It’s 2021. COVID has just hit, and I was sitting bored out of my mind at home, fresh off a stimulus check, trying to reconcile the juxtaposition of the insane world outside me against the mundanity of my daily routine.
Like millions of others in the same situation, this ennui and excess liquidity resulted in me spending more time investing. Although my time was spent in crypto, most turned to equities and derivatives. This boom had two poster children: /r/WallStreetBets and Robinhood; two sides of the same coin.
Robinhood had given zero-fee, handheld trading to the masses. This, combined with excess liquidity from quarantine and stimulus, unleashed a torrent of retail activity in the marketplace. In fact, many of you reading this were likely involved in at least part of the mania. Gamestop, AMC, and Tesla all earned hundreds of hours of coverage on their volatility, stemming from hordes of at-home day traders lured by the opportunity to make and lose fortunes. It was more than just investing; it was a cultural and social phenomenon. It was a chance to fight back against the established system and privileged financial institutions.
That same attitude is readily visible in crypto assets, yet retail involvement in derivatives is very different. Perhaps it’s because these are volatile assets, so the desire to take leverage bets on these positions isn’t as high. But, perhaps it’s also because there isn’t yet this ‘Robinhood’ equivalent for crypto; a protocol that makes it simple and exciting for investors to take tactical positions without knowing how to build a Black Scholes (or even how to balance portfolio risk).
We would expect the largest market players to dominate, but for retail to have so few accessible ways to take (theoretically) tactical positions on tokens is curious. This is emblematic of a broader theme: the crypto derivative market is still very immature for retail compared to its equity sibling. To put all this into context, I pulled together a bunch of irregularly reported data to consolidate it into a like-for-like comparison:
|in trillions of US $Data is from 1H’21||Equities||Crypto|
|Market Cap of Spot Market||$93.68||$2.11|
|Notional Amount Outstanding||$610||$20.18|
|Notional / Spot Market Cap||6.51x||10.5x|
Total Market Cap of Crypto Coins for Crypto; Equity Derivative Volume Data is pulled from BIS
The somewhat surprising takeaway here is that, when normalized for market size, crypto actually trades a higher relative volume in derivatives than the general equities market. This may be a result of higher leverage (and lower retail availability) in crypto markets, lack of regulation around naked derivatives, or greater ease of tokenization for derivative products.
There are a variety of factors that will influence the Notional/Spot multiple movement over time. Increased adoption of retail derivative trading will bias it upward. Conversely, a trading base densely populated by savvy investors – relative to the average, that is- will be diluted as crypto’s adoption spreads. This would lead to per-capita use of derivatives lowering as more assets flow in, pushing multiple down.
The short of it is if the equity multiple of 6.51x is a ‘base-case’ for a mature market, there should still be tremendous room for expansion of the crypto derivatives market, particularly among retail and DeFi investors. If you assume that the total market cap of crypto is ~$10tn in 5 years, there will likely be an accompanying derivatives volume of $70-100tn. That’s between $50-80tn of volume to be captured!
Around 85% of total ETH & BTC crypto option volume is currently being traded on Deribit, a primarily institutional platform. Binance & Huobi are the biggest overall derivative markets, again largely driven by institutions. All three of these are Centralized Exchanges. Currently decentralized option protocols share a few problems which are:
1) Low liquidity
2) Unfair pricing – for buyers and/or writers
3) Lack of composability
4) Lack of user adoption
5) Lack of protocol adoption
6) Unfair arb opps during times of high volatility
There are an ever increasing number of new protocols working around the clock to capture this market share: Dopex, Ribbon, Premia, Jones DAO, just to name a few. How do you evaluate them? What are the most compelling tokenomic derivative models in DeFi? To answer this I looked across the ecosystem, and found that Dopex ($DPX), in particular, is building a very exciting product in their Single Staking Options Vaults – SSOVs. Rather than try to compete for the same niche, Jones DAO ($JONES – not yet listed) is betting on the success of DPX, and is working to create a symbiotic relationship to add value for holders of both tokens.
Ribbon is worth noting for its best-in-class UI. Their Theta Vaults are similar to SSOVs, and they have a TVL/MC ratio of just 0.55x. A sybil attack pulled by VC backers shortly after the RBN airdrop has made investors cautious on the protocol. The team is working to rectify this, expanding tokenomics to add staking and Curve-esque yield boosts (as is all the rage).
