Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Zubin Koticha: Opyn – The Insurance Platform Which Protects Your DeFi Deposits

Episode Date: June 17, 2020

Opyn is a smart contract-based insurance platform built on a generalized (supports both put and call) options protocol called Convexity. It is intended as a platform to protect DeFi users against both technical and financial risks, and a place where ETH holders can earn substantial premiums on their holdings by providing insurance.Opyn uses tokenized ERC20 put options, oTokens, on ETH to allow option buyers to keep their upside while limiting their downside. If you buy Opyn protection, you are buying “the right but not the obligation to sell an asset at a pre-specified price”. Currently, you can buy insurance for DAI, ETH, and USDC deposits on Compound and it is completely noncustodial and trustless. Zubin Koticha, CEO & Co-founder of Opyn, is currently working on V2 of the platform with his team. Their focus for improvements are in 3 main areas; cash efficiency, trading mechanism, and network effects. They are hoping to release this within the next 6 months. This is a much-needed generalizable insurance solution against some attacks/ vulnerabilities within the DeFi ecosystem and it will be very interesting to see how their contribution to DeFi progresses.Topics covered in this episode:Zubin’s background and how he got into cryptoHow Opyn was created and the roles within the companyThe evolution of the Opyn productUsing options as an insurance solutionThe difference between traditional markets and OpynAmerican vs European optionsImprovements they are making in V2 - capital efficiency, fungibility, network effectsThe collateral as a different asset featureTrading venueAn overview of VegaSwapTimelines for the new versionEpisode links: Opyn WebsiteOpyn WhitepaperWhat is Opyn?Opyn DiscordOpyn TwitterZubin Koticha TwitterThis episode is hosted by Friederike Ernst & Sunny Aggarwal. Show notes and listening options: epicenter.tv/344

This is Epicenter, episode 344 with guest Zubin Corticeo. Hi, welcome to Epicenter. My name is Sanyaggar Rall, and today we have on with us Zubin Kortica, who is the co-founder and CEO of Open, which is a company building decentralized options on top of Ethereum. So this is actually a very interesting episode for me because Zubin, as well as both of his co-founders, a partner in Alexis, we go way back. We were all students at UC Berkeley together where we were all part of this student organization called blockchain at Berkeley. And we used to do a lot of stuff together, a lot of research, and we would compete in hackathons together.

And I dropped out to start working on Cosmos. But the three of them continued working together on a lot of cool stuff, especially with proof of stake research. And they eventually ended up forming this company together. And on top of being students together, I actually was roommates with both Zubin and a partner back last year when we lived in SF. So it was really interesting because I got to sort of watch the evolution of Open when it started as, you know, from just them wandering and looking for an idea to actually end up building and iterating on different sorts of products until they finally found the Open, which the current protocol, which really, found this sort of great market fit and it is just exploded in popularity in the past couple of months. So what Open essentially lets you do is it lets you get insurance on events on Ethereum, but not using the way you might traditionally think of insurance where you some sort of mutual

program where you have an appraiser that kind of, you know, judges how the appraising, how the praises risk and whatnot. Instead, you know, there's this notion in Ethereum where you can tokenize anything, right? And so they use the ability to create options on tokens as an insurance mechanism. So let's say you want to hedge against maker smart contract risk. You can buy your dye and hold die, but then what you can also do is buy insurance on that die. So even if, you're, If Maker gets hacked, you can always sell your dive and claim insurance on that. So we go really into depth in the episode and go very deep onto all sorts of things, especially, you know, if you're into finance, this is definitely an episode for you.

We talk about, you know, some really cool stuff about like some really technical stuff, really, about how price discovery of options premiums works and just in like, you know, differences between American versus European options and what edge cases they might be actually why they might be priced differently. And we talk a lot about obviously the Open Protocol and how they built this on chain and about how they do capital efficiency of doing the protocol as well as some really cool stuff that we didn't even get to at the end where we slightly touched on it where they are building a new sort of automated market maker similar to Uniswap.

But it's called the constant product volatility. ability AMM called Vegas Swap. And so, you know, a lot of math and a lot of finance. So if that's your schick, you should definitely check out this episode. So enjoy. So today we have on with us, Zubin Kautitia. He is one of the co-founders of the Open Protocol and very close friend of mine. And thanks for coming on the show, Zubin.

Thanks so much for having me. I'm pretty familiar with your background of how you got involved with crypto, but could you share it with the rest of the audience? I really just got lucky. Late 2016, early 2017, I was having a bunch of discussions with a bunch of friends on finance, which is actually my passion, my intellectual passion, is financial markets. I just think they're so exciting. There's always something new happening. It's kind of insane to me how market price is a single number that's a determinant of sometimes millions of different human interactions. and to me that that's incredible. Having this kind of passion for finance, I was studying at Berkeley, and in 2016, 2017, I was also studying both kind of economics, finance, as well as computer science. I discovered crypto and specifically Ethereum, and I realized it solved very fundamental issues

that existed in financial markets, and I realized it unlocked an entirely new world, being able to customize assets, being able to have like a really quick, settlement time, being able to have much lower barriers to trust, right? Because in derivatives markets, there's actually way more kind of questions of trust than there are on spot markets. So I think that's actually a really interesting consideration going forward. And once I discovered crypto, I realized I don't want to go into traditional financial markets. I want to do this full time for the rest of my life. I want to build up an entirely new financial system built on top of Ethereum. And And ever since then, I've been lucky to say that that's my full-time work, but it doesn't feel like work.

It hasn't felt like work for a second. You co-founded with two women, Apana and Alexis. Tell us how you met and came to co-found. Who covers what in the company? With Sunny, Alexis Aparna and I were all part of blockchain at Berkeley, kind of in the 2017 heyday. And it was a group of 120-ish students who were all like super-packed. passionate about crypto. I think at least 10 people ended up dropping out of Berkeley just to pursue crypto full time. And it was like the no pun intended epicenter of a lot of what was going on

in terms of the college scene when it came to crypto. Berkeley must have hated that student club. I mean, losing all those good students and, you know, having them drop out. Berkeley both hated it and loved it. I think it was like a very weird relationship where we were both a student club and we were kind of doing like real things with companies in the space. And so we were, you know, many times those were like paid gigs. And so it was very strange what exactly we were. But I think Berkeley may have hated it, but crypto generally benefited a lot from it. And at blockchain at Berkeley, I met Alexis and Aparna, who were two of like, of the most like brilliant and hardworking and kind of passionate minds when it came to this. And we just realized we worked really well.

together on very similar problems. We were all interested in proof of stake at the time, and we were doing research on that. And it just kind of ended up being like we would work all night together to like three, four in the morning every single day after class on proof of stake research and wouldn't have anyone else as my co-founders. Who covers what in the company with the three of you? All three of us are technical, and that really helps when it comes to building up a product in crypto. And the way it is right now is that Aparna is a CTO. I'm the CEO and Alexis is the chief product officer. I would say like we're too early to compartmentalize what things are happening in a very clear way. At a startup, you're doing everything together at an early stage protocol.

