The Premises of a Yield Market Using Perpetual Constant Maturity Options

Traditional finance relies on mature interest rate markets with instruments like Forward Rate Agreements, Interest Rate Futures, or swaps, to maintain liquid and consistent financial structures. On the other hand, DeFi lacks natural interest rates, making it challenging to replicate such markets. Instead, DeFi can develop its own yield market, leveraging Perpetual Constant Maturity Options (PCMOs) to introduce a new form of yield trading.

Defining a DeFi Yield Market

Before discussing the structure of a Yield market, we must first define its core mechanics. A key principle establishes the foundation:

Postulate 1

In a Yield market, not all participants can generate revenue. Participants must choose a side: earning yield when the asset’s value decreases (Short position) or increases (Long position).

This principle introduces a fundamental trade-off – yield generation is inherently tied to market movements, meaning every gain has a counterparty loss.

Base Conditions for a Proper Yield Market

To function effectively, a Yield market must meet the following criteria:

1. Observability & Measurability – Yields should derive from transparent market data
2. Consistency – Yield over time (T) should reflect the underlying asset’s performance
3. Controlled Volatility – Yields should remain stable to encourage participation
4. Term Structure – A structured yield curve must exist across different timeframes

However, this framework alone presents a challenge: because yields are directional, the market may struggle with imbalances. If most participants take the same position – such as in a prolonged bull market where Long positions dominate – liquidity risks arise. To counteract this, an additional mechanism must be introduced.

Ensuring Market Liquidity

A well-functioning Yield market must incorporate incentives to encourage participation on both sides, especially for positions counter to prevailing market sentiment. For instance, if the futures market is in Contango (where future prices are expected to rise), most investors may favor Long positions. Without proper incentives, Short positions may become scarce, leading to inefficiencies and potential liquidity issues. This leads to a second principle:

Postulate 2

To ensure liquidity in a Yield market, yield revenues should be structured to favor participants taking positions against market expectations.

From this, two additional Liquidity Conditions emerge:

1. Drift-Adjusted Yields – Short positions should earn more when futures drift is positive, and vice versa
2. Notional-Adjusted Yields – Payouts should be proportional to the notional ratio between Long and Short participants

Towards a Sustainable Yield Market

Beyond these conditions, a robust Yield market should evolve to integrate additional mechanisms that further enhance its efficiency:

• Protocol-Governed Stability Mechanisms – Implementing automated strategies, such as fee adjustments or liquidity incentives, to mitigate risks of extreme imbalances
• Composability with DeFi Protocols – Allowing yield instruments to be integrated into lending, derivatives, and structured products, expanding their utility within the DeFi ecosystem

By structuring yield generation around transparent market principles, counterparty incentives, and adaptive mechanisms, DeFi can establish a resilient Yield market tailored to digital assets – one that unlocks new financial opportunities without relying on TradFi’s conventional interest rate frameworks.

PCMOs: the Foundation of DeFi’s Yield Market

PCMOs extend the concept of Vanilla options by rolling perpetually and adjusting the strike price dynamically. They enable:

• Synthetic Perpetual Futures – A Long PCMO Call + Short PCMO Put mimics a Perpetually Rolled Futures (PRF) contract, embedding yield expectations, but participants only pay the short PCMO Put if the asset price goes down
• Cost of Carry Mechanism – Yield reflects the expected price drift over time (T), aligning with traditional carry models
• Compliance with Base Conditions – PCMOs derive from measurable data, ensure consistency, maintain controlled volatility, and enable a structured yield curve

These characteristics make PCMOs a natural building block for a new type of DeFi yield market – one that is structured around market expectations, derivatives pricing, and liquidity incentives.

And

Enhancing Liquidity with PCMOs

A critical challenge in yield markets is liquidity. If most participants take one side of the trade – especially in strong bull or bear markets – the market can become imbalanced.

• Notional-Adjusted Yield

Yield distribution should be notional-weighted to prevent one-sided market dominance. At the end of each fixing period, the protocol should adjust yield payouts based on the ratio of notional value between Long and Short positions:

For example, suppose Long notional is 3 times larger than Short notional (i.e., the majority of participants expect the asset price to rise):

• If the asset's price does increase, Long participants receive only 1/3 of the expected yield (since the Short side is paying across 3x more receivers).
• Conversely, if the price drops, the Short side receives 3 times the PCMO Put yield, compensating for their smaller notional size.

This mechanism ensures that arbitrageurs naturally step in, taking the less popular side of the trade to capture the higher relative yield, automatically balancing liquidity.

• Drift-Adjusted Strike

To further incentivize liquidity on both sides, strike prices should be adjusted based on market expectations. A simple yet effective way to do this is by embedding the futures market drift into the strike price of the less favored option.

For instance, if the market expects the price to rise, most participants will prefer Long positions. To counteract this, the PCMO strike can be adjusted upward, making it In-the-Money (ITM) for the PCMO Put and slightly Out-of-The-Money (OTM) for the PCMO Call. This adjustment boosts the potential payout of Short positions, providing a higher reward if the price moves against the trend.

The notional-adjusted yields and the drift-adjusted strikes approach ensures that:

• Short positions remain attractive, preventing liquidity shortages in one-sided markets.
• PCMOs remain a self-sustaining mechanism for yield generation, without relying on external incentives

Yield Term Structure

PCMOs leverage Futures and Options markets to derive short-to-medium-term yields (1D to 3M) with greater stability than perpetual funding rates, which are highly volatile. This provides DeFi with a structured and tradable yield curve, unlocking new financial instruments beyond TradFi’s conventional interest models.

Example, applying PCMOs to BTC/USDT, with Volatilities and Futures yields observed on Deribit as of 14 March 2025, for 2 consecutive days, we obtain the yield term structure below:

As illustrated in Chart 1, PCMOs generate distinct yields across different tenors, which fluctuate based on:

• Price variations of the underlying digital asset.
• Movements in the Futures and Options markets, which impact implied volatility and forward pricing.

One of the key observations is that the PCMO-derived yield curve is inverted, meaning short-term yields are higher than long-term yields. This reflects:

1. Increased speculative risk in the short term – Traders demand higher compensation for immediate uncertainty.
2. Smoother long-term accrual – Over extended periods, risk is distributed more evenly, resulting in lower long-term yields

Conclusion

Perpetual Constant Maturity Options (PCMOs) introduce an innovative yield market structure in DeFi by leveraging option mechanics to replicate perpetual futures. Unlike TradFi’s interest rate markets, PCMOs enable directional yield generation, ensuring liquidity through drift-adjusted strikes and notional-weighted payouts. By integrating stable term structures and market-driven pricing, PCMOs create a sustainable and efficient yield market tailored to digital assets—unlocking new financial opportunities in DeFi without relying on traditional interest-bearing instruments. 🚀