Modified Dutch Auction
Option buyers do not know the exact number of option contracts pending to sell under Typus Modified Dutch Auction. Although the capacity of options contract size is related to the amount of collateral deposited by option sellers, the final auction number will be determined by the vaulter.
When a Dutch Auction starts, Bid Price (Option Price) will decrease over time, and options buyers submit a Bid Size (Contract Size) of options they want to buy during the auction. At the end of the auction, the latest bidding price that fills the last offer will be used as the Clearing Price (Delivery Price). If it’s not fully filled, it will be delivered at the Lower Bound Premium.
If the Clearing Price is lower than bidders' Bid Price, bidders will receive a refund after the auction ends.
The following three scenarios will lead to the end of the Auction.
- The auction time (bidding time) ends.
- All option contracts are sold out before the bidding time ends.
- Vaulter decides to end the auction before the bidding time ends.
- Upper Bound Premium: 0.25 SUI
- Lower Bound Premium: 0.10 SUI
- Max Bidding Time: 5 mins
- Max Bidding Size: 100 SUI
In a 5-minute auction, the upper bound started to decay from 0.25 SUI.
Case 1 All SUI option contracts were sold out in 3 minutes, and a total of 100 contracts were sold.
- Actual Bidding Time: 3 mins
- Actual Bidding Size: 100 SUI
- Clearing Price: 0.15 SUI
The last bidder submits a new bid order to buy 1 contract when the option price reaches 0.15 SUI, which happens to be the 100th contract. At this point, the auction is completed, and all bidders who outbid the last bidder also buy as many contracts as they want at 0.15 SUI per contract. The total contract value sold at this auction was 15 SUI (0.15 SUI times 100 contracts).
Case 2 All SUI option contracts haven't been sold out in 5 minutes, and a total of 50 contracts were sold.
- Actual Bidding Time: 5 mins
- Actual Bidding Size: 50 SUI
- Clearing Price: 0.10 SUI
In this case, as the total contract size filled is 50 SUI, so the clearing price is detemined at lower bound premium which is 0.10 SUI. All bidders buy as many contracts as they want at 0.10 SUI per contract. The total contract value sold at this auction was 5 SUI (0.10 SUI times 50 contracts).
DeFi Options Vaults (DOVs), on-chain structured products, are not a new idea in crypto. Quoting one of the leading crypto options market makers, QCP Capital’s introduction to DOV at the end of 2021: “Investors simply ‘stake’ their assets into vaults which deploy the assets into options strategies.”
DOVs were treated as scalable trading of non-linear instruments on DeFi, but the imbalanced market structure of DOVs leads to its low scalability for current DOVs.
In the existing DOVs model, retail investors deposit tokens into DOVs and sell options contracts at a specific time (usually every Friday or Saturday). Option sellers take risks to earn premiums. However, option buyers are not permissionless, usually 3 to 5 professional financial institutions.
As these DOVs become more popular, option sellers will get worse yields because more options are sold at the same time, but option buyers are still limited in those 3 to 5 professional institutions. According to Glassnode data, the implied volatility of BTC options and ETH options every Friday and Saturday is 10% to 15% lower than that on other days. These option buyers sell the options elsewhere (usually CEXs) and earn high returns with extremely low risk, but the profits are actually deprived from retail investors. Retail investors take the same risk, but earn a small premium. When they find out the truth, there is a high probability that they will choose to quit. This phenomenon is the biggest obstacle in market expansion of DOV products.
Typus believes that increasing the number of options buyers is the key to solve the scalability problem. This can be achieved by introducing more professional institutions and enabling retail investors to participate as options buyers. Through the design of a Modified Dutch Auction mechanism, Typus simplifies the decision-making process for option buyers and lowers the barrier to entry for retail investors, allowing them to participate as options buyers.
For option buyers, especially retail investors, determining the option price and submitting the order is far more complicated than submitting the price after observing the behavior from other bidders. Typus aims to make users’ decision-making process as simple as possible with just one click to bid options.
The Nash equilibrium of the modified Dutch auction model is that all bidders will faithfully express their willingness to pay, which enables the option seller to receive a fair option premium. Further, acting as an option underwriter is a high risk, so a sufficient premium is required to increase their incentive.
In each auction, bidders trade off certainty against lower buy-in costs. While option prices will decline over time, bidders don't know when the auction will end, so if a bidder wants to wait for a lower price, he/she may not be able to buy as many option contracts as he/she originally planned. When people start FOMO, they may be willing to pay higher premiums to get the option contracts for speculation.
Since the Modified Dutch Auction does not need to rely on off-chain arbitrage to provide liquidity, Typus Vaults for any new underlying assets can be created quickly. As long as Typus vaulters are willing to create a strategy, and determine reasonable oracle pricing sources of an underlying asset, a new vault can be immediately seen and participated in by many DeFi players.