But generally, Aparna's in charge of like architecting the code. Alexis is in charge of designing front end related stuff. And I kind of dip my hand in both. of those worlds a little bit. So, you know, it's a nice thing to have everyone being technical. We've recently actually hired two additional people to come on and we have a few contractors as well that are helping us. And, you know, we've kind of kept that technical ethos where everyone can code at the company. Could you tell us a little bit about how the product evolved? So, you know, before you settled on the current product of like, you know, options, you were working on some other stuff largely in the DFI space. Can you tell us a little bit about what you started building

there and then why you pivoted to focus on the current product? After kind of working on this proof of stake research, we started getting like really excited about DFI. We saw that this was the real place where large amounts of usage and innovation was happening. And for me, this was like perfect because I just love finance for so long. So when DFI started to come about, we decided, you know, let's kind of work instead of just on pure research, like actually implementation. You know, take a lot of the crypto economics research that we were doing earlier, and we see defy as almost like applied crypto economics, actually building out these systems and using mechanism design to build things that people use.

And so at first we started building a margin trading platform on top of compound in Uniswap. And, you know, people were pretty excited about it. It was something that eventually got, you know, hundreds of thousands of volume dollars volume per week. However, for us, you know, at that time, DYDX started to launch. This was pretty early on, actually. This was before compound B2 was out that we started on it. And so DYDX, you know, launched and started to get serious volumes. And people started using kind of Maker and Instadap with Maker for the same purpose. And it was something that had a lot of kind of intellectual passion for us. It was something that was like really, really interesting. But we didn't see like a long-term

path forward in terms of building something with network effects in terms of building something that actually helped the community significantly over what else existed out there. And so kind of along this journey, we saw that as a early example of defy composability, just purely being built on top of other protocols, if something bad were to have it to either you to swap or compound from the contractual level, everything would kind of, for us and our users would grind to a halt or worse, you know, our users would lose money. And so we saw that there's like these kind of issues that come with composability where there's this entire stack of things from the protocol to like consensus to the actual value of Eath, to compound itself, to there's this entire

level of things that could go wrong. And any one of the dominoes would cause like a spiraling effect for us. We started to think about how can we deal with the, these risks that are compounding in defy, no pun intended, and mitigate them for the user in a very real and usable way. That's where Open came from. So you started with like wanted to solve the insurance problem more so than like starting from the direction, oh, we want to build options on chain. And you came to the conclusion that that's the way you figured out how to solve this insurance problem is throughput option. So can you tell us a little bit about why and how this works and why do put options help solve insurance and even what are options in general?

I think there's two parts to unpack about that. The first is what are put options? And the second is like, what are the desired properties of insurance? So let me start with the desired properties of an insurance contract, especially one on chain. Let's say we have any asset, right? Let's say, you know, a C token, right, representing deposits on compound. insurance is we want the value of that asset to always stay kind of above some minimum threshold.

Another way of saying that is like if we put a bunch of USDC on compound, a thousand USDC, and then we get a C token, we get a thousand dollars worth of C tokens of CUSDC. If compound gets hacked, if there's some kind of liquidity crisis or liquidity crunch, a truly insured position would allow us to, no matter what, always redeem our C token for a thousand USDC. And you can, again, have different levels of like premiums and coverage. You can say, all right, no matter what, I'll be able to always redeem 900 USDC or 800 USDC, right? And so this is the way we're thinking about it.

We're like, is there any way to make this like as protocol permissionless as possible without minimize the use of any oracles or any individuals to figure out if there was a hack or not. And that's when we came up with the idea of using options as insurance. And the ways that it works is, and this is very much the way that it works in traditional finance, is that if my C token, for whatever reason, gets loses value, whether that's a protocol level hacker or whatever, I always have the right to exchange that C token with another counterpart party on a different protocol, for a certain amount of value, let's say a thousand USTC.

So no matter what, I can use my C token to get my 1,000 USDC from compound that I deposited there, or I can use this other protocol that we use as insurance. If I can't get a thousand U.S.C out of compound, I can exchange it for my counterparty on this insurance contract. Now, what exactly is an option? So derivatives in general, financial derivatives are kind of any asset that derive, their price based on the value of some underlying asset, right? And the main kind of derivatives, you know, or maybe let's say the ones that spring to mind quickest are futures and options.

And they're a little bit different, but let's talk about that. It's easier to wrap your head around options if futures are well. So a futures contract is basically a contract that allows you to swap two assets at a specific ratio or price in the future. And so, let's say Sonny and I say hey you know Sonny I want to give you some ETH I want to sell some ETH to you but I don't want to do it today I don't have any ETH today tomorrow have some ETH so let's do it tomorrow at the price of 230 dollars per ETH which is actually the current spot price of EVE and sunny says yeah that sounds good now in the meantime if Eith goes up in price then I'll still be obligated to sell you my one ETH for $240 or 240 USDC or 235 or whatever number I said earlier.

I probably should have chosen a more round number. So at 230 earlier. But at that specified price, we have to make that exchange tomorrow. Both of us are obligated to do that. And if ETH has gone up in price, well, let's say ETH is trading at $500 on the market. I still have to give you my ETH for $240, $140, $1,000. dollars when I could have been selling it on the market for 500, right?

Similarly, if ETH has gone down in price a lot, well, then I'm selling you my ETH and getting $240 in exchange, when on the market I could only get $100 in exchange. Now, the key thing about this is that we are both obligated into this transaction tomorrow, and it's clear that in both of the cases I talked about,

whether ETH goes up or down, one person is either getting their ETH, buying ETH for very cheap, or they're buying ease for very expensive. And on the other side, one person is selling their ease for very cheap or for very expensive compared to the market price. If you could think of it almost like in this future, we already did the transaction today. We're only, we just, you know, the execution is delayed. But we've already sort of agreed upon all the terms of the deal already at this moment of time.

There's no further decision making that needs to be made. Yes, exactly. And technically sometimes you can get out of the futures contract ahead of time. And there's actually a difference between a forward contract, which is actually what I really described in a futures contract where there's like actually mark to market every day. But that's kind of all details. It's exactly as you said. And the key thing to note is that on that future date, someone's going to be upset, right? Both people are obligated.

Someone is selling their eat for too cheap or buying it for too expensive. Someone is on the bad side of the trade because, you know, both people are. are obligated. Unless the price remains stable. Unless the price remains exactly stable. Yes, exactly. For an options contract, it's a little different where one side is obligated and one side has a option, right, has a decision to make whether or not they want to make this trade in the future. So, Sonny, you and I can say, you know, Sunny, I want to have the right to sell you Eith at $240 tomorrow, but I don't want the obligation to do that. So now you're in the state of obligation

where I can make this choice whether or not I want to exercise, whether I want to make this trade for 240 tomorrow, and you will have to do it. You will have to oblige me no matter what. And so clearly in life, it's always better to have more options, to have more choices.

