All you need to know about Deri Protocol (DERI)

Introduction

The decentralized derivatives market enjoys huge potential for development. Since the launch of the Deri Protocol, it has introduced several innovative perpetual derivatives to implement the cutting-edge concept into real-world products, aiming to create professional derivatives trading tools. Originally launched on BSC and later on Arbitrum, Deri Protocol has recently been deployed on the ZKSync Era mainnet, gradually expanding its business to major ecosystems.

In this article, we will delve deep into Deri’s core product, everlasting options, and the pricing mechanism and funding fee behind it. We will also share some trading skills and discuss its tokenomics, development, and future plan.

What is Deri Protocol?

Deri Protocol was initially a decentralized derivatives exchange launched on BSC and Arbitrum. It is recently deployed on the zkSync Era mainnet and introduced various new derivatives products, including perpetual futures, everlasting options, and power perpetuals, with the core of maintaining positions by continuously paying funding fees. Additionally, it recently launched a new derivative product, Gamma Swap, which is in the beta testing stage.

The first product that Deri launched was perpetual futures, led by Binance Labs. It later introduced the pioneering everlasting options, which brought cutting-edge concepts to real-world scenarios. It also introduced the innovative DPMM algorithm for pricing, which applied the proactive market making algorithm in spot trading to options trading.

In Deri Protocol, all perpetual derivatives share one funding pool, and the trading market comprises longs, shorts, and liquidity providers (LPs). Currently, the platform only supports two underlying assets, BTC and ETH. Its trading interface is similar to that of a centralized exchange (CEX), and it is committed to providing a professional trading tool. The mechanism of perpetual futures is similar to that of the general futures trading market, where the funding pool plays the role of the counterparty and LPs share the net position risk. Traders use the pool to open and close positions. Trades are executed based on real-time oracle prices, and the funding fee is used to balance naked positions. The power perpetuals essentially use the mechanism of perpetual futures, but track the square of the underlying asset price, with the index price becoming the square of the real-time price of BTC and ETH.

Everlasting options are the highlight of the protocol and the product that the team has paid much attention to. This concept was originally proposed in a paper by Paradigm. Currently, there are very few products on the market that implement it practically, and users need to equip themselves with basic financial knowledge. Therefore, in this article, we will focus on Deri Protocol’s everlasting options.

Dive deeper into the basics of options in this Gate Learn article: What is an option?

Everlasting Options

Everlasting options were first proposed in May 2021 in a Paradigm paper, which allows users to hold option positions for a long period of time without the need to roll positions on expiry or pay the rolling fee. Like perpetual futures, everlasting options also require a fee, but there are two main differences:

1. The payment of the funding fee in perpetual futures is determined by the naked positions in the market. When the strength of longs is greater than that of shorts, the longs pay the funding fee, otherwise, the shorts pay it. However, in everlasting options, the funding fee is fixed and longs need to pay the shorts a fee to maintain their positions.
2. The perpetual futures are pegged to the price of the underlying asset, and the funding fee is calculated as mark price - index price, where the index price is the real-time price of the underlying asset obtained by the oracle. In everlasting options, the funding fee equals the mark price minus the payoff, where the payoff represents the intrinsic value of the option, i.e. the economic value that can be obtained by exercising the option immediately.

The paper also discusses the pricing of everlasting options, which does not rely on the Black-Scholes model used in traditional options. Instead, it builds portfolios of numerous rolling European options to get the general pricing formula for perpetual derivatives.

Since its proposal by Paradigm, everlasting options are still in the research stage. The elimination of the concept of expiration date can help solve the problem of fragmented liquidity in on-chain options markets.

Deri Protocol is the first project to actually launch an everlasting options product. To trade it on Deri, users need first to deposit a margin and pay to purchase an option to take a long position. LPs add liquidity to the pool and act as counterparties. Longs maintain their everlasting option positions by paying funding fees and can sell their everlasting options at any time. The protocol’s most unique feature is the pricing of everlasting options, which combines the Black-Scholes model with the proactive market making algorithm to create the DPMM paradigm, allowing more accurate option pricing based on pool liquidity and net option positions.

