DeFi Options deepdive: Premia Finance
Premia is a decentralised finance options protocol. It allows users to provide liquidity to, or buy and sell options from, a liquidity pool. Premia enables the trading of options, allows users to earn a market yield on DeFi assets and provides protection to users through hedging risk.
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DeFi options vaults have become popular among retail investors looking for an easy and accessible way to leverage their investments. By depositing their assets into a vault, investors can gain access to option premiums without having to deal with options directly. This eliminates the need for investors to deeply understand options trading, making it accessible to a broader audience.
Furthermore, users of DeFi options vaults can earn additional rewards in the form of token rewards and staking yield. This makes it an even more attractive option for investors looking to maximize their returns.
DeFi options vaults come in two forms, standalone and packaged with an AMM. Standalone vaults are independent and operate independently, while vaults packaged with an AMM aim to aggregate liquidity across options series. The latter is beneficial for investors who are looking to trade in multiple options series.
However, it should be noted that AMMs were designed for spot trading. As such, protocols had to modify the AMM pooled liquidity model to make it suitable for the convexity of options. This ensures that the liquidity provided by the AMM is suitable for the unique characteristics of options trading.
Overall, DeFi options vaults are an excellent option for retail investors who are looking for a simple and accessible way to earn high-leverage exposure.
Premia Finance is a DeFi-native options protocol that has been providing returns for its users, with returns often in the mid-to-high double digits. This innovative protocol is taking a unique approach to AMM design and making DeFi options more accessible to retail users.
One of the critical innovations of Premia is its AMM design, which has been optimized for options trading. This allows users to trade options more efficiently and cost-effectively, leading to higher returns. The protocol is also user-friendly, making it accessible to a broader range of investors, including those without a deep understanding of options trading.
Overall, Premia is a DeFi options protocol designed to provide attractive returns for its users while making the process of options trading more accessible to retail investors. In addition, its innovative approach to AMM design and user-friendliness set it apart from other options protocols in the DeFi space.
Pooled liquidity, also known as an AMM structure, benefits the DeFi ecosystem. However, a simple bonding curve AMM only considers changes in token reserve and does not account for other important variables, such as the spot price, volatility of the underlying asset, the risk-free interest rate, and the strike price and duration of the option. These variables are constantly changing and must be considered for accurate options pricing.
Premia is a protocol that aims to address these issues by offering a novel solution with its implied volatility surface and c-level features. The protocol also aims to make DeFi options yields more accessible to a broader audience. Through its smart deposit optimization framework, Premia provides example portfolios to liquidity providers, making it easier to get involved in the DeFi options market.
Premia utilizes a unique liquidity pool structure to provide users with a flexible and efficient options trading experience. Each available asset pair in the protocol has a corresponding call and put pool. The call pools are underwritten in the underlying asset, while the put pools are underwritten in DAI.
This two-pool structure gives liquidity providers significant control over which strategies to underwrite, as the demand from buyers and sellers can be different. This allows LPs to independently fill the pools with the strategies they want to underwrite, giving them more control over their investment strategies.
This approach starkly contrasts the traditional order-book model, where trade parameters typically must align. In the traditional model, a trade cannot be executed if there is no matching order. However, with Premia's liquidity pool structure, LPs can independently provide liquidity for different options strategies, increasing the chances of finding a matching trade.
The transaction flow in Premia is designed to be user-friendly and easy to understand. Users can initiate a trade by specifying their desired option details, such as option type, asset pair, strike price, expiration date, and quantity. Once the details are provided, the protocol's liquidity pool will return a quote for the trade. Users can then execute the trade through an on-chain transaction.
The options traded in Premia are represented as ERC-1155 tokens. This allows the option to be transferred or exercised at any time on or before the expiration date. This added flexibility gives users more control over their trades, as they can choose when to exercise or transfer the option depending on their investment strategies. The use of ERC-1155 tokens also allows for a more efficient and cost-effective way to trade options, as it eliminates the need for multiple separate tokens for each option.
Options traded on Premia can be exercised at any time after purchase, whether in whole or in part. This allows traders to exercise their options when it suits their investment strategies. If an option is in-the-money at expiration, the payoff is locked in, and the holder can claim it at any time after expiration. Additionally, all options traded on Premia are cash-settled, eliminating the need for underlying assets to be delivered.
A feature introduced in Premia is the option to sell options back to the pool anytime. Before this feature, traders had to find a counterparty to accept the trade on a NFT marketplace to sell their options before expiration. This feature provides added convenience for traders, as they can now sell their options back to the pool without waiting for expiration or finding a counterparty. It also benefits liquidity providers as they can pull their capital out early or place it in a new position, allowing them to earn on several positions.
The $PREMIA token accrues value to token holders through its liquidity mining program and staking mechanisms. The Cross-Chain Liquidity Mining Fund received the highest token allocation at 30%. Liquidity providers receive $PREMIA tokens as compensation for lending their assets. Stakers of $PREMIA tokens collect the bulk, an estimated 80%, of the protocol's fees. All $PREMIA holders also have governance rights, meaning they can vote on new proposals and protocol decisions. Those who own at least 100 $PREMIA tokens can submit Community Proposals regarding changes to Premia's features and the protocol's future roadmap.
Premia charges fees to support the growth and long-term sustainability of the protocol. These fees include the following:
- Option buyers are charged a 3% Protocol Fee at the time of purchase, which is charged on the option's base price and included in the quote provided to the buyer.
- Liquidity providers (LPs) are charged a 2.5% Utilisation Fee. This fee is a recently introduced feature that replaced the 3% Exercise Fee. The problem with the Exercise Fee was that it charged option buyers a second time for the same transaction, and there were no fees for options that expired out-of-the-money but utilized capital. This resulted in unbalanced fee incentives.
The new Utilisation Fee is a 2.5% annualized interest rate, calculated based on the amount of capital locked and the period the capital was utilized. It is paid by the LP at settlement (exercise, secondary sale, or expiry) and taken from the collateral stored in the option.
To reward supporters of the protocol, 80% of the fees collected are paid as a protocol fee to $PREMIA stakers. The remaining 20% of the fees go to the PREMIA treasury. This incentivizes users to support the growth and long-term sustainability of the protocol by providing liquidity and staking their tokens.
DeFi options markets are in their early stages, with most of the growth in recent months coming from liquidity providers attracted to higher yields than traditional DeFi platforms. Despite this, demand for options remains low, presenting challenges and opportunities for innovation. Protocols like Premia will be successful not by capturing a significant market share but by adapting to market conditions and developing advanced features.
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