Each of the three protocols is representative of a different derivative product niche within DeFi. Ribbon is top-of-tongue, for both good and bad in equal measure. That productivity is reflected in their $274mn TVL, and their notoriety reflected in the $150mn market cap. Dopex is the degenerate darling, toted by Tetranode and boasting unique new technology. Jones DAO is the first of the derivative symbiotes (see Convex, as a liquidity symbiote to Curve), which are protocols specifically designed to add investor value to an existing creation. Plenty has been written on Ribbon already, so I’ll be focusing on Dopex and the yet-to-launch Jones DAO.
If you’re unfamiliar with options or protocol tokenomics, this is a good breaking point. Above is a general summary of the state of the derivative options market in crypto, and below I’ll get into a slightly more technical analysis of the DeFi protocols expanding in the space.
Dopex wants to be the Robinhood of DeFi options trading; a user-friendly protocol utilizes Pool 3 style rewards to boost user yield. Available option structures are limited – there are no iron condors here, just calls at fixed strikes ranging from near to far out of the money. The team’s big development was the Single Staking Options Vaults mentioned above. These vaults make use of two tokens, DPX and rDPX, to ensure covered call writers don’t lose dollar value when their sold options are exercised. I’ll get into how this is possible after covering a bit more, but trust that it involves some creative tokenomics.
For any given Single Sided Staking Vault, depositors write covered calls based on a selected strike and asset. Option buyers then purchase these calls, and, based on performance, depositors earn yield. All fairly standard so far. Dopex utilizes European style options, meaning that they can only be exercised on expiration date, rather than whenever in-the-money. Option duration, generally a week or a month, is set by vault and called an ‘epoch’. Dopex also supplements depositor returns by staking underlying tokens to farm rewards. So to sum up, for each SSOV:
1) Strikes are set for the start of an epoch
2) Depositors lock assets into SSOV and select strikes for covered calls
3) User deposits earn yield from the staking pool and also from selling covered calls.
As the whitepaper puts it, this is an enhanced Pool 3. More rewards, but with more risk. It’s different risk than Pool 2 risk of impermanent loss. One based on movement of spot price toward strikes, which is conceptually much easier to grasp for new traders than full-range impermanent loss, let alone the v3 edition.
The goal for the protocol was to create an interface that encourages call-buying, not for the most sophisticated, but through its simplicity and ease of use. At the same time, Dopex ensures that sufficient collateral is available by increasing yield compared to a traditional, single-staking pool. This is represented in the chart below, which shows the performance in percent token change of a staker selling calls at $2,400. Assume that when the epoch starts, the spot price is at $2,000 and strikes are set at $2400/$2800/$3200. Even in-the-money, a covered call writer would still be generating notional yield. The total value of rDPX + the final deposit > initial deposit, holding price of token deposit fixed.
To help deal with the DeFi derivative protocol problems above, Dopex utilizes a system of delegates (2500 DPX staked in delegate contract) combined with a measure of realized volatility. Delegates, currently a group of five of the largest crypto derivative trading firms, are incentivized to quote fair pricing to gain more liquidity and usage of the platform to receive higher incentives, such as pool rewards and platform fees. They are also penalized incase of inactivity and malicious/incorrect reporting. This is different from other protocols which base pricing on implied volatility and Black Scholes, resulting in mispricing in out-of-the-money strikes.
Dopex is built on two tokens: DPX and rDPX. DPX is a standard protocol governance token with a bit of extra flavor. Most importantly, it decides:
1) The weights of DPX rewards for each pool
2) The rebate amounts in rDPX for each pool
3) Strike thresholds for option chains in pools
By these mechanisms, delegates are incentivized to buy and stake DPX, quote price multipliers that result in fair pricing for purchasers… [This] would result in capture of option flow from users of competing platforms considering the increase in price and liquidity efficiency.’
Staked DPX is known as veDPX. In addition to its base structure, veDPX has investor value through pro rata allocations of protocol fee collection, staking rewards, margin collateral, and synthetical collateral. The first two offer yield on the asset, and the latter two allow holders to use their tokens as collateral for cross margin option positions and synthetics.
