dVIX Proposal
Summary
The decentralized volatility index (dVIX) is analogous to the CBOE VIX index, a popular TradFi measure for measuring investor sentiment. This is often referred to as the “fear index”, or a speculative forecast of the next month’s volatility. This index methodology is proposed by @ampodgorski and @george.
Motivation
The dVIX measures the market’s expectation of 7-day BTC /ETH volatility implicit in the prices of near-term options. dVIX will provide an avenue for traders to trade volatility without needing to consider other factors usually involved in options pricing. As a tool it will provide the option to hedge, speculate, and diversify. It goes up with volatility movement: a sudden upward or downward trend will result in an increase in the dVIX measure. Currently, the CVI and Deribit’s bitVol and ethVol use centralised exchanges as the data to build their volatility measure. With Hegic and Opyn, this can be done in a fully decentralised manner.
The value propositions can be summarised as :
- Portfolio Hedging
- Strategic allocation if its to be used as a form of diversification
- Long/Short Volatility
- The possibility of volatility arbitrage opportunities
A simple example would be the case where ETH is stable at $1800 after a recent drop from $2100, a trader can take a hedge on his long position by buying the dVIX which will be relatively low from the low volatility associated with sideways price movement. If the price suddenly spikes back up to $2000, they have made money on both their long position and their position in the dVIX. Conversely, the trader will be protected if the ETH price dips further to $1600, as the dVIX will cover some multitude of this loss.
New use cases include the potential to hedge impermanent loss for liquidity providers.
Methodology
Pricing function
The CBOE VIX price reverse engineers the Black-Scholes model with the prices / premiums of options contracts to calculate the “implied” volatility of the market. As volatility is not measurable, even realized volatility is an abstraction. However, implied volatility is a useful measure of investor sentiment as the prices of derivatives in the form of options are often determined by speculative tension between well-informed quantitative strategies. This implied volatility can be obtained by reading the option premium data from a protocol such as Hegic.co. For more detail please see the attached whitepaper.
Calculation Frequency
The calculation will be performed daily.
Data Source and Handling
The data will be sourced from decentralised platforms such as Hegic.
Data Filters
Pricing manipulation prevention will be performed by verifying against other decentralised protocols, and centralised protocols. This will require maintenance and oversight from the methodologist.
Possible Constraints
Main concern is the sparsity of options on Hegic and Opyn. The immaturity of these assets possibly affects the index methodology in that the calculated volatility is very sensitive to new contracts.
Although these platforms are still relatively new the desire here is to grow with these platforms as more decentralised options and maturities are created.
Liquidity Mining
This is a peer-to-contract transaction, and the dVIX therefore requires liquidity to fulfil transactions. Liquidity providers are incentivized by the minting of new dVIX tokens that are backed by transaction fees, but minting occurs with an exponential decay with time to prevent over selling.
Dynamic transaction fees
Moreover, transaction fees are dynamic to allow for minting: similar to Balancer V2, the transaction fee is proportional to the dVIX. Selling when the volatility is high will result in a larger transaction fee to disincentivize over selling. These fees will be shared between the Index Coop, the liquidity pool, and the methodologist.
Entry points
The dVIX itself will be an ERC20 token.
Size of Opportunity
The current crypto market capitalisation of BTC, ETH is approximately 1.3 trillion. With a bigger drive from institutions into the products there will be a greater demand to reduce overall portfolio risk. Given the multiple use cases and incentives of the dVIX, 100MUSD TVL in 6 months is a conservative estimate. There is also the potential of collaborations with platforms such as Hegic and Opyn to use the index methodology to create options around it which could generate more revenue for Index.
Differentiation
The dVIX’s differentiating aspect is that there is not another of its kind at the moment, it is unique from the CBOE VIX in that it can incentivise liquidity providers with liquidity mining, and taking advantage of crypto currency options prices as the asset class approaches maturity. Without sufficient liquidity, it is very difficult to replicate once the first mover has market share.
Author Background
Adam Podgorski and George Lazarides are new Index Coop contributors and founders of 3Sigma Capital LLC. Adam is from a background in nanomaterials for renewable energy and quantitative finance, trying to make a better place one disruptive industry at a time. George is a Chartered Accountant and shares the same vision in trying to change the status quo. We both sit as asset managers at 3Sigma capital with decentralised and centralised portfolios and also getting involved with the treasury and investment committee teams of Index Coop.
Whitepaper can be found in this repo:
Simply amazing.
and I really like the sound of this index product. I think the use cases, target market (huge), and benefits to the Index Coop are logical and compelling. I also think first mover advantage and liquidity are vitally important here. And, the branding advantages of the Coop owning THE Vix product in DeFi are significant.
