Radar - Pods
One of the largest opportunities for DeFi protocols to tap into is the derivative market. With over $4 billion now locked in DeFi, there is a growing need for market participants to manage risk exposures through various instruments, particularly through the use of options.
Centralised options products exist within the world of digital assets markets (e.g. Deribit, FTX, and LedgerX) but there is still room to innovate from a decentralised perspective by eliminating the requirement of intermediaries altogether. Fortunately, in the last few months alone, there has been a significant push in making decentralised options within DeFi a reality. The table below shows decentralised options platform that have already launched or are in testnet phase.
A recent decentralised non-custodial option platform to be announced is Pods. Pods allows users can buy and sell put/call options with 100% collateralisation of the strike assets. Pod options have physical settlement (as opposed to cash) without requiring the use of oracles or liquidation systems. This is because physical settlement assumes that all collateral locked in an options position will be exercised.
Pod options themselves are American formatted meaning that they can be exercised at any point up until the expiration (as opposed to European which limits execution to the expiration date). When a seller issues an option (by locking collateral), they mint Pods which is the primitive allowing users to hold and transfer option contracts within the wider market (e.g. Uniswap). This tokenisation model is fairly similar to what we see with other decentralised option platforms, such as Opyn’s oTokens.
A particular issue that has to be considered for option frameworks within DeFi is what the opportunity cost amounts to for a seller of a contract. With this in mind, one of the unique propositions of Pods options is the ability for put option sellers to lock interest bearing assets (e.g. aUSDC) as collateral. The benefit for the seller is the increase in capital efficiency - being able to both lend and sell put options at the same time. Pods, therefore, capitalises on DeFi composability through the use of money legos.
In theory, there are also potential benefits for the buyers of put options too. The buyers can be provided with a hedge at lower costs. The buyers of contracts involving Aave tokens are then naturally exposed to the utilisation rate of the respective Aave pool.
What’s even more interesting is the timing of Aave’s new token economics which introduces a brand new governance framework and set of incentive mechanisms. As part of this new proposal, 3 million (of the total 16 million) AAVE will be set aside in a reserve that will help reward participants that borrow and supply assets to the Aave protocol.
Although the exact numbers have yet to be voted on by the community, the distribution of AAVE tokens potentially creates further incentives for put option seller to issue contracts on the Pod platform. In other words, the bootstrapping initiatives of the Aave network might help bootstrap the Pod network in lockstep.
While disparate networks can benefit from each other’s networks through certain mutualistic interactions, such symbiotic relationships come with shared (protocol) risk. This leaves us with some important questions: What consequences would a critical smart contract exploit on Aave have on Pods? How will Aave’s new (and continually changing) token economics influence the incentive for Pod option sellers over time?
Critically, Pods has to avoid becoming too reliant on a single protocol’s incentive structure for its long-term success. One potential solution could be the use of various interest bearing asset types beyond just aTokens. It will certainly be exciting to see how the Pods as well as the wider decentralised options landscaped develops over the coming months.
Pods is live on testnet and is not audited yet.