And so the person who has the option, whether or not to make the exchange, needs to be paying the other person to take on this obligation. Ahead of time, instead of like at a futures contract where you usually settle it at the fair price, right? You say like, okay, let's take today's price and then tomorrow we're going to actually make the exchange. With an options contract, you're to get an option. You have to pay the other person. And so we say someone is buying the option. They're gaining this option to make a transaction in the future. The other side is selling this option.

or writing this option, and they're making money up front a priori in order to take on that obligation. So it's a little bit different. There's no cash flow in the beginning at a futures contract, and there is for an options contract, and that's the price of the option or the premium of the option. If I turn this around, so you said you wanted this to be used for insurance. So basically, I pay the premium, which is the insurance premium, and then basically I get a payout if the event happens. if the price falls below a certain price, because that's when I can exercise the option and make the difference from you to the current market price. Can we talk a little bit about how options are actually traded in the legacy financial system? Because, I mean, they're a big thing. And when you say

insurance, in my mind, I immediately think for almost all kinds of insurance, you actually need an insurable interest, right? I can buy fire insurance on my house, but I can't buy insurance. But I can't buy I fire insurance on your house, and I mean, for a good reason. This is the case for most forms of insurance. In the traditional financial system, it is how much are options used as a speculative tool and in as how much are they used as a mechanism of ensuring a interest? I can imagine, say, being a farmer and having an option on, like, the weather or something, but can you kind of put numbers on this for us?

it's really hard to put numbers on something like that. It's a great question because, for example, bank could buy options, which they then go and sell to a counterpart who actually wants to make a hedge. And so is the bank making a speculative decision because they don't have the underlying asset that they're trying to hedge against? Or are they just like trying to make like, you know, some small spread and sell it to a person who really wants an insurance contract? So it's extremely hard to take data and figure that out. But suffice to say that there. There's trillions of dollars of options being bought just for the insurance and hedging use case by a number of different companies who are trying to hedge risks that they do have. And I think you got to a main point, right?

It's that the difference between an option being used for kind of a hedging use case and an option being used for a speculation use case is that often the person has exposure to a certain type of risk and they're using this option to, kind of hedge that risk perfectly. Now, let's take the example of the compound we talked about, right? If I put $1,000 on compound and then I have an option to sell my CUSDC for exactly $1,000, then because I really do have that money on compound and, you know, let's say compound gets hacked, then I always have the ability to get a pay out of $1,000 through this option contract by, you know, owning this production contract. However, if I don't have that, you know,

money on compound, but I want to make this kind of bet that compound is unstable or that there is some risk and I think it's being underpriced. Then that maybe that's a speculative play. So it's very hard to put, you know, kind of to separate it like that. But options, one way to think of them is, you know, with the sunny and me example, one person is shifting their risk perfectly onto the other person. And so usually it's the person who's buying the option is shifting their risk away from them onto the person who's selling them the option. And it's a really good way to shift risks around. So there usually is like kind of half speculation, half insurance is one way to think about it. How are these options typically priced? Because basically with an insurance, if I take out fire

insurance on my house, obviously there'll be an underwriter who has to know where I live and so on. and whether I like playing with candles and whatever. But how is the pricing, how does it work traditionally for options on the legacy financial system and how does it work on Open? Also, really quick, do you think it's worth like kind of distilling? I feel like one thing where maybe in my mind thinks that jumbled a little bit here is when we were saying insurance, there's almost like two different types of insurance we're talking about here. There's one which is what I think Frederico was trying to bring to earlier.

the type of insurance where I get sort of home insurance on my house is very different than, you know, more of like financial insurance on financial assets. Is this right in thinking of these as two very distinct sort of classes of things or are they really actually, you know, joint in some fundamental way? It's funny that you're saying that because I have the same impression, but basically with me, the distinction is slightly different. With me, the distinction is whether you actually need an insurable interest or whether you can buy. basically what I would call a parametric insurance, where basically you get a payout depending on what happens, which is kind of like a bet, actually. So there's a bunch of great questions there to be distilled upon.

So the first is, Sunny, what is the difference between insurance and an option on your house? Well, if you think about your house as a financial asset, which it is, and you have a put option on your house. You have the right to sell your house at a specific price, and a fire comes and burns down your house, you still have the right to sell your house at that price, right? So a put option still works as financial insurance in that case,

but people don't use options for houses in that way, usually. And the reason being that you don't really get this benefit of having a large, fungible financial market being built on top of that option contract. Now, let's say you pooled houses together, and then you made kind of this real estate index and you had options being settled by some Oracle based on this real estate index, then it could become something like insurance where if there's like a large citywide fire that would still affect property prices, not clear exactly how it would affect it, or if there were some kind of other macro risk, you would hedge against

it by this option. And this could, you know, lead to more widely traded option or more widely traded financial market, so it could be more appropriate for an option there. I think that there's a bunch of different things that are happening here, right? The first being, is it an asset that is fungible and like wildly traded? If it's not, then maybe an option isn't the perfect thing. Then the next thing is, is it an asset where some subjective quality about it needs to be determined by a human as to whether some problem happened, right? And to me, something like compound doesn't seem like that. It's very easy to say like this thing lost value so I will then myself sell the option and if it's easy to sell or exchange or is it not so easy to sell or exchange right and so you want fire

insurance for your house you want to be able to rebuild your house you don't want to necessarily sell your house and then buy another one next door right and so if it's low on fungibility and hard to exchange that's also something that's probably not as good to be an option and it's more like traditional insurance. But the kind of notion of a put option as insurance is one that's like very widely accepted and well understood in traditional finance as financial insurance. But it can extend beyond that in a world like crypto where way more things are financial than there were off-chain.

What's unique here in the crypto sense here is when you're using put options as insurance, it would be sort of like, let's say I was hedging against the price of ether going down. But what you guys are basically proposing is you can also use it to hedge against more complex types of risk other than just pure price risk. You can use it to hedge against smart contract risk because let's say I hold a bunch of dye. If there's some major smart contract within the maker contract as a whole, Open has no sense of knowing did Maker get hacked. But what it does do is if my die goes down in value because Maker got hacked, I can basically use Open there. sort of like to put it in comparison to like other insurance products in the DPI ecosystem,

like Nexus Mutual, for example, they have to make decisions on understanding was a contract hacked or not. Open has no need to do have any sort of this like introspection into the nature of other contracts. Exactly. We take it from this group of individuals deciding what happened and whether that counts as like an insurable event. And we say like, no, we're going to make it kind of like a game theory question where it's only profitable for someone to make a claim or to make an exercise for themselves if some problem happened. And by doing that, we're, you know, first of all, I think it's a more crypto-native approach, but also I think it's beyond that, it's also kind of, it allows you to scale much better without having like individuals looking at every single problem, right? And I think

kind of along that set of ideas, Sonny, you made a really good point there. Any time you have any collateral or value sitting on chain, no matter what it is, if it's tokenized, especially if it's tokenized and fungible, then you can basically write an option on it. And so you can, in this way, using Open. Like, for example, DX Dow, right? DXDAO is a great example of a, you know, important contract that actually is not tokenized. So let's say DXDAO gets hacked. And, you know, DX Dow is securing quite a bit of value. And how can I use Open to sort of ensure my voting rights on DXDAO? I'm actually not intimately familiar with like the mechanics of DX Dow, but is it possible to

write a wrapper contract that itself represents voting rights on DX Dow? I'll give you an example that might make sense. Vodrika, do you want to respond to that? No, because in principle, the DXO, they can withdraw reputation. The DXR could revoke Zubin's reputation just because they don't like his face and the vote passes. So basically it's not something that has to be fair. It's just a democratic process in a way. In principle, you could say I want to ensure against my reputation being lost,

but then again, it's not a market. It's a democracy in a way. I think there's a better example. But it's like the kind of lack of fungibility of voting rights. They're not exactly perfectly fungible assets. They can behave very differently through this kind of democratic process that Rizrico was talking about. An example that makes a lot of sense. So let's take a non-tokenized one.

