Exploring Decentralization Options: All Set, Just Waiting for the Right Moment

Options are a type of right, a contract in which both parties agree on the terms of delivery and the type of goods delivered. The emergence of smart contracts allows contracts to be executed automatically in an on-chain, intervention-free environment, with clear and transparent conditions and processes for contract execution, creating a favorable environment for the operation of options. Since the DeFi summer of 2020, countless teams and projects have begun to venture into decentralized options. Three years later, the industry has shown a flourishing development, with significant progress in accounting infrastructure, types of options, and market-making algorithms.

As the market enters a bear phase, the cost of token incentives is increasingly rising. The inflated activity of decentralized options has begun to decline. With the exception of a few projects, innovation is focused on micro-innovations of financial products. The market rewards breakthrough innovations that align with blockchain architecture and decentralized environments, with projects like Lyra standing on the shoulders of giants forming a DeFi matrix, creating a unique algorithmic system for options pricing. Although the market size is shrinking, Aevo and Lyra occupy an absolute leading market share.

Compared to the hundreds of billions of dollars in off-chain transaction volume, the current scale of on-chain Options is barely a fraction. In traditional markets, the nominal transaction volume of Options is basically on the same level as futures. From this data, we can conclude that the on-chain Options market is in its early stages. In the second half of 2023, the technology of layer 2 networks gradually matured, and the low-cost infrastructure technology supporting the order book Options market triggered new growth in the on-chain Options market.

We have long passed the DeFi summer of "Decentralization is good". All decentralization will be questioned: Why decentralize!

Background of Decentralization Options

What are Options

To understand decentralized options, two questions must be addressed: what are options, and why decentralization?

Options are a type of choice, where both buyers and sellers determine the time and price of exercising the option. The holder of the option has the right to execute the contract as agreed.

Options are a special type of financial contract and a financial instrument related to price fluctuations. Analyzing from the nature alone, options not only reflect the price changes of the underlying asset, but also reflect the rate of price changes and the differences in exercise times, etc.

Options are a financial instrument related to risk pricing. The changes in option prices can reflect price attributes that spot and futures cannot express, providing investors with more dimensions and tools for hedging risks and designing asset portfolios.

In addition, the uses of Options are extensive. Understanding the uses of Options helps us identify the precise users of Options products. In the traditional world, Options have many uses beyond being a leverage tool:

1. Risk management tools: Enterprises or projects can obtain the right to buy or sell at a specified price within a specified time by purchasing Options, locking in the upper and lower limits of expenditures and revenues, and guaranteeing minimum profits.

2. Financing Tools: The company can raise funds by selling Options. For example, in October 2022, Tesla raised $2.2 billion by selling 5 million call Options.

3. Organizational Incentive Tools: Many traditional large organizations incentivize middle and senior management through Options.

4. Leverage and Speculative Tools: Investors can use small capital to leverage large returns, even betting on trading opportunities in terms of time costs or volatility dimensions.

What is Decentralization Options

Decentralization Options refer to smart contracts issued on the blockchain that have the attributes of options. Compared to traditional options markets, they do not require permission, are publicly transparent, have no default risk, and have stronger combinability with other decentralized products. The execution of options is guaranteed by blockchain smart contracts and is executed automatically. This is the only difference between Decentralization Options and traditional options.

Why Decentralization Options are Important

The advantages of decentralized Options over centralized Options are mainly reflected in:

1. Eliminate default risk: The execution environment, processes, and conditions of on-chain Options are open and transparent, with no uncertainty from a clearing perspective.

2. Fairer: Founders and the team have no privileges, and all participants can only participate in the game under the smart contract.

3. Deeper and closer capital collaboration: Decentralized options are an indispensable part of decentralized finance, with the potential to replace centralized options.

Currently, on-chain Options are mostly positioned as leveraged tools or volatility underlyings, and more complex ones become components of certain investment strategies, forming structured investment products.

Decentralization Options Market

Compared with traditional finance, decentralized options have differences in terms of underlying assets, users, and channels, which presents the possibility of differentiated competition.

1. Different underlying assets: Decentralization options are best suited for native on-chain assets.

2. Different user groups: Lack of participation from industrial capital makes it difficult to form rigid demand. On-chain options users should be more programmatic rather than manual.

3. Different compliance preferences: Decentralization Options attract individuals with low compliance requirements.

4. Broader underlying scope: Decentralized exchanges can allow more digital crypto assets to become options underlyings through the "private pool" concept.

5. High participation threshold: Due to the high difficulty of using the product and significant compliance risks, the amount of participating funds and users remains scarce.

6. Low capital utilization efficiency: The no-default risk under smart contracts requires over-collateralization, leading to generally low capital utilization efficiency.

Bottlenecks in the Development of the Decentralization Options Market

1. High costs: including operating expenses, risk costs, and educational costs.

2. The market is immature: lacking stability and necessary demand, making it difficult to form sufficient liquidity.

3. Low capital efficiency: Decentralization platforms cannot pursue users for excessive losses and must reduce the risk of liquidation.

4. Immature infrastructure: Infrastructure such as wallets and exchanges is complex and difficult to use.

Decentralization Options Race Track Pattern

The decentralized options track can be divided into options issuance, options market making, and structured products under options tools. The main projects include:

• Automated Classic Options Market Making: Lyra, Deri, Optix, Premia, Panopic, Hegic, Aevo, etc.

• Structured Products: Ribbon finance, theanuts finance, cega, BracketX, etc.

• Exotic Options Design: Y2K finance, Opyn, Deri, Smilee finance, etc.

Decentralization Options Track Ecological Niche

The characteristics of decentralized options lie in the pricing of volatility and risk management. As the composition of investors changes, capital preferences will shift from high-risk, high-return to low-risk, moderate-return. Controlling risk and forming a financial system with different risk preferences may be the key to winning the DeFi battle in the Layer 2 war.

Summary

The decentralized options sector has formed a series of projects centered around classic options with BTC and ETH as the core underlying assets, alongside various ERC20 options and exotic options as the periphery. The future of options pricing should be the point pool model and automated market maker model.

The use of on-chain options has not yet highlighted its characteristics and lacks significant bonuses to attract players. The on-chain industry scale is insufficient, with no obvious risk management demand. Traditional functions such as options financing and options incentives have not been reflected in on-chain businesses.

Although options are not currently at the core of demand in the competition of second-layer networks, they provide us with the opportunity to redefine the attributes of on-chain assets. As the market matures, decentralized options are expected to play a more important role.