A new tool for hedging DeFi asset risk-decentralized volatility platform Divergence uses digital options to reduce risk ‘Paradoxes’
As DeFi continues to evolve, with projects in various areas such as DEX, lending, liquidity mining, and yield aggregation, the DeFi world has become quite rich in components, but there is still a lack of effective, easy-to-use solutions to trade and hedge against the volatility of assets that exist in different DeFi application layers, leaving users inevitably exposed to multiple risks of volatility at the same time.
While digital options have a long history of development in traditional finance, there has been no actively traded options market in the DeFi space, and Divergence seeks to spearhead and shield investors from DeFi tokens to achieve more stable returns.
Divergence’s goal is to simplify the complex price discovery mechanism in volatile markets into a simple, straightforward buying and selling experience. Market participants can bet on the price movements inherent in the DeFi space and on the likely outcome of market events.
On September 7, 2021, CryptoJ invited Bonna Zhu, Founding Member of Divergence, to be a guest on this episode of AMA, “A New Tool for Hedging DeFi Asset Risk — Decentralized Volatility Platform Divergence Uses Digital Options to Reduce In this episode of AMA, Bonna Zhu, a founding member of Divergence, joins us to experience how to use options derivatives to improve DeFi capital utilization.
The following is a compilation of AMA’s text, with some deletions.
The AMA will be separated into two parts:
1. Guests answer questions
2. Our guests will answer the questions asked by our community members
Please stay quiet at the first section and ask your questions during the second section.
Now, let’s start!
Question1:Welcome to CryptoJ. Firstly, can you tell us a little bit about Divergence, its background and vision, and what problems can solve? Can you summarize the main features of the Divergence?
Bonna Zhu：Divergence is a decentralized financial risk hedging and trading platform that serves three main types of users: 1) risk-averse users: providing simple, easy-to-use risk hedging tools; 2) risk-taking users.
Question2:Divergence has introduced various interesting stories and concepts in the design of the project, such as the “volatility smiles” logo (a curve describing the relationship between implied volatility and strike price) on the homepage.
Could you please tell us more about the interesting story behind the project, such as the background of the core team, how you met and built Divergence?
Bonna Zhu：The core members are all old colleagues in the industry. Met in early 2018, although we worked in different institutions in the industry, each other has continued to maintain a very deep contact and communication collaboration. 2020, DeFi market rapid development, due to the nature of work, we are also involved in it，the team members are deep dex trader, yield farmer and part of the protocol governance participants, the deeper touch is that in addition to the more substantial potential returns, the risk and uncertainty is also larger, and there is no relatively simple, easy to use on-chain tools to hedge the multiple risk exposure brought by the nesting of assets in the defi world.
Question3:Divergence obtained comprehensive attention from the market with rapid growth, which we believe can’t be achieved without partner’s support. Could you share your current financial status and cooperational progress?
Bonna Zhu：Divergence’s product idea and concept has been recognized by top institutions in the industry and supported by many top DeFi founders. Our disclosed investors include leading investors like Mechanism Capital ,KR1, Arrington Capital, P2P Capital, Orthogonal Trading, DeFi founders like Do Kwon, founder of Terra, the founding team of DoDo, Sandeep, co-founder of Polygon, igor, founder of xDai, etc.
Question4:An important component of the Divergence protocol is the crypto option, so what exactly is the definition of an option, a DeFi option? What are the current practical applications and how does the Divergence protocol fit into crypto options? In your opinion, what is the future direction and the scale of the DeFi options market?
Bonna Zhu：Options are a non-linear financial derivative (corresponding to the linear financial derivatives of contracts and futures), which are widely used in risk management and portfolio construction. In contrast to traditional finance, the market size of options is actually on a par with futures. Data shows that in 2020, the total global futures and options volume reached 46.77 billion lots, of which options accounted for 45%, and the volume of options trading hit a record high for three consecutive years. In the crypto finance market, bitcoin and ethereum options trading also reached record highs in 2020. Among them, the highest BTC options position has doubled up to 6 times, and the highest ethereum options position has risen nearly 70 times. The soaring figures confirm that the demand for options is strong and crypto options will definitely become a major market trend in the future.
