AMA, 16th June 2021. Today Joel Jabalera, CEO of Stakely, presents a new chapter in our AMA series. We welcome Bonna Zhu and Lianne Li, founding Members of Divergence, that will be with us answering your questions about this excellent project.
—Joel: It’s very exciting for us to have you here, Bonna.
— Bonna: My pleasure!
—Joel: The AMA has just started. Bonna, maybe we can start with an intro about you and your project.
— Bonna: Sure, my name is Bonna, and I’m one of the founding members and investors of the Divergence protocol. I used to work for AscendEx and Huobi, mainly as a researcher, staking/DeFi product manager, and I was associated with business development. Early last year, when DeFi came into everyone’s view, I and a couple of close fellows became active yield farmers and liquidity providers across various protocols. Despite the lucrative yields that we’re seeing, we also found very high-risk exposures that any typical farmer & LP could potentially face. Unfortunately, there’s no effective tool for DeFi users to hedge these risks easily on-chain.
—Joel: Yes, it is true.
— Bonna: So, we came up with the idea of building something around this and started to focus on this volatility topic. And came up with Divergence, a platform for people to trade, hedge and profit from DeFi native volatility. To 1) serve DeFi users and protect their holding value; 2) to offer an additional source of yield — volatility premium, in addition to traditional lending, staking, yield farming rewards for LPs; 3) to offer an easy-to-use tool to speculate and profit from asset value changes. We have an ambitious goal, but also going step by step, our V1 product is a very easy-to-use, binary option platform. There are two articles, Introducing Divergence and How to trade crypto options on Divergence, that will give you a high-level introduction, as well as product specifications if you want to dig a little deeper.
—Joel: Great! It was an excellent intro, congrats for the project!
— Bonna: Thanks, Joel. Oh, here comes Lianne, another founding team member, and also the big brain behind the core modeling and product design.
—Joel: Hello, Lianne.
— Lianne Li: Hello, everyone. It's a pleasure to be here. I came from a background in commodities derivatives research & trading, and had worked at Huobi Research as well. And that’s where I get to know and work with Bonna.
—Joel: Good to know, thank you Lianne. Let’s start with the questions.
Q: Could you explain how Divergence differs from traditional liquidity pools?
Bonna: The fundamental difference is that Divergence pools facilitate the automatic market-making and peer-to-pool swaps of binary options tokens. Each pool can be considered a specific binary options market with its own underlying, expiration, strike price, collateral, and rollover mechanisms (per strike or per target volatility). Only one type of collateral is used per pool.
LPs are sellers of binary options tokens. For every collateral LP creates a pool with, a Spear and a Shield is minted and automatically funded. LPs get to set the open price for the pool. Afterwards, the Spear and Shield are traded via our specialized AMM mechanism, which is described in this Participate in volatility trading post.
Traders trade with the same pool using the same collateral. They can buy and sell Spear and Shield like they swap for a token with Uniswap.
Q: What are the main advantages that Divergence offers to LPs?
Bonna: I will handle this one I guess there are majorly two very unique and favorable features that we offer to LP. First, high capital efficiency basically derivative tokens (binary options) minting and liquidity seeding is an integrated process on Divergence, and does not involve over-collateralization, and an LP doesn’t need to actively manage his positions upon expiration in order to continue market making for a pool, the smart contract will auto-roll over his liquidity positions to a new expiry.
Second, composability binary option pools on Divergence can be created by LP using any fungible tokens, including those DeFi assets issued by a variety of protocols, you can actually utilize a yield bearing asset to fund pools and earn rewards on Divergence on top of what you already have access to on other venues.
Q: How many assets are required to provide liquidity on the Divergence platform?
Lianne: One type of fungible ERC-20 asset is used per pool on Divergence. There’s no minimum threshold for liquidity providers to create a pool, as long as they are willing to pay the gas fees.
Q: What differentiates Divergence of traditional binary options?
Lianne: Good question! Traditionally, binary options are heavily traded in OTC markets. There are a few regulated exchanges and brokerages that also facilitate binary options trading. These markets typically perform price quoting and trade matching on a centralized order book. The underlying can be anything — from stocks to commodities to FX.
Binary options prices are quoted by their implied volatility, and the business is done in a centralized fashion. So, generally there’s an expensive middleman somewhere.
On Divergence, the market-making and trading are conducted on-chain and facilitated by smart contracts. It is a fully decentralized market where anyone can participate in the real-time price discovery process.