If you put dye in the DSR, it's just sitting there, right? You're not getting some ERC20 token that represents that die until someone made a wrapper contract called chai. And what you do is you send your value to this wrapper contract, which then routes it, essentially two dye. This wrapper contract represents your fraction of all chai, and chai represents a fraction of all die in the DSR, right? You can essentially do this at any point, and then you can essentially write a option on that chai. And so if something wrong happens with the DSR itself, you still have insurance. Let's say, like, for some reason, all the die and the DSR gets locked and all the other dye is working perfectly, but the die and the DSR gets locked.

If you have a option on your tri, then well, you can still redeem your try for value. So there's very many cases when there's like a fungibility of an asset that has value, where you can essentially just like create a wrapper token on top of it and then write an option on that. Does that make sense? Yeah, I think so. So can you talk about how exactly that option is priced? Yeah, so this is a great question. So I think you first asked about pricing in like the traditional financial world. This is a really good question. It was actually a very difficult problem to solve for a long time and people use different methods to kind of simplify it.

And then there's kind of the meme is just like, oh, price everything using black shoals. But black sholes isn't really a way to price an option. Blacksholes is a formula that takes some notion, idealized notion of implied volatility, which is the volatility of the underlying asset. So let's say we have this option on Eath, right? Eith has a lot of volatility. So what Blackshould allows us to do is if we have some estimate of how volatile ETH will be in the future, then we can use that future estimate to price this option perfectly. And that's what Blackshould does.

It takes things in the volatility space and turns that into things in the price of option space. So that's very complicated and a lot of jargon. let me break it down a little bit is that there are a number of different ways to price options that if someone has an kind of estimate of how volatile an asset will be in the future, then that person can price an option, right? And there's also other ways to price options. You can look at other options that are very similar and use that to figure out what the price of a different option is, right? And so what you end up getting is the market has different estimates of volatility and how

eth is going to act and tail risks, et cetera. And the market will then out of that will like converge to some market price of these options. And this works especially well like getting efficient prices when like the underlying asset is really, really like widely traded. And the option itself is also a very popular option. Now, how does it work for Open? Well, for options like the options on compound C tokens, like that's an entirely new asset class that never existed before.

And so the market kind of, you know, has been figuring it out. And there's been a lot of irrationality and mispricing along the way. But moving towards like increasing levels of rationality. After the compound options, we launched an Heath Put Option series, which like allows you to hedge against ETH flash crashes like happened on Black Thursday. And that has been extremely kind of consistent relative to the compound insurance and in how it's priced. And it follows very close to the deribate price, which is like this off-chain options protocol that allows your ETH options. And there are some ARB opportunities that emerge,

but captured pretty quickly by very sophisticated like market participants. And essentially this market price emerges that allows you to estimate how volatile ETH is going to be in the future, which is a really crazy concept. You can take option prices and take an estimate of how volatile Eath will be going forward. I'm still not 100% certain on what exactly determines the option price. So I totally understand that basically past volatility is a good indicator, typically of future volatility. But basically when you say the open options price is similar to Deribut, I mean, basically the volumes traded on Deribut are like orders of magnitude larger than on open. In my view, the open price would just follow the Deribate price.

Exactly. Because, because, I mean, basically, but then that kind of begets the question, how are the options priced on Deribate? And yeah, I kind of understand like the market, the market finds a price. And basically, there's probably different people who have different opinions about the future volatility of assets and how that could go. Is the answer, at its cool, it's not an exact science. It's a market mechanism. And the market kind of decides what the price is. Exactly, right? So you can think of it like this.

The way that markets price implied volatility or price options is the same way that they price the underlying, right? How does the market determine what the price of ETH is? Right? It's something that's very much not an exact science. And I think you touched upon that point that estimating what volatility is going to be in the future is like never going to be an exact science. No one has that perfect ability to price the future.

And as a result, you have extremely intelligent minds that are trading on these markets that are kind of all collaborating and competing against each other in a way that a single market price will emerge. Right. And so that's where alpha comes from, right? That's where, you know, if an investor is able to price volatility or to estimate volatility, better than all the competitors, then that investor is going to outperform those other investors, right? And so everyone is competing to find the best market price,

just like they are for ETH. So let's talk about the difference between traditional options markets and open. So basically on traditional options markets, you need an issuer, right? So basically, if I can't just buy an option on anything that I want, what's that like for open? So basically on open, can anyone kind of list new options? or is that you guys? Or what's the process?

Yeah, so this is really interesting. I think there's a lot of things to unpack here. But the main, the short answer is yes, anyone can list their own new option on any asset, right? And we made the protocol permissionless in a way that, like, no, there's, it's quite easy to do that. There's certain, like, parameters you have to work within, but for the most part,

can build an option on, you know, on someone built an option on like curve, CRV, right? So and people can build options on whatever they want, S&X token, lend token, whatever you want. You can do that. Then the other question you had was about like the difference between traditional markets and an issuer and, and how open works. And I think this is also a great question. So in open, the way it works is, you know, if you can remember, Sunny and I have decided we're going to do a trade in the future, right? And the way it works is that I have this right, but not an obligation, right, at this option to give Sunny one Eath and in return, Sunny's going to give me 240 U.S.DC, right? Now, for me, I don't need to keep any collateral as the option buyer, as the person who owns the option, because I will only actually.

ever make this exercise event when it is profitable for me. But it being profitable for me means necessarily that is unprofitable for Sunny. Right. And so Sonny needs to get 240 USDC sitting in a vault to allow for this physical settlement. Right. And so let's say Sunny has 240 USDC sitting there until the option expires. I come and I exchange my one Eath and automatically the contract will send me Sunny's 240 USC.

Sunny has the right now to take the one Eth that I put down there, right? And that's how settlement works here. Now, there's a couple of different things there, and that's pretty much actually how the entire protocol works. If Sonny wants to come and mint a new option that the world has never seen before, let's say at a strike price of $133.5, right? then Sonny just puts $133 and $5 cents into a vault and can mint that new option.

Or let's say Sunny wants to write an option on a new asset, like the link token, right? Then Sunny puts down however much the strike price is down in that vault. And the contract that Sunny is essentially like customizing says that that will be unlocked by anyone who holds, the option if they send in one link, right? And so that exchange will happen in the future. So when I put it down into that vault, I first get the O token and then I go figure out how to sell it. Exactly. So it's essentially like minting dye, right? You're like putting down a bunch of collateral

in a vault to mint dye and you can do whatever you want with it. And you can sell it to someone. You wouldn't want to hold it. It's like going and opening a CDP and then holding the die that results. Like it doesn't provide any value to you. It only provides value when you can sell it. on an exchange or something like that. And so that's exactly what people would do. Yeah. So this opens up questions about capital efficiency. I know you're going to ask about this food drink.

But yeah, I would love to talk about that. That's the basic high level of how open works. Before asking about, that's totally true. I was going to ask about capital inefficiency here. Conversely, that means as the person who has opened the vault, if I buy back the O tokens from the market, I can close it again, right? So basically I can get out at any time. Exactly, right?