High barriers and few users are common perceptions of crypto options in the industry, but in fact, the current market size of crypto options is far larger than perceived, as a large portion of options trading is done in the inter-institutional OTC market, and as a large number of institutional and professional users enter the crypto market, they have a huge demand for hedging and will trade corresponding options derivatives and add them to their investment portfolio.
For Divergence, however, we prefer to start with the DeFi market and make it easy and convenient for more general users to participate in on-chain trading of volatility derivatives such as options.
At present, users participating in the DeFi market often have large amounts of money nested in different agreements, with great uncertainty in returns, but lack of effective derivative instruments to hedge risk, and options are the missing piece of the decentralized financial market map. Compared to futures, options provide multi-dimensional risk hedging and non-linear risk return, and have irreplaceable financial product attributes. We have chosen to focus on DeFi options because we see a huge gap in the derivative market in the decentralized financial market, which is a great potential market opportunity for us.
Question5:Options、DeFi options products also have relatively high barriers to entry due to the complex financial concepts incorporated in the products, so where are the target users and groups for Divergence? How can we attract more ordinary individual users to participate in the Divergence application?
Bonna Zhu：Divergence targets users include both DeFi market veterans with a need to manage risk, as well as trading users and market makers with considerable familiarity with derivatives, and ordinary traders.
The original intention of Divergence product design is to allow users to trade options, a type of financial derivative product that has a certain threshold, just like in uniswap swap tokens. The page design is as close as possible to the swap products on the market for a reason.
Uniswap and other swap products have helped educate a large number of users to get used to trading spot through dex, so on this basis, we hope to allow users to gradually adapt to the underlying of the derivatives category.
Question6:Can you give us a brief introduction to the Spear/Shield concept introduced in Divergence options? What is the mechanism and usage of these two tokens in Divergence? What is the specific pricing method?
Bonna Zhu：This one is a result of Gamified by our call option, and put option. In our setup, Spear (spear) represents a long price, or a long price movement, with some aggressiveness, while Shield (shield) represents a short price, or a short price movement, with some defensiveness.
1）Let’s take a single strike price pool as an example, buying Spear means that the price of the underlying asset will be higher than the strike price at maturity, and if correct, each Spear will receive 1 share of the pool’s pledges and Shield will receive nothing; while buying Shield means that the price of the underlying asset will be lower than the strike price at maturity, and if correct, then each Shield gets a reward of 1 share of the pledge in the pool, and Shield gets nothing. For example, a user buys a copy of Spear at 0.6 DAI, and at maturity, the user predicts correctly, he or she gets 1 DAI in exchange for a return of 0.4/0.6, nearly 70%.
2）If the user is not confident enough to accurately judge whether the underlying asset price is above or below a certain price, he can also choose to participate in the trading of a pool with a strike price of an interval, i.e., bearish or bearish price fluctuations, specifically, in this case, buying Spear (spear) means that he is optimistic that the underlying asset price will either rise above a certain price at expiration or fall below a certain price, i.e., violent fluctuations will occur, which can be profitable, while buying Shield means that he believes that the underlying asset price will be less volatile before expiration and will still operate within the strike price interval.
Question7:How do users add and withdraw liquidity in the Divergence protocol? Is it possible to withdraw liquidity before the expiration date? How are fees calculated?
Bonna Zhu：The user can select one of the existing option pools to inject liquidity (the pledge used to deposit the pool). Once injected, they receive an LP token, which is used to represent their share of the market in the pool, and receive the corresponding option sales fees, as well as transaction fees, etc., based on the share of the market. If the user wants to withdraw liquidity, there are two options available.
1）Redemption by appointment, that is, before the expiration of the pool is still in the pool to be marketed, but do not participate in a new round of options marketed, the user needs to wait until after the expiration of the pool to get back the pledges corresponding to the corresponding marketed shares, before the actual settlement of the pool, the number of pledges that can be retrieved is uncertain, but still can get all the proceeds generated by the pool before expiration.
2）Immediate redemption, i.e. not waiting for the pool to expire and immediately taking back the pledges attributed to them in the pool, is more expeditious, but to avoid competitive withdrawals, the user pays a fee of up to 1%. The fee stays in the pool and is attributed to LPs that remain in the market making, and the specific fee formula is：
That is, if the pool has no net sold options, no fee is charged, and if there is a user holding options, the closer to expiration, the higher the fee, capped at 1% of the withdrawal.