While DPX is worth a look on its own, rDPX makes it even more exciting. Unlike DPX, which has a fixed emissions schedule and a max supply of 500,000, rDPX has an unconstrained cap. To manage inflation, rDPX is minted only when purchasers make net profit on the option positions in an SSOV. To help compensate call-writers for their underlying losses, pool participants receive rebate tokens, rDPX, at a rate of 30% of losses incurred by the pool. This means that even in instances where options expire in-the-money, the yield generated by the SSOV could still outweigh traditional staking. That’s why strikes well above the money in the example chart above are still yielding >100% of initial investment.
That said, this tradeoff only works if you’re token agnostic and dollar focused. In cases of pool losses, depositors will exchange their staked asset for rDPX. This concept is not dissimilar to impermanent loss in a liquidity pool where the price of one of the assets increases. Yes, you still earn yield on your position, but you may end up with a different composition of assets than you began with.
Like DPX, rDPX can also be used to mint synthetic derivatives (built with UMA) tracking stocks, commodities, and crypto. These synthetic derivatives can be considered as the Layer 2 of Dopex, and help provide rDPX with intrinsic value. It ensures use cases for the token; accumulating (and LPing) rDPX is synonymous with bullishness on DPX synths and margin usage growing.
On the backend, this upward price pressure on rDPX is happening because of the mechanism by which synthetic assets are minted. Assume a 250% collateral ratio (per their docs)- that would mean that in order to mint $100 of synthetic tokens, you would have to deposit $250 of rDPX into the protocol. As demand for these derivative assets grows, users will have to bid on a semi-scarce asset. This will drive up the price of rDPX, increasing the total amount of synthetics able to be minted. These synthetic products will allow users to leverage positions (up to 40% leverage at liquidation, for 250% CR), hedge, or gain alternate exposure.
In addition to its primary use case around synthetics, Dopex includes a number of other value accruing features for investors: rDPX will be a fee requirement for SSOV additions; fee accrual from staking DPX can gain boosts through staking rDPX; burn mechanisms to have deflationary pressure on rDPX.
In what can only be considered an act of war, Dopex launched a major update to the platform shortly before I planned on publishing this (1/20). While upset, I couldn’t stay mad after reading through some of the planned changes, which introduces a collateralized stablecoin, DPXUSD, makes important deflationary changes to rDPX, and throws their hat in the Curve War ring by creating rates vaults. Let’s touch on these updates in more depth, because each addresses a different key theme.
It makes complete sense to create SSOVs for Curve pool APYs. The pools are fundamentally fairly low-volatility, but move just enough to make speculation worthwhile. Where things get really creative is in the deployment. By creating variations of the vaults with leverage ranging from 100-1000x, based on low weekly variance, they allow for speculative positions on the Curve Wars from institutions, protocols, and individuals. Remember that veDPX allows for adjustment of SSOV strikes. This means that through owning veDPX, holders will be able to influence the Curve Wars through rate gauges. All of this is accomplished with significantly lower capital intensity than owning CVX and CRV.
To make the plan possible, it made sense to issue a stablecoin backed by native collateral like DPX/WETH and rDPX/WETH liquidity positions. DPXUSD is used for any stablecoin denominated vaults: Rates, SSOV-Put (Call vaults, but for Puts), and more. However, this plan only accentuated concerns around rDPX’s infinite supply and impermanent loss for liquidity providers.
Enter rDPX v2. This process draws on Olympus’s bonding system, but expands it in a process that they call ‘double bonding’. In short, what this aims to accomplish is to not only increase protocol owned liquidity, but also simultaneously put deflationary pressure on rDPX. Sounds complicated? Yes, but also not as much as you’d think. There are two stages of the double bonding, one focused on liquidity and one on stability.
What this somewhat confusing image shows is the flow of assets through the double bonding system, resulting in minting of DPXUSD. The way that it works is that one comes to Dopex with 50% of bond value in rDPX/USD liquidity, and 50% in either USD stables or rDPX puts. The protocol is now 75% backed by stables (half of 50% from rDPX/USD pool, and 50% USD), and can deposit these assets into Curve or SSOV-Put to farm. Dopex then burns rDPX in an amount equal to Value of the Bond*ROI, and mints DPXUSD in an equal amount to be vested and transferred to the bonder.