DPMM Pricing Mechanism

The pricing of everlasting options in the Deri Protocol is conducted in the following way:

First, the protocol obtains two inputs - the underlying price and volatility - from the oracle, and then puts them into the Black-Scholes model to obtain the price corresponding to the traditional call or put options. Second, apply this parameter to the integral pricing formula of general perpetual derivatives to obtain the theoretical price of everlasting options. Finally, adjust the theoretical price based on DPMM.

The theoretical price is used as the final trading price after being adjusted by DPMM. DPMM essentially applies the PMM algorithm of the DODO protocol to options. Compared with Uniswap’s constant product algorithm (x*y=k), the biggest advantage of DPMM is that it can actively aggregate liquidity towards the current price and achieve a relatively smooth price curve, thereby providing higher capital utilization and lower slippage. The PMM pricing formula consists of the following parameters:

In the DPMM mechanism, when the risk parameter k is set, i refers to the theoretical price of the everlasting options, and B refers to the current net position of the liquidity pool, Q refers to the current liquidity of the pool. This converts the price curve in spot trading (variables are i, B, and Q) into the price curve of everlasting options derivative trading (variables are the theoretical price of the option, pool net position, and pool liquidity). It adjusts the actual trading price of everlasting options based on the current liquidity of the pool and net position, to concentrate liquidity near the market price to improve capital efficiency.

Initially, the theoretical price of everlasting options is the starting point of a balanced liquidity pool, where the net position is 0 and the trading price is the theoretical price. When there is a trade, the theoretical price will change constantly. Specifically, a buying trade pushes the price up while a selling pushes it down. The price change due to the trade is proportional to the trade size. The DPMM mechanism can be used to balance naked positions in the market and make pricing more accurate and reasonable when there are obvious long or short sentiments.

Funding Fee

In traditional finance, if an option holder wants to extend the period of his positions on expiry, he needs to close the existing positions and then purchase a new option with a later expiration date. The cash flow in this situation is the profit obtained from closing the position and the cost of purchasing the new option.

Therefore, the funding fee formula corresponds to the cash flow of these two aspects, which is essentially the cost that needs to be paid to maintain a fixed position.

The team sets the option period to 7 days, but the funding fee for everlasting options is calculated on a per-second basis. For long positions, the funding fee for 7 days is calculated as follows:

FundingFee for 7 day= Markprice - Payoff

The mark price is the current trading price of everlasting options calculated by DPMM pricing and the payoff is the profit obtained from exercising the option immediately. The funding fee per second = funding fee for 7 days / 604,800.

How to Trade Everlasting Options on Deri

To trade everlasting options, users need to connect their Metamask wallet first and deposit margins (BUSD for the BSC chain and USDC for Arbitrum) into their accounts. Click “Option” to start trading everlasting options. See below a step-by-step tutorial:

Step 1: Select products with different underlying assets, strike prices, and types. Taking the BTC call option with a strike price of 30,000 as an example (BTC-30000-C), the red and green candlesticks on the trading page represent the price changes of everlasting options, and the blue line chart represents the price changes of the underlying asset BTC. The numbers on the right axis show the price of everlasting options, and other parameters such as the product name and funding fee are displayed at the top of the page. For example, the real-time mark price of the everlasting option is 223.31, the daily funding is 31.9018, the transaction fee is 5% of the mark price at the moment, the volatility (VOL) is 63.66%, and the total net position is 0.1496 BTC.

Step 2: Choose if you want to buy or sell the option and enter the amount to set the position size. Once done, click “Buy / Long”. Below is an example of buying BTCUSDC-30000-C with 10 USD.

