.
Hegic holds the third place in the list of derivative platforms with $80 million locked on the platform.
For example, on 20th November, if a user purchased a 2-week Call Option for 7,500 ETH on the Hegic platform, blocking just over 774 ETH. Then on 4th December, the Option was executed at $485, it would allow the initiator to earn 1,337 ETH.
Opyn is an open, decentralized Options platform on Ethereum, allowing its users to create Options using oToken.
In order to create an Option, users need to provide full backing by sending the collateral to the smart contract, receiving the realized Put Option in return. Each oToken smart contract specifies such parameters as expiration time, the underlying asset, price, strike asset, collateral type, Option type, etc.
Option tokens that possess the same parameters are interchangeable. After Options are created, they can be sent to any Ethereum address or traded on the Uniswap exchange. The pricing of tokens is determined by the market price on Uniswap and by the supply and demand-based market of oToken at any given time.
Opyn allows Options initiators to receive premiums by selling Options directly to users, allowing ETH holders to build up their asset position. The platform offers insurance for such assets as USDC, DAI, UNI, WBTC, YFI, and others.
Decentralized ACO Options protocol from Auctus is based on Ethereum and functions similarly to Opyn protocol. Compatible with ERC-20 ACO tokens are designed to form Options through their own smart contracts. Options are available on the platform with the ability of execution prior to the contract’s expiration. In order to receive bonuses, Option sellers must fully back Options contracts in ETH or USDC.
ACO uses Chainlink as an oracle to determine the price of underlying assets. ACO also allows the creation of individual liquidity pools, allowing Options creators to determine the range of strike prices and expiration dates. In the future, Auctus plans to develop a vault with automated investment strategies to create a sustainable supply and demand on the platform.
PlotX is a decentralized prediction protocol that uses an automated market maker model (AMM) instead of an order book. Liquidity pools are created for each market and obviously support trading on these markets.
The platform is currently in the beta testing stage on the Ethereum mainnet and has two trading pairs available: BTC-USDT and ETH-USDT.
In order to access the markets, you need to connect Metamask or any other wallet that supports Wallet Connect. There are three time frames available on PlotX: 4-hour, daily, and weekly. Users can also predict future price behavior and make a forecast.
Markets on the platform go through several stages over time: receiving forecasts, waiting for results, recording results, rewards distribution. This allows each participant to make a prediction and follow the development of the events. Suppose any of the participants disagree with the results, at the stage where the results are being fixed. In that case, they have the opportunity to open a dispute, which in turn activates the resolution mechanism.
In all PlotX prediction markets, you need to select the leverage anywhere between 1X and 5X, where the minimum loss in case of a wrong forecast is 20% of the set amount, and the maximum is the entire deposit.
Trading Options is connected to the underlying assets, so the determination of the price of the assets is done by an oracle. PlotX has integrated solutions from Chainlink and Provable, to use external quotes in processing the predictions.
Platform developers are working on a scalability solution to increase transaction speeds using Matic Network. This will also allow the creation of markets with shorter time frames through the use of sidechains.
PlotX will also launch a prototype of its markets using the Elrond blockchain, which will reduce commission fees and increase network bandwidth.
Charm Finance’s decentralized Options protocol is now in its early stage of public beta testing. According to the developers, they managed to create a new mechanism to create Options markets that will be liquid and cheap for the users.
This is an AMM system that provides the ability for users to buy and sell Options without relying on a separate pool of liquidity and liquidity providers to place traded assets. Created by AMM, Options tokens can be generated and burned, and Options prices can be set exclusively according to supply and demand.
AMM predictions and Options adaptation, according to the developers, allow creating more liquid and efficient Options markets.
Primitive is a protocol for creating Options on Ethereum with mechanisms to work both on Opyn and ACO platforms. The Options token on the platform is Prime, and liquidity is supplied by the Options initiators. Primitive uses a simplified pricing model for Options.
Currently, the development of Options tokens and liquidity pooling model as a means of exchange is underway.
On November 23, the founder of yEarn.Finance, André Cronier, announced the launch of the Deriswap decentralized protocol, which will combine swaps, Options and loans on the platform into a single contract that allows users to interact with numerous types of assets. American call/put Options with full collateral will be available on Deriswap. According to Cronier’s statement, the pooling of swaps and Options will result in compensating losses caused by the volatility of the selected pair.
The platform is in the audit stage, and its launch is planned for the nearest future.
Decentralized Options trading pitfalls
The problems faced by decentralized Options trading markets are low bandwidth, high transaction costs, complex interface, the possibility of fraud, relatively weak security, and more.
Scalability issues and transaction costs are already being addressed through the use of second-layer protocols. A bright example of such developments is PlotX cooperation with Matic and Elrond.
The security problem stems from the fact that the projects in the field of decentralized finance are innovative, and experience in building secure solutions in this area is still insufficient. This led to the blocking of ~$28,000 in the Hegic protocol even after passing the audit and platform release on the Ethereum mainnet. An error was caused by a typo in the code, after which the platform was rebooted, and the funds were returned to users.
Options are complex but useful trading tools used by many traders. As the market for decentralized finance grows, traditional financial instruments are being transformed into a decentralized format and find more and more use cases.
Disclaimer: The contents of this article are not intended to be financial advice and should not be treated as such 3commas and its authors do not take any responsibility for your profits or losses after you read this article. The article has been presented to provide readers with general information. There is only personal experience described herein. The user must do their own independent research to make informed decisions regarding their crypto investments.