This puts deflationary pressure on rDPX, similar to LUNA, while denominating assets in a token more useful for activity in the protocol. This also has the beautiful side-benefit of reducing emissions over time. Remember that rDPX rebates are paid out based on notional losses. So, as the price of rDPX rises over time from liquidity bonding pressure, it will take increasingly small quantities of rDPX to pay out losses. If you didn’t follow that, no worries, a slightly simplified example below.
1) Anon goes to Dopex with $200 in rDPX/USD and $200 in DAI
2) Anon deposits the tokens into a DPXUSD bond with 5% ROI.
3) Assume rDPX = $100. Dopex then burns 4.20 rDPX ($400*1.05)
4) $420 of DPXUSD is minted and vested to Anon over 5 days
All in all, Dopex is an excellent pick for a wide suite of investors- those looking to boost notional yield on long-term holds, those who seek user-friendly options, and those looking to invest in new tech. As far as value for money goes, Dopex is trading at ~6.4x MC/TVL vs. Ribbon at 0.5x. However, considering the number of low-hanging fruit available to increase size and number of SSOVs, there is a good argument for that ratio decreasing price movement aside. If I had to choose, rDPX is especially interesting here with a market cap around ⅓ of the size of DPX and, honestly, more interesting tokenomic value for holders.
Given the simplicity of use of Dopex, it’s hard to imagine there is a niche for Jones DAO to sit, but never underestimate the power of building vertically in DeFi. Like Curve / Convex, Dopex should become increasingly efficient as TVL in the protocol increases. Jones aims to add locked funds to Dopex via three primary user groups:
1) Users who don’t want to actively manage their options strategies and/or would like to utilize JonesDao option strategists’ expertise.
2) Users who would prefer not to lock their assets in Dopex SSOVs for a whole epoch and would like to keep their deposits liquid.
3) Protocols who want to earn additional yield on their treasury assets without employing treasury management experts.
Let’s look into each of these a bit more in depth. The first category of users is the most broad, encapsulating any investor who wants to use the yield-boosting features of Dopex, but is unsure of how to set strikes or determine options risk. To mitigate this uncertainty, Jones uses a series of vaults labeled simply by their risk-level and asset type. Users can then simply deposit their given token, select a risk, and be on their way.
The second category is the most interesting one, as it addresses the liquidity issues around locking assets in an SSOV for a full epoch. Remember, that once a token is deposited into a vault, it’s unable to be accessed until the end of an epoch. This is based on the assumption that users are only using vaults for long-term holdings. If I wanted to just passively earn yield on these tokens, I could go to Aave and have the additional flexibility to leverage my position. Jones rectifies this by introducing jAssets.
“jAssets are fully composable yield-bearing asset tokens that unlock liquidity and capital efficiency for assets locked in options strategies. When a deposit is made to the primary Jones Vault for an asset, a jAsset token is minted to represent the deposit. Upon withdrawal, the jAsset token is burned and the deposit + yield is received back by the depositor.” – Jones Whitepaper
jAssets are useful because they allow for a variety of activities mid-epoch. Based on a teaser from Jones, I suspect that they will have a partnership with Rari allowing users to deposit jAssets into a Fuse pool and borrow against them. Furthermore, it effectively converts the European style options issued by Dopex into American style options. By selling the jAsset, you’re able to ‘exercise’ the option and claim profits.
Jones announced the JONES token sale, set for 1/25. JONES accrues value in a few different ways. Most directly, JONES claims a 2% annual fee on total TVL, as well as a 20% performance fee on yield generated. This play on the 2 and 20 model popular in the Hedge Fund world is the user cost for unlocking their Dopex assets.
In addition to this, locked JONES will be converted into veJONES. Like other Curve-esque tokens, veJONES holders can vote on gauge weights for Jones Vaults and jAsset pools. This aligns usage with long term holders and creates efficiency by allocating farming resources to the most used pools. Locked JONES also receives a portion of protocol fees and JONES emissions.
At the very least, Jones seems like an incredible derivative (hah?) opportunity of Dopex. If you’re bullish on the incredible tokenomics coming out of the team, Jones will be a crucial part of the Dopex future by allowing for investor flexibility. I’ve been impressed by the speed at which the team has built and created partnerships, and will be keeping an eye on the launch.
This report is not investment or trading advice. Please conduct your own research before making any investment decisions. Past performance of an asset is not indicative of future results. The Author may be holding the cryptocurrencies or using the strategies mentioned in this report.