On-chain Options Trading and SSOVs on Ethereum L2s: An Analysisby@fearsomelamb789
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On-chain Options Trading and SSOVs on Ethereum L2s: An Analysis

by FearsomeLamb789March 6th, 2022
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The Arbitrum L2 is built on top of the popular Dopex protocol. It allows you to send your funds to the L2 instead of sending them to the main network on-chain. Arbitrum runs every transaction using the same smart contract code as the mainnet. It runs computations on its own network and then posts the net effect of those computations back to main Ethereum blockchain. The downside is that Arbitrum inherits Ethereum security, but it is just a separate chain after all.
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To begin with, warning for the Orange coin maxis: Yes, Bitcoin is money, let the other coins rebuild decentralized finance however they like.

Now that we just got rid of the hodlers, let’s talk about ways to decentralize loans, savings accounts, currencies, mortgages… For this article, we will focus on derivatives and more specifically on Options trading.

We have not yet seen most derivative financial products on Defi. Among these, we find Perpetuals, Options… Current data informs that the global equities market is worth about $38 trillion. The global derivatives market is worth as much as $1 Quadrillion.

However, as much as we like to trade on-chain, there has not been a feasible solution to solve this problem yet. Here is where the Arbitrum L2 comes in, specially Dopex. As per Investopedia, an Option in finance gives you the “option” to buy or sell an asset at a certain price at a certain time. A “call” option gives you the right to buy at that price (call for the item), a “put” option gives you the right to sell at that price (put up for sale).

The problem comes because traders come up with strategies that involve more frequent trading than just buying and holding an asset. They might put a variety of puts and calls across future expiration dates at different target prices as a way to hedge their exposure. When done in Ethereum, that could easily involve thousands of dollars in gas fees.

Despite the insane Ethereum gas fees driving adoption of a number of alternatives such as Solana, BSC, Avalanche… most alternatives end up sacrificing decentralization or security for the sake of scalability (which can be a good or a bad thing depending on your wallet’s holdings of course).

At this point, it is worth mentioning that gas fees on Ethereum are meant to be high. In spite of that, the goal for Ethereum is not to be a transaction layer for users and traders to transact on. It is just meant to be the settlement layer for a bunch of other chains to sit on top of. These transactions can therefore be run much faster and in a cheaper way. Since an L2 sits on top of Ethereum, you normally can’t get to one unless you start on Ethereum.

All of the growing L2s offer “bridges” where you can send your Ethereum funds to the L2. There’s one for Polygon, Arbitrum, Optimism, and more are on their way. The problem is that since these bridges are on Ethereum, they cost Ethereum gas to use, which we know can get pretty expensive.

Once you have bridged your funds to the L2 the fees are minimal.

Since we care about trading options, we will focus on the most popular protocol, which is Dopex, and is built on top of Arbitrum, which is an optimistic rollup. On Ethereum, there are two broad types of transactions: transfers and computations.

Transfers move ETH from one wallet to another and are where Ethereum and Bitcoin are essentially the same. But Ethereum also has a computational layer where the network can run the code built into smart contracts just like your computer is running the code built into this website. Arbitrum solves this problem by moving Ethereum smart contract computations off-chain. It runs those computations on its own network and then posts the net effect of those computations back to the main Ethereum blockchain.

Arbitrum still runs every transaction using the same smart contract code as the Ethereum mainnet, it just doesn’t use up Ethereum computing space to do it. The downside is that Arbitrum inherits Ethereum security, but it is just a separate chain after all.

SSOVs: Single Staking Options Vaults

Contrary to what happens in options trading where you can exercise an option at its expiration data to buy the corresponding amount of the underlying, exercising your options trades with SSOVs is a little bit different.

As an example, if you were to use Dopex, you don’t lose the entire principle if the calls you are selling end up in the money. Instead, you only lose the difference. It is also worth noting that, as a depositor, your total ETH balance is not protected, but its USD values are. This means that if you deposit 1ETH at the strike price of $4K, you will either get back 1ETH or $4K worth of ETH, and in both cases, you will also get all the premiums earned along the way.

Similarly, as a Call Option buyer, you’ll either get back nothing, or you’ll get back the difference between your strike price and the market price, as denominated in ETH.

Current limitations

Among the current limitations stand out that these are European-style options. This means that they can only be exercised on their maturity day, so you can’t exercise the option to claim your profit before that date.

Also, due to the staking nature of the contracts, these options contracts are not liquid. For that reason, they can’t be sold to somebody else once you buy them. All you can do is just hold and wait. Similarly, the current epoch only allows for only one end date and 4 strike prices. As Dopex becomes more popular they might expand their offerings.

Forward-looking approach

The team has stated that they will expand their offerings and integrate American-style options as well as Atlantic Options with flexible exercise timing and liquidity for buying and selling options contracts. Redacted vaults will be implemented as well, which will give more room to speculation on the Curve Wars

Emissions and distribution

  • Operational Allocation: 17%
  • Distributed across 5 years. This allocation is used to initially handle governance, incentivize the development of community suggestions and help grow the platform with newer features/upgrades, and account for other operational costs.
  • Farming (Liquidity Mining): 15%
  • The farming period is set to 2 years with an initial boosted rewards period of 4 weeks.
  • Platform Rewards: 30%
  • Distributed over a period of approximately 5 years. These rewards will incentivize the use and upkeep of the Dopex platform.
  • Founders Allocation: 12%
  • 20% initially staked in liquidity pools
  • 80% vested for 2 years distributed using a drip system via a smart contract
  • Early Investors & Token Sale: 26%
  • Early Investors: 11%
  • 50% Vested over 6 months
  • Token Sale: 15%

To conclude, the Dopex team seems more inclined towards involvement in the Curve Wars rather than going the Olympus Pro route and eventually offering permissionless pools.

As of right now, it offers an unprecedented options trading framework for on-chain speculation. If you like trading options, just connect to their Dapp on Arbitrum during one of the end of the month windows and deposit some collateral with which to buy options.