So it's just unwinding it. Just like it's very actually similar to the maker system. I think logically to think about it, that helps a lot. So it's just like buying back dye and then birding it against your vault. Then you can take out your eath. Just like that, you can buy back the O tokens that you've minted and then use that to close out at any time. Does this mean that O tokens have to be American options? No.

Right. So the question of when two. parties can exercise is a different question than when a seller can exit or a buyer can exit the position. Because it knows who the opener of that was, it allows me to exit as well before. Exactly, right? So another way to say this, right? So, you know, Sonny used the word American option. Now, American option is one of which I as the buyer of the option can exercise. I can change my one Eath for Sunny's 240 USC at any time before the option expires. The European option only allows you to do that upon ex parte.

It's not that one of them is more highly traded in Europe and one of them is more highly traded in American. I think it has something to do with the fact that, you know, America, we love freedom. So we give the freedom to exercise at any time before X-Free. I'm just kidding. It's just called American in Europe here, and it's just a nomenclature thing. And the thing with European options is that even though they can only be exercised at expiry, which is one second in time,

they usually have the exact same price as American options because they can be sold on the free market or on the open market, I should say, for their worth, which is usually greater than their cash value, which is how much they're going to be exercised for. But they're not as helpful on open, on flash crashes though, right? Like, you know, let's say there's a, you know, we see this happen on exchanges all the time where there's a bug in the exchange. price of BTZ drops like a cent for like for like five seconds and an American option would be nice for that because I could have some Mike be watching that and execute immediately when that happens while that maybe isn't possible with European. Exactly. So that's a great point, which is that like there are certain edge cases in which American options are better. So one is a question of liquidity, how liquid is the options market. Another question is like how

liquid is the underlying market because maybe you want, you know, you would incur a large amount of slippage through trying to buy an asset and instead you could have an American option that allows you to like bypass that slippage. And so there's a couple of questions like in the one that you talked about is some like technical edge cases as well, which is why open options right now are American for the smart contract related stuff. But that that is a really good and interesting point. No, I mean, one of the edge cases where basically an American option is preferable to European option is when you run the risk of the option issuer going bust, right? So basically if you can't be sure that your option is actually that you'll be paid back at face value

at the time that the option settles, then actually an American option is preferable because you can redeem it when you begin to have doubts. the person that you have entered into this contract with is credit worthy. But on Open, as you said earlier, everything is fully collateralized. So basically, you actually have to over collateralize all the options on Open. And the reason that Zuber knows I'm going to ask this is because I told him before the show that one of my main criticisms of the system was that it's really capital inefficient. So basically you have to put up a lot of capital to actually offer those options,

which especially makes, make options that are pretty far out from the current price, very illiquid, because you need to put up a lot of capital, basically the inverse of the probability of that happening. So, Zuban, you told me that everything is going to, that that's currently correct, but everything is going to get much better with version two. So tell us about version two. Yeah, so let me dive into version two. First, I want to expand on kind of what you were saying, Friedricha. So very similar to the dye ecosystem, right?

You're putting down a bunch of capital to mint an asset. And capital efficiency represents how much capital you've put down relative to the amount of asset you can think of that you've minted, the value of those assets, right? Now, let's take a super out of the money option. That means that I would not exercise it right now if it were American. So let's take a put option on ETH. A put option means you have the right to sell an asset. So a put option on ETH is the exact kind of option that Sonny and I were talking about earlier.

And let's say the strike price is at 100 USDC. So that means that in one day, 24 hours from now, I get to choose whether to give Sonny, you know, my one Eth in return for his 100 USDC. Now, I'm only going to ever exercise, again, I have this option to exercise. I'm only ever going to exercise. I'm only going to ever make this exchange when my one-eath is worth less than the 100 U.S.D.C. Sunny would give me in return.

And that only happens if in one day, Black Thursday happens again, and Eth is worth $90, right? in which case I'll get Sunny's 100 USDC and I'll give him one ETH which is worth $90. My net profit from exercise is $10. So you can think of, all right, this option should be worth sought like the probability of ETH flash crashing to $90 in one day times the payout I would get of like $10 or even more potentially, right? Let's say there's like a 1% chance. then, well, this eth is worth, sorry, this option should be worth only like 10 cents or less, right?

And again, this is a very high-level way of thinking about volatility. It's not actually the right way, but it's one way of thinking about it. Right now, that means this option is worth 10 cents. But Sonny needs to put down the entire value of the collateral, the entire strike price, 100 USDC in order to mint something and sell something that's worth 10 cents. Now, that's clearly really capital and efficient, right? Compared to Maker, where you need 1.5x the amount of dye that you minted as collateral. Here, you need it's like a hundred times as much, right?

And so for out of the money options, this doesn't work. The best way to do it instead was to make sure that Sunny had more than the premium of the option and the price of this option, right? And so if the option is worth 10 cents, Sunny only needs 15 cents, 20 cents, or a dollar, right? Now that's the key question that we, you know, again, we're starting to build out V2, which is exciting and we're doing a lot of this like kind of ideation and getting a lot of opinions from the community. So if you're interested in just like reach out to me about any kind of research questions you had. But for V2, the question is how do we ensure that the amount of margin or collateral, Sunny has is always worth more than the premium.

And for that, you need some way to estimate the premium really quickly. And there's two ways to do that. The first way to do that is to have some kind of Oracle based on the price that it's trading on Uniswap. Now, that doesn't make a lot of sense because we've seen not only can Uniswap market prices change quickly, but even with Uniswap V2, options are so volatile that to make sure that you're always kind of have more margin than the premium of the option. is like really hard when there's a big market change in the price of either or somewhere like that.

All right, so we need to, that doesn't work. So what is another way we could do it? Now this is a little bit more involved, but the idea is to look at two things. The first is a shock parameter. And this is actually kind of how clearing houses do it in traditional finance. And the shock parameter will say,

how much can the price of ETH slide or crash before a liquidation event will happen, right? And different protocols have different shock parameters. For example, Maker has 33%. So if you're 1.5x collateralized, if Eth falls 33%, then you're exactly one-to-one collateralized. Okay, so let's take a shock parameter of 33%, which represents a 150% collateralization ratio.

Then the next thing is we want some overestimate of the options, premium, not just the actual options premium. And we want something that will always be an overestimate of the options premium. Okay. So the way to do this is something called linear interpolation, right? And this is a little bit more involved, but essentially any option has something called delta, which represents the amount that the option would move with a $1 change in the price of ETH, right?

And the maximum delta of any option is, it has a magnet. of one, which means that an option is never going to move more in its price in absolute dollar terms than eth will. In percent terms, it's much higher because the option can be worth cents and move one dollar, whereas eth is worth $200 and move at $1, right? But in dollar terms, it's always capped at one. So then what you can do is you can take the value of an at the money option, essentially draw this perfectly straight line from the at the money option to like infinitely in the money and out of the money options, right? And you can cap the change in the options price and say if there's a 33% change in the value of EF, what does this mean that this

option will be worth later? Right. And then at any time you say any option will need the amount of capital that is at least as high as the value of that same option if ETH crashed immediately to 33%. And then you also choose some overestimate of volatility. Again, volatility is positively correlated with an option's price. And so let's say you choose volatility 500%. That means ETH is bound to move 500% per year within some kind of probability distribution. then you can say, okay, we're basically saying we're overestimating price and we're adding a shock parameter. And this is still over collateralized this option, even if those two things went wrong.