Question8:What are the expiration dates of the Divergence Agreement? What is the settlement method on the expiration date? What are the differences between the option agreements with different expiration dates? How should users choose?
Bonna Zhu：There are currently three types of option expiration dates, or time periods, that we support: 1) Daily market, which expires daily at 8:00 UTC; 2) Weekly market, which expires every Friday at 8:00 UTC; and 3) Monthly market, which expires on the last Friday of each month at 8:00 UTC, relatively consistent with the expiration dates on Deribit.
Each pool has its own expiration time, after which: 1) the smart contract will calculate the winners and losers of the position (call or put), the losers will not be able to access the pledges in the pool, while the winners will be rewarded according to the relationship between each option and each pledge in the pool. 2) For LPs who choose to “book redemption” before expiration, the pledges corresponding to their LP share will be calculated and can be taken out by the LPs. 3) Any remaining pledges are used to open a new market and rolled over to the next maturity date.
The user’s choice of expiration date is more a combination of their risk hedging term needs. If they are a relatively speculative trading user, they will choose a pool with a short term, where token price fluctuations will be more sensitive and rapid, as well as an earlier settlement time.
Question9:We know that Divergence has introduced AMM mechanism in the protocol design, is there any risk of unpredictable loss when users use it? Besides the risk of AMM, what other risks do users need to be aware of?
Bonna Zhu：In the case of a liquidity provider, there may be a risk of an infrequent loss because the liquidity provider is a passive market maker and the theoretical price of the option will change in response to market fluctuations, which may not be reflected in the actual price and will need to be adjusted by the trader through trading. In addition to the risk of inconstant loss, as a trader, you may also need to pay attention to the risk of liquidity. If the liquidity provider withdraws the liquidity from the pool, it will affect the exit of the user of the position before the expiration of the option, but Divergence has certain constraints on the liquidity provider to redeem the liquidity, if you choose to immediately redeem, you will not be able to take the pool according to the the pledges corresponding to the worst settlement outcome, as well as there will be a certain penalty fee to ensure that, even in the event of a massive LP withdrawal, the pool will still be able to continue to operate.
Question10:We see that the Divergence Kovan beta is open for public testing, can you share with us the main features and some brief demonstrations of what is open on the beta network?
Bonna Zhu：Of course, our test network is open for 1) trading, users can trade options like swap tokens on uniswap; 2) adding and redeeming liquidity, users can choose existing pools to add liquidity to become LPs or redeem at any time; 3) new pools, you can open an option pool for market making according to your parameter preferences; 4) settle and get rewards, if you choose to hold the option to expiration, the pool settles at expiration, and if you are the winning party, you can CLAIM the reward; 5) Data Watch Board to see through the information. We recorded a video of the interaction with the test network as follows：
How to Trade Binary Options on Divergence: https://youtu.be/vFONYxAOvJY
Question11:Regarding value capture, how is Divergence’s token economy model designed, how do you incentivize users to hold tokens for a long time, and what are the application scenarios for tokens?
Bonna Zhu：DIVER tokens are primarily used as governance tokens for Divergence, as well as acting as incentives in the system, and can also be pledged to generate revenue from different sources. The entire Divergence economic system, will mainly generate the following economic benefits, including: 1) transaction fees, of which 75% is allocated to the liquidity provider and the remaining 25% goes to the treasury, with subsequent allocation determined by governance; 2) quick redemption fees, if LPs choose to redeem liquidity immediately, a fee will be charged, which will remain in the pool and be divided among the remaining LPs .
Question12:RWhat are the next steps for Divergence after the beta launch? Will there be any new product launches? Will there be collaborative development with other projects? When will the main website go live?
Bonna Zhu：We are planning a beta contest, and we will conduct a public bug bounty with immunefi after our audit is completed and before the main website goes live. the main website is expected to go live in October, and we will cooperate with various DeFi protocols to support their tokens or protocol-issued assets as pledges and price targets for the option market. The main network is expected to go live in October.
