A Faster, Safer Way to Trade Options Across Blockchains

Table of Links

1. Abstract and Introduction

2. Preliminaries

3. Overview

4. Protocol

   4.1 Efficient Option Transfer Protocol

   4.2 Holder Collateral-Free Cross-Chain Options

5. Security Analysis

   5.1 Option Transfer Properties

   5.2 Option Properties

6. Implementation

7. Related Work

8. Conclusion and Discussion, and References

A. Codes

• A.1 Robust and Efficient Transfer Protocol
• A.2 Holder Collateral-Free Cross-Chain Options

B. Proofs

• B.1 Transfer Protocol Proofs
• B.2 Option

Abstract

Options are fundamental to blockchain-based financial markets, offering essential tools for risk management and price speculation, which enhance liquidity, flexibility, and market efficiency in decentralized finance (DeFi). Despite the growing interest in options for blockchain-resident assets, such as cryptocurrencies, current option mechanisms face significant challenges, including limited asset support, high trading delays, and the requirement for option holders to provide upfront collateral.

In this paper, we present a protocol that addresses the aforementioned issues by facilitating efficient and universally accessible option trading without requiring holders to post collateral when establishing options. Our protocol’s universality allows for crosschain options involving nearly any assets on any two different blockchains, provided the chains’ programming languages can enforce and execute the necessary contract logic. A key innovation in our approach is the use of Double-Authentication-Preventing Signatures (DAPS), which significantly reduces trading latency. Additionally, by introducing a guarantee from the option writer, our protocol removes the need of upfront collateral from holders. Our evaluation demonstrates that the proposed scheme reduces option transfer latency to less than half of that in existing methods. Rigorous security analysis proves that our protocol achieves secure option trading, even when facing adversarial behaviors.

1 INTRODUCTION

The emergence of blockchains, such as Bitcoin [27] and Ethereum [6], has given rise to decentralized finance (DeFi), transforming traditional financial systems by eliminating the need for intermediaries. DeFi’s open, transparent, and permissionless architecture enables users to access a wide range of financial services, including lending, borrowing, and trading, without being constrained by geographical or institutional barriers. Smart contracts further enhance its appeal by automating transactions, reducing operational costs, and mitigating risks like fraud or human error. As of July 2024, DeFi protocols hold a total value locked (TVL) of approximately 102 billion USD, with 207 million USD allocated to options markets[11].

Options are crucial components of Defi markets, offering participants more sophisticated tools for risk management and investment strategies. Options provide traders with flexibility in uncertain markets, enabling them to hedge against potential price fluctuations or speculate on future asset values. An option is a bilateral agreement between two parties, where one party holds the right, but not the obligation, to execute a transaction under predetermined conditions. Assume Alice buys an option from Bob. Then Alice is called the holder and Bob is called the writer of the option. Say the option grants Alice the right to purchase 100 "guilder" coins using 100 "florin" coins before the weekend. In exchange for this right, Alice pays Bob 2 florin coins upfront as a premium. If the value of guilder coins rises during the week, Alice can exercise her option to acquire them at the lower, agreed-upon price, securing a profit. However, if the value of guilder coins drops, Alice can choose not to exercise the option, limiting her loss to the initial premium. This flexibility makes options a valuable tool in DeFi, allowing users to better manage risk while maximizing potential gains.

There are some existing protocols for options on blockchain, but they are insufficient due to several limitations. First, existing protocols lack universality: option trading platforms[1, 2, 10, 30, 44] are largely confined to mainstream cryptocurrencies, such as BTC and ETH, and do not provide users with the ability to independently create options for non-mainstream cryptocurrencies or other digital assets. Second, the option pricing lacks robustness and flexibility to align the needs of the traders. Some protocols [1, 2, 10, 30, 44] heavily rely on external oracles which are susceptible to price manipulation and code vulnerabilities [22, 31–34, 37, 45]. Some protocols [1, 10, 44] utilize traditional pricing models like BlackScholes [4, 5] and operate under broad economic assumptions. Their methodologies fall short of meeting the needs of traders who seek the flexibility to trade with customized pricing.

