ON–047: DeFi (Part 2)

• In the wake of the recent DeFi rollercoaster, Hegic, a new, novel and innovative decentralized options protocol has launched on Ethereum by Molly Wintermute. Hegic’s new and revamped protocol launched on October the 10th and is a venue where users can buy/sell both Bitcoin (wBTC) and Ether (ETH) put or call options. In recent times, centralized exchange options trading has begun to attract significantly more market participants and experienced rapid rises in volumes, growing ~6x since the start of the year.

Source: Skew

Just as decentralized exchanges (DEXs) appeared after the success of their centralized counterpart, given the backdrop of raising concerns around privacy and custody, decentralized options protocols followed suit. Where Hegic differs from its competitors is its unique liquidity pool design for writing options. There are three core participants of the Hegic network that eloquently interact with one another to create the Hegic system: option writers, option buyers, and staking lot owners.

Hegic utilizes a novel bidirectional liquidity pool (LP) design, that allows ETH or wBTC to be provided as liquidity, used to sell both put and call options. Premiums paid by option buyers are paid to the LP, however, similarly profits from in the money options are paid out by the LP. Through embracing one of DeFi’s most successful and novel constructs, liquidity pools, in one month, Hegic has attracted $32m of liquidity that option buyers can now tap into.

Source data: Etherscan

• Traditionally, options trade in order books where writers can create options around fixed expiry dates and strike prices to sell into the market. However, due to the aforementioned LP design of Hegic, option buyers are granted the flexibility to set parameters (custom strike, custom size, expiry). This has enabled market participants to access depth that, to date, has not been available in decentralized order book protocols, in which liquidity is spread and allocated across specific durations and strike prices.

Source: Hegic Analytics

• In aggregate over the first month of trading on Hegic, there have been ~900 options traded with a total value of almost $35m.

Source data: Hegic Analytics

• The HEGIC token is the platform’s native token and has a right to claim a share of the protocol fees (1% of all options volume traded on Hegic). Fees are paid in the underlying option’s asset, which results in stakers receiving a yield in either Bitcoin (wBTC) or Ether (ETH). Whilst acquiring a staking lot requires 888,000 HEGIC, several staking pools have been created that allow for smaller HEGIC holders to gain access to the yield (jmonteer23, zLot, yearn finance).

Source data: Etherscan

• With the early volume and value of options being purchased on Hegic, staking lot holders have been realizing a relatively lucrative yield (~50-70% APY) paid in wBTC and ETH. This has provided high incentives for HEGIC holders to participate in staking, resulting in staking lots accounting for ~65% of circulating supply.

Source data: Hegic Analytics

The decentralized options landscape is just starting to ramp up, especially in the wake of recent regulatory actions (FCA ban crypto derivatives trading for retail), privacy considerations (increased KYC/AML of centralized exchanges), and user fund security (centralized exchange withdrawal issues and vulnerabilities).

Hegic is a new decentralized options market whose design is experimental but leverages DeFi native constructs and designs. The result is unmatched liquidity for options in DeFi, LP/writer premiums, flexible option design, and distributed protocol fees to stakers. Such characteristics can help grow the DeFi ecosystem by providing downside insurance (puts) for lending platforms (Maker, Aave, SNX), upside insurance (calls) for those exiting wBTC/ETH positions to farm with stablecoins, or the opportunity to develop options strategies for the growing money manager protocols.

Disclaimer - Hegic is still in Beta and like a lot of DeFi is experimental, users should proceed with extreme caution and DYOR.