Context
Before we get to the heart of the story of options in DeFi, what exactly are options? Options are derivative products that derive their value based on the change in the price of the underlying asset. People use options to largely speculate or hedge their positions.
Any change in the underlying asset’s price drives a change in the option’s price. In DeFi, we have options trading protocols such as Opyn, Dopex, etc. These could be looked at as base layer protocols i.e., where options are minted/created and on top, we have protocols that build structured products via vaults (e.g. Ribbon) to improve the UX and make it easier for regular users to get exposure to volatility via options.
Timeswap being the world’s first fully permissionless, oracleless, and fixed-term money market can be used as an options protocol, to be clear, as pseudo options! Let’s take a look at how!
Diving in!
Timeswap money markets have liquidity pools expiring at different maturities. Each lender and borrower interacts with a liquidity pool to execute lend or borrow transactions. Timeswap borrowers have an option to repay the loan before maturity, if they choose not to repay, they’re considered as defaulted on the debt. Here the borrower is effectively holding a call option on the asset that’s being lent & borrowed, whereas it’s the lender who’s selling this option. The collateral locked by the borrower can be considered as the premium being paid for the option.
So, a user has to pay the premium and get exposure to the underlying asset without buying it directly. In Timeswap’s case, you pay the premium in terms of the collateral and get exposure to the underlying liquidity pool.
None of the option buyers have an obligation to exercise the contract and make it good, they pay the premium upfront just to enjoy this benefit. To get things in perspective, the strike price will be the market value of the debt at maturity.
How do Timeswap’s pseudo options work?
If the market value of the collateral (option) is lesser than the debt (underlying asset), you won’t claim your collateral as it makes more sense to default and take debt off the table. In this scenario, prudence is to exercise the option.
On the flip side, if the market value of the collateral is more than the borrowing, you’ll claim the collateral by repaying the debt, thus not exercising the option.
Timeswap’s pseudo options offering
Money markets in DeFi are plagued by numerous cracks that make users’ capital inefficient and consequently, liquidity moves away. We have built Timeswap in a way that solves all the money market problems with an AMM at the core.
So, there would be no liquidation of your collateral (option) anytime due to market volatility, until the option or loan doesn’t mature exactly how options work in TradFi or DeFi.
Plus, all the liquidity pools are independent and all of the capital will flow in the pools that are deeply liquid rather than getting fractured over different pools of the same money market thus ensuring minimal slippage & deepest liquidity. All in all, Timeswap’s liquidity pools are a vault in themselves.
Real-time example
Call option:
Let’s say, I’m bullish on ETH and predict its value to appreciate until the above pool matures (20th Feb), so I borrow USDC by locking ETH at a 1.06 times collateral ratio. I get USDC in return, which will be in turn used to buy more ETH as I believe its value to go up and collateralizing that ETH only to borrow USDC at a minimal collateral ratio, I will keep repeating this in loops. As the pool matures, and if my prediction comes to fruition, I will claim my ETH or in other words buy ETH by paying less USDC than in the market. Effectively, this is how any borrower can use a Timeswap pool as a ETH call option.
Put option:
On the flip side, if I predict ETH to fall until the pool matures, as a borrower I can short sell it. By locking it as collateral I could borrow stables and when my prediction comes to fruition with ETH falling, I’ll not repay my USDC as it has appreciated in value and it makes sense to default on the debt. In this way, a user can use a Timeswap pool as a ETH put option.
To sum
Timeswap owing to its value propositions, the protocol is poised to be a pseudo options market platform that can provide its users to go long or short any loan by lending/borrowing.
What do you think anon?
**
**