Source: https://deri.io/#/trade/options

Step 3: A confirmation window will appear, which shows that using 10 USD to buy this derivative can get a position of 0.004 BTC. The trade price of the option is 223.31 and the transaction fee is 0.0044 USDC. If all the information is correct, click “Buy / Long “ to confirm.

Source: https://deri.io/#/trade/options

Step 4: It should be noted that similar to perpetual futures, you need to ensure a certain amount of margin in your account, which can be found in the “Contract Info” section at the bottom of the trading page. As shown in the figure below, the initial margin ratio is 0.61%, the maintenance margin ratio is 0.3%, the Delta is 0.13, and the Gamma is 0.000075.

Source: https://deri.io/#/trade/options

Step 5: The trading page also provides a dashboard, which displays the user’s current position and trading history. Each position will show the entry price when the user purchases the product, and the mark price. The difference between the two is the user’s unrealized PnL.

In addition, the dashboard also displays the accrued funding fee (Accd Funding). The sum of unrealized PnL and the accrued funding fee is the total PnL of the account. Since the everlasting options cannot be exercised, everlasting option holders need to sell them to realize the profit. For sellers, as the funding fee continues to accrue, users need to buy the corresponding position to close the position before the profit can be withdrawn.

Tokenomics

The $DERI token has a total supply of 1 billion, of which 60% is mined through liquidity mining and 40% is allocated to the team, early investors, and the treasury. According to this original plan, the team and early investors would be allocated 360 million $DERI tokens, which will be unlocked linearly over two years. However, 100 million of these tokens were later transferred to the treasury, so the treasury actually received a total of 140 million tokens, while the team and early investors received 260 million tokens.

Currently, the mining rate of $DERI is 800,000 tokens per week. The team obtains 20% of the transaction fees, meaning that it will deposit 20% of the transaction fees into the DAO foundation to regularly buy $DERI from the secondary market and burn it. According to the team’s monthly report, over 2.1 million $DERI tokens have been transferred to the deadlock address since the launch of the burning mechanism in June 2022. (Source: Deri Protocol Monthly Report for March 2023 https://deri-protocol.medium.com/deri-protocol-monthly-report-for-march-2023-bf1070e91e0c)

Current Development and Future Plans

The Deri team enjoys excellent financial and technical backgrounds. The co-founders, 0xAlpha, and Richard, graduated from Peking University and received their Ph.D. in the United States, with rich experiences in quantitative trading of traditional financial derivatives.

Since rolled out in 2021, the everlasting options have been continuously updated and iterated, showing promising development progress and potential. However, users need to have professional skills to trade it, making the overall pool liquidity not as robust as many others, with a total value locked (TVL) of just over $2 million.

Inspired by the power perpetuals, the team has recently launched a new derivative protocol called Gamma Swap, which is currently operating as a beta version and is particularly suitable for volatile markets. The longs can obtain the positive Gamma value of the underlying asset, while shorts will continue to receive funding fees. In the future, the project team also plans to launch NFT derivatives.

Source: https://defillama.com/protocol/deri-protocol?denomination=USD

Recently, due to Arbitrum’s airdrop incentive, its ecosystem projects have attracted a lot of funds and new users. Deri Protocol has also benefited from it, with a total of 386,311 $ARB being awarded from the airdrop. Notably, the team plans to expand to multiple chains, including its recent deployment on the zkSync Era mainnet.

Conclusion

Deri Protocol has launched a variety of new perpetual derivatives, with everlasting options being a highlight. It is the first to propose the DPMM pricing mechanism, which introduces the proactive market making algorithm of spot trading into options, making the pricing more accurate.

Everlasting options alleviate the liquidity fragmentation problem, but it has a relatively higher threshold and is hence more suitable for professional traders. That is why the liquidity on the platform is not that sufficient.

Deri Protocol is currently planning to expand to multiple chains, illustrated by its deployment on BSC first, and then on Arbitrum and ZKSync. It aims to bring derivatives to more public chains in the future.