Decentralized Futures and Options Markets

 

Instructor: Andreas Park

 

• Perpetual futures are a main finance innovation in crypto
• one of the biggest markets by notional volume
• unique challenges for decentralized markets:
  • How do we ensure delivery with pseudo-anonymity
  • \(\to\) Lyra liquidity pools
• options and AMM spot highly related: Panoptic

Content

Some Data

Perpetual Futures:
Centralized (Derebit/BitMEX/Binance) and Decentralized (Hyperliquid)

Forwards \(\to\) Futures: Definitions

• Futures returns scale roughly linearly with leverage until margin exhaustion.
• Both long and short must post initial margin.

Why trade with futures? Profit and Leverage Basics

• Purpose: collateral protects against default; losses paid daily via variation margin.
  • Initial margin: minimum deposit to open position (1–10 % typical).
  • Maintenance margin: lower threshold triggering liquidation when breached.
• Mark price:
  • Estimated “fair” value from a basket of spot exchanges.
  • Used for unrealized P&L and liquidation to avoid false triggers.
  • Mark-to-market: exchange continuously credits winners and debits losers.
• Differences crypto vs traditional futures:
  • Crypto markets trade 24/7, with exchanges combining broker + clearinghouse functions.
  • No external CCP; default risk absorbed by insurance fund.

Margin Basics for Futures

• Introduced by BitMEX (2016)
• No expiry:
  • position stays open as long as margin is sufficient.
  • \(\to\) no rollovers, continuous exposure.
• Spot anchoring (perp):
  • normally spot and futures price converge close to expiry
  • in crypto funding payments that are made every few hours (8) pull perp price toward index.

What is a Perpetual Future (="perp")?

• Index price
  • Average of spot prices across major exchanges.
  • Reference value for “fair” pricing.
• Mark price
  • Index plus smoothed short-term premium adjustment.
  • Used for liquidation and unrealized P&L to avoid volatility spikes.
• Traditional jargon: basis= the difference between the futures price and the spot (index) price. 

  • Positive basis (futures > spot) → market in contango.

  • Negative basis (futures < spot) → market in backwardation.

• Premium: Difference between perp and index prices.
  • Positive premium (Perp > Index): longs pay shorts.
  • Negative premium (Perp < Index): shorts pay longs.
• Premium in perpetuals is analogous to the ‘basis’ in standard futures, except that it’s continuously settled through funding rather than expiring and converging at maturity.

Key Terms: Index, Mark, and Premium/Basis 

Numerical Example: Funding and Margin Lifecycle

Isolated Margin

• Margin allocated per position.
• Liquidation limited to that position’s equity.
• Preferred for high leverage and short-term trades.

Cross Margin

• All positions share one margin pool.
• Profits on one leg offset losses elsewhere.
• Preferred by hedgers and market-makers.

• Exchanges apply “haircuts” or higher initial margin on volatile collateral.

Background: Margin Modes and Collateral Types

Decentralized Futures: Hyperliquid

Decentralized Options: Aevo/Lyra

• Spot (cash) markets: direct exchange of assets.
• Options: contracts for future trades — require assurance that the writer can deliver.
• In pseudonymous systems, collateral replaces credit.
• On-chain models pool collateral and price options algorithmically (AMMs).

From Cash Markets to On-Chain Options

• Liquidity providers deposit collateral into Market Maker Vaults (MMVs).
• MMVs back multiple strikes and maturities for one asset.
• AMM layer: dynamically quotes option premiums and adjusts implied volatility.
• Delta pool: hedges exposure by trading the underlying on external markets.
• LPs earn option premiums minus hedging costs; positions remain fully collateralized.
• Withdrawals allowed subject to vault risk limits and cooldown.

Aevo/Lyra Overview

• Traditional OCC (Options Clearing Corporation):
  • Acts as central counterparty; guarantees exercise and assignment.
  • Requires margin reflecting net portfolio risk (SPAN methodology).
  • Allows offsets across positions (e.g., spreads, covered calls).
• Aevo:
  • Smart contract replaces OCC; collateral locked on-chain.
  • 100 % collateralization — each option’s full exposure is backed in the vault.
  • Automated hedging substitutes for clearing-house margin monitoring.
• Result: Aevo provides certainty of settlement but with higher capital lock-up.

Margin and Collateralization (OCC Analogy)

Collateral and Margin Risk: Aevo vs OCC

• Aevo replicates clearinghouse collateralization through smart contracts.
• AMM + Delta Pool maintain solvency and automate hedging.
• LPs earn option premiums, carry Vega risk, but face minimal counterparty exposure.
• Main trade-off: safety and transparency vs. capital efficiency.

Summary

Decentralized Options: Panoptic

short put = short call + asset = covered call

-long call = - long put - asset = covered put

Panoptic's Overarching Idea

1. LP position payoff \(\Rightarrow\) short put option (locally)
2. Short LP position \(\Rightarrow\) long option (whether call or put depends on current price relative to range (last slide)
3. Fees Collected \(\Rightarrow\) options premium payment

\(\Rightarrow\) they become an options clearing house 

• Liquidity Providers (LPs) deposit tokens into Panoptic vaults.
  • Vaults place funds into Uniswap v3 as price-range liquidity.
  • LPs earn both swap fees and option premiums.
• Traders open synthetic option positions:
  • Panoptic constructs the corresponding Uniswap LP position on their behalf.
  • Traders post collateral (e.g., USDC or ETH) to ensure solvency.

How it works