This page outlines some features that all traders should know before making a trade on the Lyra Protocol.
Options that are shorted (sold) to the AMM by users need to be collateralized. In V1 of Lyra, all shorts needed to be fully collateralized which was very capital inefficient. For instance, selling 1 ETH call would require having 1 sETH available as collateral.
Avalon will allow users to partially collateralize their shorts, greatly improving capital efficiency. This would mean, selling 1 ETH call would require, say, 0.4 ETH - a substantial improvement over V1. Further, short calls will now be able to be collateralized in either the base (ETH, BTC, etc) or quote asset (USDC). Short puts will only be able to be collateralized with the quote asset.
Users will always have the option to fully collateralize their shorts (and so have no chance of being liquidated - see next section). If a user chooses to partially collateralize their short, they must deposit a minimum amount of collateral.
The minimum amount of collateral (in the base asset) for a short is computed by finding the premium of the same option with a time dependent shock volatility and a static percentage shock to the spot price. Specifically, the minimum amount of collateral required will be given by:
MinStaticCollateralis the absolute minimum amount of collateral required for any (partially collateralized) short. Here,
ShockVolis a large, time dependent static volatility while
SpotShockis a static percentage shock to the spot price.
Users must maintain at least the minimum amount of collateral or the will be liquidated by a liquidator. For more details on this, see the next section on Liquidations.
When a user's collateral falls below the minimum collateral (described in the previous section) they are eligible to be liquidated. This occurs via keepers, users who call the liquidation function on an underwater position.
When a user is liquidated, the user is forced to buy back their option in such a way that will (in expectancy) favour the AMM/LPs.
The user's remaining liquidity will then be penalized by a flat percentage, for more detail see Partial Collateralization Parameters. This slashed penalty will then be split between the liquidator, the AMM, and the security module.
The protocol enforces trading cutoffs to ensure that the mechanism remains accurate and performant. This has some important implications for traders:
- Traders will not be able to open positions with the AMM for options with <12 hours to expiry.
- Traders will not be able to open trades with the AMM for options with deltas outside the specified cutoff for a given asset. For example, if the delta cutoff range is set to 10-90, users will be unable to open positions in options with a delta less than 10 or greater than 90.
ForceClose will allow users to close their open positions at any time/delta
Partial cash collateralization for options means that the pool is open to insolvencies when the
totalAssetValueof the LP. In order to address this issue, values for long holders will be reduced by a certain percentage that makes the LP solvent again. This is calculated using the
AdjustmentNetValueScalingFactor, a parameter that caps the total value of the pool that is used to scale down longs. When an option is closed or settled, the option value will be scaled down by the percentage (
optionValueDebt) which makes the pool solvent again before funds are transferred to the user.
Overall, this scaling system is put in place to prevent insolvency in the pool by reducing payouts for long holders in the event that the value of the options exceeds the total value of the assets in the pool. It is important to note that this is an extremely unlikely scenario due to large cash buffers and constant delta hedging.