To offer general options covering a wide range of blockchainresident assets and create options with prices that reflect traders’ needs, researchers have proposed using Hashed TimeLock Contracts (HTLCs) for establishing options. HTLCs [16, 48] effectively address the limitation mentioned above: they enable the trade of arbitrary assets and allow market-driven pricing without reliance on external oracles. HTLC is initially designed for atomic swaps which have been demonstrated to be equivalent to a premium-free American call option1 [14].

However, current HTLC-based option protocols [13–15, 21, 42] face significant challenges regarding transferability and collateral. Most research focuses on establishing the option contract between the buyer and seller. Once an option is established, it should be tradable. However, most works overlook this crucial feature. In [12], the authors introduced transferable cross-chain options, allowing options to be transferred post-establishment. Despite its innovation, their approach has two limitations: prolonged transfer time and vulnerability to the Phantom Bid Attack. In this protocol, the option transfer requires 9Δ (approximately 9 hours on Bitcoin), where Δ represents the block confirmation time[2]. This process is inefficient. In the case of phantom bid attacks where an adversary creates multiple fake buyers who offer higher prices but fail to finalize the transfer, the option holder/writer is unable to sell their position.

Existing protocols require option holders to provide full collateral upfront. This is problematic because options are typically much cheaper than their underlying assets and are primarily used by holders for leverage. To address this, the requirement for upfront collateral should be eliminated. Eliminating the need for upfront collateral poses non-trivial obstacles. In HTLC-based options, the option is structured as the holder’s right to exchange their assets for the writer’s assets. To ensure the writer receives the holder’s assets when the option is exercised, the holder is required to provide a collateral. Without this collateral, there is a risk that the writer could give out their assets without receiving anything in return from the holder. We can possibly utilize cross-chain bridges to solve the problem. However, based on the current research progress on cross-chain bridges, they are not secure and mature enough for adoption due to various attacks, such as private key leakage [24] and code vulnerabilities [28].

Contributions. In this paper, we introduce a cross-chain option protocol that offers universal accessibility for various assets, enables efficient option transfers, and eliminates the need for upfront holder collateral. Building on existing works, two key challenges remain: enabling efficient and robust option transfers, and removing upfront collateral for holders. We propose an efficient and universally accessible cross-chain option protocol without upfront holder collateral that addresses these challenges. A comparison of our protocol with others is shown in Table 1. Our contributions are summarized as follows:

• Efficient and Robust Option Transfer : We propose an option transfer protocol that enables the transfer of assets with less latency and more resilience to phantom bid attacks. The key idea is the adoption of Double-AuthenticationPreventing Signatures (DAPS) to option transfer finalization. By DAPS, our proposed protocol completes the option transfer more than twice as fast as state-of-the-art methods when all parties are honest. It can defend against the phantom bid attacks by finalizing the option transfer solely by the option seller.

• Holder Collateral-Free Cross-Chain Options. We design a option protocol without requiring the holder to post collateral when the option is established. The key idea is the introduction of economic incentives. We let the option writer withhold a secret for option exercise and provide a fair guarantee. The guarantee serves as an compensation to the holder if the writer fails to release the secret when the holder exercises the option.

• Combing the above two schemes, we propose a protocol for efficient cross-chain options without upfront collateral from holders, achieving a option trading protocol closer to those of traditional options. What’s more, the protocol can support concurrent bidding of multiple potential buyers. The option transfer time is constant regardless of the number of bidders.

• We provide a rigorous security analysis and implementation of our proposed protocol.

The rest of the paper is outlined as follows. Section 2 introduces the model. Section 3 provides an overview of the holder collateral-free cross-chain option and the efficient option transfer protocol. Detailed descriptions of the protocols are presented in Section 4. Security properties are analyzed and proven in Section 5. Related works are discussed in Section 7. Section 8 summarizes this paper.

[1] This confers the right to purchase the underlying asset.

[2] Δ is a time period sufficient for each party to release, broadcast and confirm transactions in the blockchain, typically 1 hour on bitcoin