There are no centralized authorities of any kind who determine the pricing of implied volatility for binary options. Implied volatility is not a direct input to our pricing mechanism. Instead, it is derived from the market price of Spear and Shield.
Q: Is there a possibility of impermanent loss when trading on Divergence?
Lianne: Unfortunately, yes. On Divergence, liquidity providers are sellers of binary options, and they are obligated to meet the claims from the sold options. Suppose the traders are net long Spear and the underlying price moves in their favor, each Spear can claim 1 collateral from LPs. Conversely, if the underlying price does not move in the favor of traders, LPs get to keep the collected premiums.
There are different ways to mitigate the impact of impermanent loss, including buying Spear or Shield to hedge LP position, or having an offsetting position in other DEXes or centralized exchanges.
Q: What makes Divergence different from other platforms like Aave or Compound?
Bonna: Aave, Compound are on-chain interest rate markets, whereas Divergence is positioned to be a risk management and volatility trading platform. Interest rate risks that users face from Aave or Compound can be easily managed and hedged on Divergence.
So, in some way, we fulfilled the missing piece of many current DeFi platforms — that is the ability to help users hedge risks, and can be good partners to existing DeFi protocols.
Q: Can I provide liquidity with non-fungible tokens in Divergence?
Lianne: Unfortunately, we do not support non-fungible tokens as collateral.
Q: Can I provide liquidity in Divergence using synthetic tokens?
Lianne: As long as they are fungible ERC-20 tokens, yes.
Q: I have seen that the platform has two native Spear/Shield tokens. Should I acquire them before trading, i.e. are they acquired by exchanging them for any other token or stablecoin?
Lianne: When trading Spear/Shield, you are swapping with the pool. You only need to deposit your collateral into the pool to buy Spear/Shield. Spear/Shield are virtual tokens that only exist in their specific pools. They are not transferable ERC-20, and therefore you would not be able to find them in your wallet. You can check your Spear/Shield position via our dashboard and proceed to sell them or claim your payoff after expiration, if any.
Q: Can you briefly explain what are the functions of Spear and Shield?
Bonna: Spears are gamified representations of binary call options, whereas Shields are representations of binary put options. In a nutshell, Spear buyers make bullish bets on the price or price volatility of a coin. Shield buyers do the opposite.
- Spear token holders will be eligible to claim 1 collateral at expiry if the settlement price of the underlying is HIGHER than the strike, or lands outside a price range.
- Shield token holders on the opposite, will be eligible to claim 1 collateral at expiry if the settlement price of the underlying is LOWER than the strike, or lands within a price range.
Q: Can I trade Spear and Shield on other platforms, such Uniswap?
Bonna: No, you can only trade Spear and Shield on Divergence DEX. Spear and Shield are not designed to be withdrawable ERC-20 tokens, instead, they are “virtual tokens”, you won’t see them show up on your Metamask once you purchase them.
Q: Will the price of Shield or Spear depend on the token used as collateral?
Bonna: The pool is settled in the token used as collateral. Let’s say the collateral for a pool is DAI, then Shield & Spear are priced in DAI. After the binary option pool is created and starts trading, the price of Shield/Spear are basically determined by the market, based on a bonding curve we built. The bonding curve is based upon the Uniswap Constant Product model, however, the price of binary call, and the price of binary put, will always add up to 1 collateral, and this is hard-coded in the pricing curve. This is the very typical feature of binary options.
Basically, whoever buys Spear or Shield will push the price of onside up and the other side down, in order to continuously maintain the equation.
Lianne: Yes, the collateral essentially is the payment token and does not affect the pricing of Spear/Shield directly per our bonding curve.
Q: What tools can users use to improve their predictions within the platform?
Lianne: There are various resources available on the theoretical pricing of conventional options. For binary options, they can be easily adapted. While pricing models are far from perfect, they would help you get a sense of how Spear/Shield are valued. You can work your way backwards to an “implied volatility” based on the real-time pricing of Spear/Shield. And then you can use that to help you find trades based on the relative pricing of the options “implied volatility”.
Of course, it would be beneficial to have a view on the underlying price of an asset. And there are many ways to do this — fundamental and technical analysis, quantitative analysis of price behaviors etc. The tools that already exist for trading futures and other derivatives will be helpful in this regard.
Q: I have read that you define your platform as agnostic and therefore can operate on any network, what networks do Divergence currently operate or build on?
Bonna: We’re going to deploy the product on Ethereum mainnet first, and some other EVM compatible platforms as next step, and when Ethereum L2 is fully functioning, we will also move from L1 to L2.
