As we approach $1b in notional volume traded, it’s time to take another step forward in the evolution of The Lyra Protocol. This blog will share the implications of the Newport upgrade, covering how we’ve extended the protocols capability to integrate with any perpetual exchange on any EVM compatible chain to provide lower fees for traders and better capital efficiency for LPs.
TLDR: Lyra Newport removes the need for the Lyra AMM to swap to spot assets, collateralizing with cash and hedging with perps instead. This has some substantial benefits, including:
✅Improved capital efficiency for the AMM
✅Tighter bid-ask spreads and an improved trading experience
✅New opportunities with increased system modularity
To view the governance proposals voted in by the community to progress with this upgrade, click here.
The Lyra Protocol is an options automated market maker that serves as the backbone for a composable, programmable and efficient options. In Lyra v1 and the Avalon upgrade, liquidity providers would deposit sUSD to ‘Market Maker Vaults’ (MMVs) on Optimism. The MMVs algorithmically price options using a modified Black Scholes formula (more here), creating always-on, two-way options markets. Traders can buy and sell options and LPs are rewarded with the fees (see historic performance here). Lyra was the first options AMM to allow the sale of covered calls and cash secured puts back to the pool, however some tradeoffs accompanied this innovation.
The current mechanism manages collateral in the following way:
- Trader buys a call option contract on ETH
- The MMV automatically goes to a spot exchange and purchases 1 ETH to lock as collateral to ensure the position remains solvent and can be paid out.
- Once the trader’s position is closed or expires, the ETH collateral is then sold back to the spot exchange as the position is settled.
- As traders buy and sell options, the MMV locks collateral against these positions and becomes exposed to price fluctuations in ETH, or movements in Delta. To hedge, the MMV periodically goes to the spot exchange to long or short ETH to remain delta neutral.
This means that the Market Maker Vaults pay swapping fees for every collateralization and hedging trade. These fees are passed on to liquidity providers in Lyra MMVs, lowering overall yield and increasing the spread on Lyra’s option boards. This has served us well but it's an expensive, capital inefficient process that can be improved.
Lyra Newport Primer
The Lyra Newport upgrade allows the MMVs to partially collateralize short positions with cash, removing the need to swap to the base asset to collateralize and hedge. It also introduces the use of perpetuals as the collateralization and delta hedging instrument. As the MMVs shift to holding a significant portion of cash against the options a number of benefits may arise including:
- Improved capital efficiency for the AMM
- Lower spreads and an improved trading experience
- New opportunities with increased system modularity
Improved capital efficiency
Newport aims to substantially reduce the fees paid by LPs and increase the amount of options the pool can sell with the same amount of liquidity.In the last 6 months, ETH LPs have paid ~$800k in fees to Synthetix (~9% of the current pool value). With the Newport upgrade, this should be reduced with cost savings passed onto LPs in the form of higher yield for the same amount of trading volume. In addition, each option sold by the AMM will now be partially collateralized (with 70-90% cash) meaning that traders can access more liquidity from the same amount of deposits in the MMVs.
Cash collateralization also reduces the MMVs exposure to the underlying asset movements meaning the size of the delta hedging trade can be drastically reduced.
Looking at the delta exposure over time on the ETH pool, it’s pretty clear that this change is generally a 10-20x improvement on the amount of fees paid. The ETH market's largest absolute delta position was on the 12th of September, with:
- Long call collateral exposure = 1422
- Net option delta = 500
- Meaning a short of 1922 needed to be opened to hedge this delta exposure
In this worst case (historically, for ETH), needing to hedge only 500 deltas compared to a total of 3300 is at least a ~6.6x improvement on the amount of fees paid by LPs. For the BTC market this improvement at worst is still ~2.2x on swap fees paid, on average still ~10x.
Improved trading experience
Additionally, as the AMM will now be partially collateralized with cash, the SpotPriceFee parameter may be reduced as it no longer needs to account for a whole unit of the underlying asset. As a result, this portion of the option fee structure may be reduced resulting in tighter, more competitive spreads on Lyra.
Lastly, collateralizing with cash allows the protocol to become even more modular, gaining the ability to integrate with any perpetual exchange on any EVM compatible chain for collateralization and delta hedging. By running instances of the protocol on multiple L2s, the resiliency of the protocol to an individual shock to one of them increases. Further, Lyra gains access to an array of new users, integrations and collaborations as it expands into new ecosystems.
We’re excited for our first multichain expansion to Arbitrum, integrating with GMX perpetuals, collateralized in USDC…stay tuned 👀
The introduction of partial cash collateralization for options means that the pool is open to insolvencies when the netOptionValue exceeds the totalAssetValue of the LP. In case of an unexpectedly large and/or sharp market movement, long options holder payouts will be scaled down by a certain percentage, reducing their gains. Note, this is an extremely unlikely scenario given large cash buffers and constant delta hedging. Read more about this risk here.
We’ve also partnered with Sherlock to provide ~$5m in TVL insurance coverage and a $500,000 bug bounty for the new mechanism and smart contracts.
Lyra is a protocol for options liquidity built on Ethereum. Lyra allows users to buy and sell options that are priced with the first market-based, skew-adjusted pricing model.
Stay tuned for more important updates, key date announcements, and exciting opportunities by following us on Twitter.
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