The actual implied volatility of ETH for at the money options is actually around 80% on Deribut. So 500% is just a massive overestimate, right? And what you get, again, is a up collateral system that is like, depending on the exact option, but can be anywhere as much as like 5 to 10x more capital efficient as the current implementation of Open. And so just to recap, what you do is you will try to figure out an upper bound of the options price if ETH were to crash 33% and volatility were at 500%. And you use that at the money option to kind of interpolate to the out of the out of the

money options and in the money options and using these overestimates for any arbitrary option, you can make sure you're overcapitalized. That's how it would work. Within a certain confidence interval, right? So basically you'd always have like the Black Swan event where basically you happen to be under collateralized that once because everything in the book went wrong. So what would happen in that case? Right. So this is where you were going to ask, me questions about like, you know, tokenization and kind of monetization. This is where, you know, it's a very similar set of assumptions that you have for maker where if ETH crashes like 90% in a minute, like the whole maker's system is like kind of wrecked to a certain extent. So you have to

make some kind of, you have to be, get comfortable with some level of tail risk, again, being like very mindful of it and having like a lot of buffer. But there's there's always the black swan, right, if you want to get undercapitalized or get more capital efficient. And what happens here is very similar that outside of a event that would destroy all of the rest of defy, open would always be overcapitalized. And then you can do what Maker did, which worked really well on Black Thursday, which is have some kind of asset that can be used to plug like any kind of undercapitalization or like any kind of insolvency of the system.

And so that's one way to think about adding a governance and kind of tokenization to the protocol is having a very similar MKR-like model. So on Black Thursday, what happened just, you know, for background is, so the MKR holders actually had to jump in and basically MKR was auctioned off. in response to the events on Black Thursday, maker introduced USC as another type of collateral, right, to add more elasticity to the system because basically there wasn't enough die

to actually close out are the underwooder CDPs. This is my point exactly. So it's not something that you would expect to happen on any given day, but especially in this world where volatility is high and sometimes even higher, like on days like Thursday, it can happen, right? So basically you want to make sure that you have like this layer of governance or someone who is ultimately responsible in order for people not to lose faith much earlier. What maker has is it's got that, I mean, it's fairly crude.

I mean, basically it's the maker's sales of MKR tokens and then the global settlement. But basically having that as a credible, the last line of resort, even if you think you'll never use it. Just because you have it, you'll probably never lose it. But basically this makes sure that people don't lose trust in the system much earlier, right? So what are your thoughts on that for Open? Exactly. And I think it worked beautifully for Maker on Black Thursday. I'm not sure what Mayer would have done if they didn't have the ability to kind of plug the capital holes in the system with MKR. So it worked.

worked really well and, you know, Defi continued functioning. I think there are lessons to be learned from that, including being even more aggressive. And that's why we've chosen like really ridiculously high parameters for like volatility, et cetera. The system is actually even more cap like kind of conservative than I said, but for like a number of different kind of edge case reasons. But that's the main gist of it. And I think that a similar thing would provide a lot of kind of confidence for for users of open as well. So I think that's one very viable way to go forward. But it's not necessarily the only one. And again, it's an open dialogue between us and the community. And so we would love to hear anyone's opinions or

thoughts on that. But that is one way to do it. So I see why you want to be able to post collateral that's much less than the total amount but you want it to be using more cash settlement that makes a lot of sense you know in the paper you mentioned that you also want to allow people to post collateral in an asset type that's different than what the underlying actually is why is this such a desirable feature especially when weighed against like this seemed like a lot of additional complexity so what's the benefit out of that and an additional risk This is a great question, right? It comes from a key observation if you look at the original options we're making.

So compound options. Let's say that to ensure someone, you're making, you know, you need 100% of the capital. And so you're making like a 10% per year on it. And compound is yielding you 5%. Now, putting money into open to ensure someone's, compound deposits is not very different from putting that money into compound itself, right? And so if I'm putting a thousand USDC into compound, I lose it if compound gets hacked. If I'm putting a thousand USDC into a open option, I will also lose it if compound gets hacked.

But I also have this additional risk of like open smart contracts on top of that. And so it's this weird dynamic if like the insurance is more than. the interest rate on compound, then no one's going to buy insurance because then they're getting a negative interest rate by like having assets on compound and then insuring them. And if the interest rate is below the one on compound, then you just put your money on to open rather than putting it into compound in the first place. So what you need there instead is the ability to put down eath and get like 10% on your eath instead. And that's like one way to think about it. It's like you want to put as collateral the asset that has the lowest interest rate,

that that's the lowest opportunity cost of being used as collateral. But it also has the highest risk, right? Well, like price risk. Yeah. So that that is like a problem. It has some, you know, very significant price risk. But it also allows you to hedge against some problems with USC. Like if USC itself is the issue, then ETH is not going to, you know, collapse. And so, I think it's a trade-off there. It's a really interesting mechanism design question that you brought up. Now, for more like

ETH options, right, why would we want a different asset? Well, in traditional finance, usually people are putting down like dollars or our Fiat currency when they're minting options or when they're writing options, I should say.

And for a call option on Eith, right? it's actually different than a put option on ETH. A put option on ETH, I have the right to give you my one ETH, and you'll give me like 240 USC in return, right? But if it was a call option, it's the other way around, where I still have the ability in this option,

but the option is the opposite one. It's the option to give you 240 USC in return for your one Eats, Sonny. And so for you to write that option, instead of putting 240 USDC in a vault, you would actually put one ETH in the vault. So that if I come with my 240 USDC later, I always will get your one ETH in return. But so you're putting down ETH again to mint this option, but you don't want to be putting down ETH to mint this option. You actually want to be putting down USD because most people mint options. And like it's kind of the more logical thing is to put down USDC as.

is collateral. Unless you want to write a covered call, which is where you own the asset that you have an option on top of, which is exactly what it's talked about there. So there's a bunch of different reasons why we would want a different asset. And it also kind of brings up what Friedricha talked about earlier, which is that the maker system got much more kind of, you know, resilient after and robust after adding multiple different collateral types like USDC plus ETH are both allowed to mint dye. Similarly, a multitude of different collateral types should be used to mint options in our view. So I want to talk about a little bit about going back to about how we achieve fungibility because that's sort of like an important aspect. So, you know, a couple, like two weeks ago,

I was helping one of my friends with her hackathon project. And, you know, I was able to write a put option contract in like 30 lines of code. But that's not the hard part of what you guys have done. The primary thing what you guys have done is figured out how to add to really tokenize and make these assets fungible. And there's a lot of parameters that go into the options. And so the term for this is called a series, which is a set of options that sort of have all the same parameterization.

