How does the Pods Protocol work?

Pods protocol enables an easy hedging experience for users as well as liquidity providers. Under the hood, it is a decentralized non-custodial options protocol that enables users to buy, sell, and provide liquidity using an Options AMM.

In this post, we’ll explore the basic functioning of the overall protocol. For more details, the documentation can be found here, and soon we will release the whitepaper.

DeFi users confront three major pain points today:

• Users hold portfolios of volatile assets and want to hedge their risk to reduce their exposure to volatility.
• Placing and managing options orders in decentralized order books can be costly and the current low liquidity may not justify the opportunity cost.
• Providing options tokens as liquidity in Uniswap may translate into severe impermanent loss since it can only update the price based on a limited amount of inputs, as we explain in this previously published blogpost. That also means that users may not find reasonable market prices for buying or selling options using general-purpose AMMs.

Protocol Overview

Our core components (Options Instrument and Options AMM) address these pain-points differently.

Currently users can participate:

• as sellers or buyers of either puts or calls in the Options Instrument and/or
• as liquidity providers in the Options AMM.
• create their own options series and equivalent AMM pools.

See below a diagram that shows how the functions connect between the core components of the Pods Protocol:

Pods Protocol Overview

Options Instrument

As a quick reminder, an option is a contract between two parties (in our case, between a user and the contract). The parties agree to do something in the future. if a certain condition is met. Learn more about DeFi Options here.

The Options Instrument component is where the general options contract rules are managed.

The Options Instrument can mint, unmint, exercise and withdraw puts (call options coming soon on the app) and outlines details like asset pair, strike price, expiration date for each option series. The implementation requires the options to be fully collateralized.

To increase capital efficiency on the collateral locked, the protocol allows users to lock aTokens as collateral and accrued interest in their positions across the options lifetime (this is what we call smart collateral). The options Pods protocol currently has are European and they have a physical settlement, leaving no exposure to liquidation systems.

The Options Protocol is responsible for handling the rules in which the collateral will be managed, exercised, and withdrawn. The trading and pricing facilities take place in the Options AMM.

• Options tokens are standard ERC20 tokens and can potentially be sold on another DEX or a P2P basis.
• Anyone can create new options series at any time by following our documentation.

Find below a diagram that shows the user flow of a European Put option from both the seller and buyer point of view:

Put Option user flow on the Options Instrument component

You can find details about the math and the code of the Options Instrument component in our documentation.

Options AMM‌

The Options AMM is a one-sided AMM built to facilitate bootstrapping an options market by using an Automated Market Maker approach.

The Options AMM has the following properties:

• Price discovery
  The AMM updates the premium price based on the current spot price of the underlying asset (leveraging ChainLink’s oracle), the time until expiration, the implied volatility (calculated based on supply and the demand for options tokens observed in the pool).
• Single-sided liquidity provision
  It is possible to add liquidity on one side of the pool. The pool will track the user’s initial exposure and, by the time the user removes liquidity, the withdrawal position should reflect the initial exposure within a new distribution of assets. The new position will be composed of a new asset distribution (stable coins and option tokens), impermanent gain or loss (depending on the pool’s return), and AMM fees generated during the liquidity period.
• Inventory imbalance and price changes
  If there is no inventory imbalance (meaning canceling trades that happened in the pool), price changes due to price calculations should not represent a loss for liquidity providers.
• Fair distribution on pool returns among liquidity providers
  Pool returns should be distributed correctly across time and proportion among liquidity providers.

General derivatives price formulations use one or more data from the market (like the spot price of the underlying asset) to calculate a derivative price. Our model’s price discovery mechanism uses external factors, combined with calculated properties (such as time to expiration and risk-free rate) and internal factors (such as the Implied volatility) to calculate the current premium according to Black Scholes. For more details on pricing check out the Pricing section in the documentation.

The use of an Options AMM unlocks a new level of simplicity when buying hedge. Allowing a user to be always at one click away to find liquidity and buying a hedge for its portfolio is a game-changer for the user experience.

If you’re interested in learning more about our implementation, you can find our documentation here. Stay tuned for upcoming updates. We are looking forward to hearing your suggestions, ideas, and feedback.

About Pods

Pods is a decentralized non-custodial options protocol. Users can create options and trade them through an Options AMM on the Ethereum Blockchain. Pods is the easiest way to hedge crypto in DeFi.

We invite you to take the first step in your new mission: start testing the app on app.pods.finance

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