Q: Can you explain in what consists of the strike price?
Lianne: There are two types of binary options markets on Divergence. One type only has a single strike price. Spears get paid if the underlying settles at or above such a strike, and vice versa for Shields. This strike price is specified by the pool creating LP. If a strike price does not exist for the market you are looking into, you can create a pool with that particular strike price. Another type uses a price range as strike price. Spears get paid if the market settles outside of this price range, and vice versa for Shields.
Q: When I execute an operation in Divergence, does it have an expiration date? If so, do I have to renew it manually?
Bonna: Each binary option pool on Divergence has an expiration cycle, meaning that if a market reaches its expiration date, it will be renewed for the next expiration date after settlement.
Q: What is target volatility, and how can we use it in Divergence to get the most out of it?
Bonna: Target volatility is a percentage that the system uses to derive and update strike prices for a certain expiration date. And it has a “+”, or “-”, or “+/-” sign upfront. For example, there’s a +5% daily market for ETH-USD, if the price settles at $1900 today UTC 8, higher than its strike price $1800, tomorrow, the new strike price of this pool will be $1900 * (1+5%).
Q: In the future, Divergence may address other prediction markets, such as sports or casino games?
Bonna: Our binary product is capable of even supporting different off-chain prediction markets such as sports, games, provided a robust price feed can be sourced from trustworthy oracles. But they are not in our short-term roadmap, as the decentralized finance market itself is big enough.
Q: Do you currently have partnerships with other DeFi protocols?
Bonna: We are connected with a variety of major DeFi projects in the space, some of which are our investors, including Terra, DoDo, Curve, Lido etc etc. As a protocol with composability built in DNA, we will work with different DeFi protocols once we release the product, by offering:
- The opportunity to hedge relevant risks that they face when interacting on those DeFi protocols.
- The ability to directly utilize second or third layer assets issued on those DeFi protocols as collateral to make markets on Divergence and have access to volatility premiums, and other yields.
Q: Can a user schedule the exit of an operation before its expiration, or must he necessarily wait for its expiration?
Bonna: Selling a position before expiration is ALLOWED, users get to exit anytime that he deems appropriate. A user who bought a Spear at 0.4 USDC can sell his Spear back to the binary option pool if he saw the Spear appreciates to 0.8 USDC after 30 minutes. Flexibility matters!
Q: Divergence minimizes the risk and volatility of the assets traded on its platform?
Bonna: We offer users the opportunity to hedge the volatility of a variety of underlying and help reduce the risk exposures a typical DeFi user would face. So, the answer is YES.
Q: Is the volatility expiration date (daily, weekly or monthly) chosen by the user or Divergence?
Bonna: In the beginning, the system will have daily, weekly and monthly markets, and they all have their own corresponding expirations, which are:
- Daily: UTC 8 every day;
- Weekly: UTC 8 each Friday;
- Monthly: UTC 8 on the last Friday of each month.
Q: When a liquidity provider chooses to early withdraw from a liquidity pool, How long before the expiration date can you do it?**
Bonna: A liquidity provider gets to withdraw liquidity from a binary option pool anytime.
- If he wants to withdraw collateral right away, there’s an early withdrawal fee, which will then go back to the pool to share among the stayed LPs.
- If he doesn’t feel the rush, he can choose “expiry exit”, which is a function that will allow him to remain as an LP until the market (the current expiration) expires, and there’s no fee required.
— Joel: Great AMA Bonna! We end with all questions. Do you want to add more info to the community? We will support the project as investors.
— Bonna: Sure, whoever is interested, can subscribe to our Announcement Channel or stay tuned to our Twitter Divergence.
— Lianne: Yes, we are at our final yard for testnet launch, and please stay tuned for more info.
— Bonna: And we’re in the final yard before releasing the public testnet, stay tuned!
— Lianne: Yep, appreciate all the questions. For people who have not had a lot of exposures to options/prediction markets, we’ll work on sharing educational resources as much as we can, Please feel free to ask questions in our community groups.
— Joel: Perfect! You can to select the three winner questions?
— Lianne: It’s hard to pick. Let’s see: Is there a possibility of impermanent loss when trading on Divergence? I have read that you define your platform as agnostic and therefore can operate on any network, what networks do Divergence currently operate or build on? When a liquidity provider chooses to early withdraw from a liquidity pool, How long before the expiration date can you do it?
— Joel: Thanks, feel free to share info here when you want about the project.
And the winners of this AMA are... @DTK21, @Jremurci and @Kikocr!
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