1. Overview of DeFi options library
DeFi Option Vaults (DOV), also known as Theta Vaults, refers to users depositing funds into corresponding Vaults. The protocol automatically sells fixed-term European options in the market based on a pre-set strategy and transfers the accumulated option fees. Revenues are distributed to users.
This model is similar to a DeFi income aggregator, eliminating the need for users to research and combine relatively complex option strategies on their own, expanding the user base of options and structured products, and lowering barriers (such as qualified investor qualifications).
Through Vaults aggregation, users can also save gas fees for on-chain activities.
Traditional DeFi liquidity mining usually gives users an amazing rate of return in the early stage. In addition to sharing transaction fees, it usually subsidizes LP through the issuance of additional tokens. However, in the later period, increased selling pressure on tokens and falling prices will lead to a decline in the rate of return.
DOV's income comes from the implied volatility at the time of option trading, not a subsidy.
Overall, DOV is not mainstream in the DeFi market. It is in a relatively early stage of development (gradually appearing in 2021) and has a small user base. However, the Lego attributes of DeFi are naturally suitable for building structured products and can also build investment portfolios across protocols ( For example, POS Staking+LSD+liquidity mining+put option combination).
2. Ribbon Finance Overview
https://app.ribbon.finance/
Ribbon Finance is the first DeFi structured product project that supports multiple chains (Ethereum, Solana, Avalanche) and executes automated options strategies through smart contracts. Its smart contracts have been code audited by Peckshield, ChainSafe, etc.
The project was founded in early 2021, with a total financing amount of US$16.6 million. The main investors include Paradigm, Dragonfly Capital, and Coinbase.
Ribbon Finance’s current TVL is approximately US$55 million, and its peak TVL reached US$300 million.
Project income mainly comes from sharing users’ investment income and management fees. If the strategy is profitable that week, a management fee of 2% of the annualized asset management scale (0.038% per week) will be charged, and 10% of the profits will be shared; if the strategy is not profitable that week, If you can make a profit, no fees will be charged.
This mechanism does not have a mechanism similar to high water mark, so if the user loses one week and makes profit one week, even if the total revenue is zero, the protocol will still charge the profit share for the week.
According to TokenTerminal data, the protocol earned a total of US$5.09 million in revenue in 2022, accounting for approximately 5% of the capital size.
As an early DOV project, Ribbon Finance has provided a large amount of liquidity to the decentralized options exchange Opyn.
However, pure DOV also has shortcomings. The main reason is that it can only execute the option seller strategy. It is too simple and lacks flexibility. Users can only passively accept products with customized expiration dates and execution prices.
3. Strategy & Products
In the early version of Ribbon V1, the manager selected the strike price (strike price) of the current week's option for its treasury. Later, the updated version of Ribbon V2 calculated the execution price through smart contracts, avoiding manual decision-making and improving decentralization and scalability.
Options are cash settled, while common dual-currency products are physically delivered.
1) Strategy mechanism
a) Algorithmic Strike Selection:
Its algorithm will select options that expire next week and have a Delta value of 0.1 (the default parameters may change and are determined by the community) as the selling object. Since the value of deeply out-of-the-money options is close to 0, it is crucial to choose options with appropriate exercise prices (different degrees of out-of-the-money) to obtain a balance between risk and return.
The protocol will use the BS model to calculate the exercise price of the strategy's selling options based on the volatility, and do so before executing the strategy every Friday.
The spot price is obtained through the oracle machine Chainlink; the price at expiration is provided by the oracle machine Pyth.
Market volatility is obtained through the self-developed (closed source) volatility oracle RVOL through the historical data of Uniswap v3 transaction prices. For BTC and ETH, Deribit's volatility data will be used for updates.
Expansion—Basics of option pricing models:
Binary tree and BS model
Taking call options as an example, regardless of discount, the basic pricing logic of options is:
However, in reality, the price S of the underlying asset cannot be determined, but the probability of different price trends can be assumed to calculate the option value. This is the basic principle of the binary tree pricing model.
Expanding the stages of the binary tree to infinite nodes and infinitely small periods (through calculus), the BS model (Black-Scholes Model, Black-Scholes model) is obtained, which is the basic formula for option pricing and has won the Nobel Prize. Bell Prize in Economics.
Its most important basic assumption is related to probability, that is, the price of the underlying asset (stock) obeys geometric Brownian motion (random walk), and the logarithmic return of the asset obeys the normal distribution.
This formula can be roughly understood as follows: through the probability distribution function CDF of the normal distribution (Nd1 in the announcement), the asset price on the maturity date is obtained; through Nd2, the execution price is obtained (because it is unknown whether the option is valuable at expiration).
Nd1 in the formula describes the sensitivity of the option price to the underlying asset (that is, the delta of the option), and can also be understood as the expectation of the price of the underlying asset at expiration; Nd2 can be understood as the expectation of the option execution cost, that is, the execution cost. probability of right.
The underlying logic of the pricing model is to calculate expectations through probability. For example, Monte Carlo simulation assumes a probability distribution, conducts path simulations countless times, and finally obtains the average of countless possibilities.
b) Theta Vault Auction:
Every Friday, Theta Vault will deposit all funds received that week into the decentralized options exchange Opyn, and mint will issue oToken as a certificate.
These oTokens will be auctioned in the institutional OTC matching market paradise.co in the form of a blind auction (hidden bid, the highest bidder wins), and premium will be collected as income. The oTokens that are not fully sold will be exchanged for collateral.
If the option expires and suffers a loss due to the counterparty exercising the option, the collateral (coins) retrieved from Opyn will be reduced.
2) Products
The early V1 version provided a buy straddle strategy, but because it was relatively niche and there was no shortage of speculative products in the currency circle, it was not very popular and has been removed from the shelves.