and thus they are fungible with each other. How do you decide what parameterizations get turned into serieses? Like you probably don't want to make a contract for $233.5. But how do we know what segments you do it on? And also when it comes to things like expiration dates, who decides what expiration dates are? Yeah, this is a great question. So as you said, the desired properties of these options are fungible

so they can be traded on uniswap, they can be traded on dexes. They can be kind of, it's just having them meet fungibles way better, right? So the goal setting into this protocol was to make everything ERC20s, every option. Now, the way it works is that two options that are different, right? If I have an option to, you know, again,

a put option on Ethan, a strike of 250, that's a different option than one with a strike of 240. If I have an option with an expiry of, you know, one week, that's a different option than an X period of two weeks. weeks. And so you get this very, you know, deep complexity, the more different series are trading. And it's harder to get a lot of liquidity on any decks if you have like an infinity of series trading. Luckily in traditional finance, you know, there are series that generally trade far more than others. And it's usually at the money options that are nearer to expiry

with a certain set of like very kind of standardized expiries, which is like on specific Fridays of the year. There's four Fridays of the year. There's quarterly options. And these are the ones that liquidity kind of naturally has like come around these specific options, right? So building open, we are trying to think of very similar questions. The way we started it now and Friederga also had mentioned this earlier was given that

Deribut is like, you know, much older and is, it has a significantly more volume. thus far, we've essentially decided to have options that are very popular in Deribate, also tradable on Open. So that, you know, it just adds kind of this really nice property that people know that, you know, if they want to hedge it, they can hedge across two platforms. It allows people to ARB very easily. It allows for liquidity to kind of be shared amongst two different protocols entirely. And it also allows people to play in options markets that were not able to previously, like, get on to Derivit for whatever reason. So that's one thing.

We try to support the options that are most popular, like empirically. But, if you were to create a new option on Open, it would also be fungible with options of that series. What would be you would need to do is you would need to convince other people to also trade that option, other people to come mint and write that option, other people to buy that option, other people to list it on uniswap. And so the liquidity becomes like this kind of network effect that you need to build up. But it does retain fungibility, right?

And so that's a really good and very interesting point. I think it's also, you know, Friedrich, we were talking before the show a little bit of network effects. This leads nicely into that kind of question of like, how do O tokens interact like with each other? And to what extent does fungability affect that? And if they are just completely fungible different tokens, why not like create a fork of open?

So these are really interesting questions as well to talk about. But I think like fungibility at its core is the thing that allows the option market to form rather than it just being like individual insurance contracts between individuals peer to peer. Yeah. So could you go ahead and talk, tell us a little bit about that. Like how are you thinking about changing this in B2? Yeah. So the network effects question is I think the biggest one. And so I want to be very clear on like exactly what this means, right?

So there's two parts of the network effect. The first is if I'm going to mint or like buy or whatever a new token, why would I want it to be on open rather than a fork of open? So that's like one question of network effects, right? Which is like across O tokens, does the liquidity of one O token benefit the liquidity of other tokens? O tokens. And the second question is, to what extent if I want to create a new option, am I able to easily buy and sell this new option that has never been seen before by the world? And how does the liquidity of open influence that, right? So these are two very similar,

but kind of different questions. Now, let's look at traditional options markets. The truth is in traditional options markets, there's something called combination payoffs where you can use two different options to create a combination that never existed before alone and to also max, you know, cap your loss. So I'll give you an example of this, right? Sonny, let's say that we have two options between us that we've, you know, sold to each other. So you've sold me the option to, you know, put option on ether 240 strike. That means you've given me the option to give you one ETH in exchange for your $240. Right.

And you've put $240 in a ball for that. Let's say I've also sold you an option. And that option is you have the right to give me one ETH for a price of $239, right? So what happens in the worst case scenario to either of us, right? Well, the maximum loss for you, Sunny, is $1. Now, where does that come from? Let's say, like, you know, your losses as someone who's selling an option are maximized when ETH falls to zero. And your gains as someone who's bought an option are maximized when ETH falls to zero.

So let's say ETH is falling to zero. Then essentially, you have to pay me 240 USDC in exchange. for a worthless each, one-eath, which is completely worthless now, for the option that you've sold me. But then you also have the option that I've given you, right? And that allows you to give one, the one-eath you just got for me in exchange for my 239 USC, right? And so you've essentially given away 240 USC in the first exercise and gained 239 USC in the second exercise. And so your maximum loss, right, has been $1 this whole time. And so actually what we're able to do is compose these two options into one position called a put spread. And we say Sunny's written a put spread with a

max loss of like $1. So you only need one USDC total for these two options positions to exist. And this is like actually really incredible because you've essentially taken selling an option. you've made it something that's that where you can cap your you're capping your losses and so instead of doing a 239 put that you're bought buying for me you can instead buy like a hundred dollar put option so your maximum loss is instead just like you know 140 or you can do it at like 140 and you have a maximum loss at 100 or you know whatever you want and so any two options in this world are able to kind of interact with each other and create a network effect in the sense that they massively reduce the capital costs of being someone who's writing a

spread relative to someone who's just writing a negative option. You can go beyond just credit spreads and debit spreads and put spreads and call spreads. You can buy things like iron condors and butterflies and straddles and strangles, which are even more complicated positions, which themselves, again, have very defined maximum losses. And so you can have 10 different options interacting and have one vault with a very clear defined max loss that's written all of these. So that's how the question, one of the ways network effects are dealt with in the next version that we're currently working on V2. So I hope that kind of makes sense.

So basically, if I repackage that, does it mean in V2 you won't have to collateralize 100% and the put spreads and the call spreads will be used to kind of ensure, sure that risk is managed? Yeah. So first of all, you won't need to put in 100% of, you know, the strike price in B2 just because we're doing some of the linear interpolation-based margining that we talked about earlier. But then you can go even further on your capital efficiency by having a spread, put spreads

and call spreads. And that will make it even more efficient. And also you have this network effects where if someone creates an O token on a fork of open rather than open itself, it can't necessarily be used as collateral in a spread, right? And so there's no way that they can use that to make a vault, which has like a strike of one. So you have this massive increase in network effects. And then there's a way to go even further, right? It's like the two options that Sunny and I talked about were an ETH options with the same X free, right?

Put options on ETH with the same X3. Well, if you extend like some similar margining principles, then you can have an ETH and a call themselves basically have, let's say, one half the margin required for just a plain call or just a plain naked put itself. And then you can go even one step further than that, which is you can say like, if Sonny has a Bitcoin option that he's bought and then he's sold an ETH option, you can, since Bitcoin and ETH are correlated, you can use those together to reduce Sunny's margin requirement.

And you're essentially using that Bitcoin option as collateral in the ETH option. And that's something called, you know, a portfolio margin. You take an entire portfolio and you say that like the margin of that entire portfolio is less than any one individual asset because there's correlations between assets. Again, that's like probably for V3 rather than V2 or it's like more advanced even than the next version. But here's how you create like a network where every O token is like a family that can interact better than it could have. well. So it sounds like V3 is going to have like an in-built matching engine because basically the matching engine itself, you know, of the trading mechanism needs to know a lot of rules about how things are composable and what can be used as a collateral for what, right?

Yeah, I think this is a great question. So the margining system itself needs to be like a lot more sophisticated as we go along. And again, in traditional finance, exchanges are very sophisticated in the way that they use a margin, I should say clearing houses rather. And there's never been an options clearing corporation or a clearing house in the United States that's, you know, in the last hundred plus years that's ever been fully insolvent, like that's ever had to default on any obligations. So they're able to get much more aggressive margining and manage the risk at the same time.