There are currently 3 products, including Covered Call, Put Selling and capital preservation strategies. All options are European options.
a）Covered Call
It is similar to dual-currency investment - sell high, but the product is cash-delivered, that is, only the number of coins corresponding to the difference between the spot price and the execution price is deducted.
The user pledges the corresponding spot and enters the options library. The Covered Call strategy is executed every week of the agreement (every Friday) and the call options expiring next week are sold in the corresponding options market. The exercise price is determined by the algorithm; the user receives option tokens as certificate.
This strategy is a financial product that pursues a high winning rate and low profit-loss ratio. Even if the currency price rises sharply, resulting in a currency-based loss, the difference will be deducted after cash settlement and will still be profitable based on U-based calculations.
Taking the T-SOL-C (SOL call option selling strategy) product as an example, due to the bear market in 2022, the short call weekly winning rate reached 91.67%. However, due to the doubling rebound of SOL at the end of December, the product currency standard retracement was relatively large. big. However, if calculated according to the U standard, it is still profitable from December to now.
b）Put Selling
The strategy of simply selling Put option naked can earn fixed income when the market goes flat or rises. However, this product is also cash-delivered, so it is not suitable for accumulating coins.
Option sellers have a high winning rate but a poor profit-loss ratio. When the market drops significantly, the retracement is large.
c) Capital guaranteed product: R-EARN
Ribbon is called a twin win strategy, which is essentially a two-way shark fin. While buying fixed income, you also buy a call barrier option + a put barrier option.
Its base yield is 2%, and the upper and lower limits are 8% above and below the execution price.
It should be noted that Ribbon's guaranteed income is provided through its lending product Ribbon Lend, which are all unsecured demand loans to trusted market makers.
Its lending status is 100% to Wintermute. Due to the unsecured loan, this product has certain credit risks.
d) Capital guaranteed product: R-STETH-EARN
Ribbon is called a dolphin strategy, which is essentially a bullish shark fin. While buying fixed income, you also buy a call barrier option.
However, the underlying asset used by Ribbon is stETH. Users can choose to invest in ETH or stETH, and the underlying source of its currency-based income is the Ethereum pledge of the Lido platform.
Since the ETH invested by users will be returned to stETH (before the Shanghai upgrade, Ethereum pledge is irreversible), users will suffer losses if the exchange rates of ETH and stETH are decoupled. On the Ribbon platform, the two are equal by default.
The exercise price of this product is based on ETH, and the proceeds are sent in the form of stETH.
Since barrier options are non-standard products, all Ribbon option transactions on this product are conducted through external market makers, so there is a risk of counterparty default.
4. Platform structure
1) Age
Ribbon Finance's upcoming decentralized options exchange uses Rollup technology, is deployed on Ethereum, uses an order book model, is designed for professional options traders, and provides liquidity by introducing options market makers.
Self-built exchanges can provide more strategic options for their DOV products, and DOV can also attract traffic to the exchange and complement the ecosystem; for users and market makers, an integrated options exchange can make it easier to hedge or close positions in advance.
Aevo is currently in the closed testing phase and will eventually be integrated into Ribbon Finance, which can solve the problem of DOV being too simple and inflexible.
2）Ribbon Earn
The supplement of Theta vaults, the underlying income source of capital-guaranteed products, and the capital side of Ribbon Lend.
Users who invest stablecoins in Ribbon Earn will receive rToken as proof of deposit.
3）Ribbon Lend
In the defi lending market for institutions (similar to TrueFi), users can invest funds without permission, but institutions lending funds require whitelist access. Since no collateral is required for borrowing, the interest rate will be significantly higher than Aave, up to 5.4%.
The lender's rate of return is determined by the capital utilization rate.
Currently, the only institutions that have gained access are Wintermute and Folkvang (the fund pool is temporarily closed). Ribbon cooperates with the crypto credit rating oracle Credora (invested by Polychain, Coinbase, Hashkey and other institutions) to obtain real-time credit ratings of institutions.
If a lending institution defaults, Ribbon will organize a debt auction. If the final bid is approved by rToken holders, the debt will be transferred to the corresponding institution for recovery and claims.
5% of the borrowing interest will accumulate and flow into the insurance pool.
4）Ribbon Treasury
An option library specially customized for DAO organizations, DAO's asset management platform, can customize financial products according to DAO's needs, such as different expiration dates, different risk preferences, option fee currencies, etc.
Current partners include Balancer, Abracadabra, and Badger DAO.
5. Token Economy
The platform issues token $RBN, which adopts the veToken model and is locked for up to two years. After locking, you pay a certain fine to unlock it in advance. Like veCRV’s mechanism, veRBN can be used for governance voting, sharing of protocol revenue, and boost borrowing rewards.
50% of the protocol revenue flows into the community treasury, and the remaining 50% is distributed to veToken holders in the form of ETH.
6. Summary
As a DeFi asset management platform for retail investors, Ribbon's current ecological infrastructure is relatively complete, including options exchanges, market maker matching, and lending platforms. Although it is relatively early, the framework has been set up, and the basic framework is worth learning from.
about Us
JZL Capital is a professional institution registered overseas that focuses on blockchain ecological research and investment. The founder has rich experience in the industry. He has served as CEO and executive director of many overseas listed companies, and has led and participated in eToro's global investment. Team members come from top universities such as the University of Chicago, Columbia University, Washington University, Carnegie Mellon University, University of Illinois at Urbana-Champaign, and Nanyang Technological University, and have served at Morgan Stanley, Barclays, Ernst & Young, KPMG, and HNA Group , Bank of America and other internationally renowned companies.