So that's something that we're kind of, you know, we want to make defy as good as that. And then the second part of this two-sided question is the question of trading venue. And we can talk about this more, but Uniswap is currently where O tokens are traded, but it's not the best venue for O tokens, right? Uniswap is an incredibly powerful platform, but it doesn't work as well for financial derivatives, like options, which they have like some kind of time limit and they're approaching expiry. Because as time goes on, the option is decreasing in price.

And if it expires out of the money, then a second before expiry or the time of expiry, it's a worthless, you know, token that has no worth. And so on uniswap, what you get is this notion of impermanent loss when two assets are converging in their price, diverging, I should say, in their price. you're getting a permanent loss. And so when you have a pool where it's an O token relative to an asset that is not decreasing in price, then you're going to get 100% earned permanent loss as a liquidity provider. And so right now as like the open team, we've been the liquidity providers just like kind of as a community benefit role.

Like we're not, we're definitely like dealing with losses as a result of being like a liquidity provider on, on Uniswap right now. But in the long run, the question is, how do we do better? And there's two main ways. The first is to do what is most commonly done in traditional finance, which is have a central matching engine

with a really nice order book style exchange. And this is kind of like, you know, what DYDX has moved towards for their spot and perpetual positions. The other is to build an AMM that's like, similar to uniswap or maybe similar to balance or something in that family, but works much better for, for options.

And so that's what Vegaswap is, which is like an earlier stage idea of a options native AMM that reduces impermanent loss significantly over over uniswap or options. And that's something you guys are building? So right now we're building v2 with like Vegas swap being like kind of still in the ideation phase and like the goal is to first really release vaguswap as a paper and get like a lot of community input on it because I think it's actually like quite complicated as a system but it's not necessarily like it's on the roadmap for v2 it can be like a thing like on top of v2 and

it's still possible that you know central matching engine is actually the best solution for users of open as friedricha mentioned so should I give kind of a summary of how vaguswap work Maybe briefly because I think we're running out of time. Yeah, but I'd be super interested. Yeah. So the way it works is the super highest level is that essentially you don't want impermanent loss. You want this system that knows that these options are going down in price.

And so it's consistently on a block-by-block basis, reducing the price for offer of these options. Now, in an options market, there's two things you can think about. The first is like getting pricing this option perfectly using like some notion of black shoals and then using the market to determine implied volatility. Again applied volatility, if someone says that they use like black shoals to price an asset without like and that you're going to get some like perfect market price that doesn't actually make sense. What you need is the market to input their estimate and trade implied volatility and then black shoals comes out the other side. And so Vegas swap will do is allow people. to trade volatility itself. And then every time they make a purchase or a sale, they're trading volatility.

And then this AMM will use this volatility to kind of give an output value of the option. And as every block goes by and there isn't a trade, because it's using a constant implied volatility, the value of the option will go down, reducing impermanent loss. Another way to do this is just say the option is worth $10 right now. It has a cash value of zero. that means it's that, you know, if I were to exercise it right now, my net profit would be zero or less than zero. So it has a cash value of zero. And so there's 10 blocks left. Let's reduce it by $1 in value every block until X3. Or we can do something more appropriate, which is actually square root of time.

So let's reduce it by like a square root of like T every single block. So those are the way to think of Vegas swam at a high level. Yeah, and if anyone's interested looking, it's hidden away on the website, but there's a link to the paper there. So if you can find it, it's a great read. One last, I'm also DM me on Twitter or anything if you're interested in that.

One last technical question I had, just a U.S. question before we move on to the final stuff about business model. But can I roll over options? Because it seems like that could be a big UX annoyance. If I just want to, you know, have something more continuous, but I have to go buy up new O tokens every time. Is there a way to roll them over easily? Yeah, it's a great question.

And it's definitely something a lot of options sellers want to do, where they want to continuously be just like shorting options or selling options. The way you would do this is actually, like, it doesn't have to be native in V2. So we're thinking about doing that as a wrapper on top of V2. And, you know, if anyone in the community is interested in building this, this is actually really cool. you can think of it as like a set rebalance, right?

Where in a set rebalance, there's this group of individuals who are incentivized to make these trades between two assets. So that like let's say, you know, E-P Bitcoin, they're making like using an auction. They're making, they're rebalancing the set by selling one for the other, right? Like the fair market value. And you can do something very similar for Open where let's say you're on a buy side and you want to like rebalance. What you can do is you can take someone's existing options position and have like this group of individuals who's like able to rebalance that O token that's about to expire with one that's like has a longer X free. You can do this also on the sell side by unwinding someone's option by buying it on the market, unlocking their collateral and using that to sell a new option. So it's very doable to like do a set style rebalance for rollovers.

And that's like one of the active research questions also for V2. Cool. So this fabled V2, when are we going to see it? So V2 is going, so we've still not started the, you know, we're still in the question of like in the research phase. We only started working on it a few weeks ago. And so still a lot of questions are being figured out. but I would say we should have it within the next six months or so.

Hopefully we can do it sooner than that. But at the very least, it should be to audit in the next six months. And we're trying to just build this as quick as possible because it's something that a lot of users have expressed that they're really excited about and really, really want. Cool. And then basically as soon as your users are locked in because they want to deposit open options as collateral.

I assume there's also going to be a fee. So this is a really good question on like the business model of V2. I don't think taking straight up fees, protocol level fees, for like an admin key to accrue is actually a very user-friendly way to accrue value to the protocol. One way to accrue value is, you know, kind of, well, Well, I guess there's two ways to think about it is that having an MKR type token, which is more accruing fees as like as a general overall like permissionless

from like a general overall permissionless protocol point of view where the fee isn't as much like a fee to use, but more like you can think of it as like to burn and reduce the supply so that those individuals are incentivized to be like an insurance fund. similar to MKR. So the MKR style model seems more user-friendly because it's not that you're just giving a fee to someone because they built the protocol. It's that you're giving a fee for someone who's very active in the protocol to be an insurance fund. So that's one way to think about it. But again, nothing is like very set in stone. I don't think that V2 is going to come out with an MKR style token built immediately in. Maybe we do something. more like the comp style of like releasing it and then with time you can add the governance plus

like recapitalization mechanism with time. But we're just trying to do it in the way that's the like most favorable for like users of the protocol in the long run and also most sustainable. And so that still remains to be seen how that is. But there's a lot of interesting ways to do it. Cool. Fantastic. We're holding on to the edges of our seats. I'm really excited to see what's going to happen for a version two. Thank you for coming on, Zubin. Yeah, thanks so, thank you so much. Excited likewise. It's been a pleasure to be on here. And, you know, options are like a $500 trillion plus dollar market in traditional finance. And I think Defi can do it better. And I think that there's going to be so much innovation. And the opportunity is,

is ours for people in Defi to build an even better financial system. Good closing words. Thank you. All right. Thanks so much. It doesn't end here. There's much more of this conversation, and you can hear it by signing up for Epicenter Premium. As a premium subscriber, you'll get access to a private RSS feed where you can hear the interview debrief, which goes on for an extra 20 minutes. You'll also get exclusive access to roundtable conversations with Epicenter hosts and bonus content you won't hear anywhere else. Go to epicenter.orgs slash premium to join the community and support the podcast. Thank you.