Whitepaper
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Dual Finance Whitepaper
Overview: Dual Finance’s flagship product Dual Investment Pools (DIPs) are the next advancement to crypto market’s standard implementation of Decentralized Option Vaults (DOVs) or more accurately referred to here as Structured Product Pools (SPPs). DIPs improve significantly upon SPPs by allowing further customized and controlled option yield strategies for token holders. Dual Finance is able to offer these products in a more competitive, capital-efficient, and risk neutral manner than any other SPP protocol via live streaming prices, rehypothecated collateral, and a novel staking offering. Armed with what will be known across Decentralized Finance as Rehypothecated Lending Pools (RLPs) and Staking Options (SOs), Dual Finance is positioned to leapfrog all existing SPPs and become a base layer incentivization protocol by leveraging the DUAL token built on Solana.
Dual Investment Pools (DIPs):
DIPs are effectively covered call (Upside) or put (Downside) positions designed to provide users with additional yield versus HODLing in choppy markets. From traditional finance and specifically foreign exchange, the product may be known as Dual Currency Deposits. While these products may be based on simple derivative structures, Dual Finance’s implementation of Upside DIPs and Downside DIPs have several significant advantages to older versions.
1. Streaming Prices Current SPPs are executed extremely sloppily leading to high slippage. The SPP admins currently conduct their individual auction processes weekly on Fridays, all selling 1-week options. Market makers are aware of the schedules, sizing, maturities, and strikes for each SPP prior to auction time. Therefore it is unavoidable that these order flows are front-run to a degree by selling volatility OTC or across screen markets ahead of auctions, resulting in worse pricing for users. Further, if you deposit capital into SPPs you may not receive any return until the first Friday following your deposit, when your stake is first at risk. Current SPPs are also gameable, whereby if you know a vault is at risk of losing money you might be able to withdraw funds early to avoid losses. Ironically, users pay fixed management fees for all of these poor practices.
Dual Finance instead streams prices for DIPs via a quoted APY % and equivalently its stablecoin premium. This immediate available liquidity is a crucial product improvement. Rather than all users pooling into single strikes, maturities, and prices that are sold all at once, DIPs offer a live executable price that can be sold at any time. Therefore, Dual Finance allows for rolling subscription periods via the streaming prices, rather than weekly auctions. Dual Finance may take principal risk positions on the DIPs and/or offload risk to partner market makers to earn a spread. The streaming nature of the DIP prices allows for better risk management for users, who can better time moves in the underlying asset and more easily trade delta neutral positions by knowing the exact price & time of execution. Users ultimately have far more flexibility and control of their yielding DIP positions versus SPPs.
2. Customizable Yield APYs quoted by SPPs are a rough estimate of their target yield, and the actual return can vary significantly based on moves in the underlying price during the auction period and by general demand for volatility in each underlying product. SPP auctions target yield purely by adjusting strike prices of 1-week options. The effect this has is to lower front end implied volatility and lower aggregate APYs over time. Additionally, concentrated risk on certain strikes reduces their relative demand and can cause increased pin risk.
Dual Finance allows users to spread out risk and the effective APY they gain over time and price by offering multiple maturities and strikes. DIPs are more functional for users because they have a menu of strike prices and maturities across tokens to target their desired APY and therefore risk tolerance.
3. Transparent Premiums Unlike SPPs who market themselves as a purely positive APY product, DIPs are completely transparent about the potential negative outcome because they are physically settled products. Users who subscribe to a DIP on Dual Finance are quoted the two outcomes prior to execution. For a user who subscribes to a SOL Upside pool, they receive either [premium] + [initial deposit] in stablecoin & SOL respectively, or just the [strike price] + [premium] in stablecoin; users may consider this the “Dual Investment” nature of the product. The simplicity of this mechanism is its advantage. Dual Finance emphasizes that any users should be fully aware of the risks present and while APY quotes will be provided, they are only intended to be useful to compare relative premiums across strikes, maturities, products and other protocols. Additionally, users get paid premium at the moment they subscribe, unlike SPPs. That immediate liquidity has significant value, as it is unencumbered and can be allocated to yield farm elsewhere immediately.
4. Straightforward Settlement DIPs are physically settled to avoid what is known as dDelta risk which is present in all cash settled SPPs. At expiry maker makers and users alike must hedge the fixing price if they want to keep their delta risk flat. This is sometimes difficult in practice, especially with lower liquidity underlying products which can be subject to high slippage and thus impair their initial option pricing. Physical settlement more easily expands the universe of assets that are eventually offered as it does not require an index or oracle price feed to settle, which can be manipulated against users. The decision of whether to exercise is solely with the buyer of the DIP. An expiry time of 8:00 UTC on Fridays has become the standard as Deribit, the main source of liquidity also expires then. Since DIPS are American style, physically settled options, there is a benefit of moving expiry time back to one more friendly to all time zones, all while further reducing pin risk of concentrating option expiry across strikes and time. Therefore, Dual Finance DIPs will expire at 12:00 UTC while being agnostic to the date. For comparison and simplicity’s sake, to start DIPs will also be Friday maturities, but that is subject to change by the DAO.
Tokenomics (DUAL): Dual Finance (DUAL) tokens are the governance token for the Dual Finance ecosystem and effectively serve as its DAO. DUAL holders can propose strike and maturity selection changes, or any other discretionary parameter, including adding new products. Indirectly, DUAL tokens represent long option exposure to the DIPs as Dual Finance may inventory risk, rather than hedging every DIP with market makers. Any revenues generated by the protocol as decided by the DUAL holders may be spent to burn DUAL. DUAL tokens will contain voting escrow rights whereby emissions of DUAL Staking Options can be directed based upon which products are voted for thus incentivizing further participation and APY. Ultimately, DUAL tokens allow for control of the Dual Finance treasury to be used to incentive all types of work on the project across technical development, code audits, bug bounties, administrative, legal compliance, business development, marketing, and liquidity provisioning.
DAO Constitution Dual Finance DAO will establish a DUAL Constitution. The DUAL Constitution will initialize parameters that are in the best interest of the treasury over the long term. The parameters will consider min/max limits on DIP and SO sizes, moneyness and maturity as well as bounds for incentivization mechanisms. The parameters set forth by the Constitution are intended to be immutable, but can be amended by unanimous votes with high quorum thresholds. Additionally, the DAO will enact a second less difficult threshold for passing business-as-usual proposals, to keep Dual Finance nimble and innovative. These actions will ensure the protocol is able to operate in perpetuity absent of early contributors. The goal is to create a DAO and treasury that is rug-pull proof and self-sustaining.
Rehypothecated Lending Pools (RLPs): In traditional finance, it’s common to allow for rehypothecated derivatives trading, whereby banks use client collateral, for their own purposes. While Dual Finance requires user deposits to be fully collateralized by the token for Upside DIPs or stablecoins for Downside DIPs, additional yield lending those assets is possible through Dual Finance via RLPs. Market makers who wish to participate in Dual Finance by purchasing DIP risk have demand to borrow tokens to hedge their delta, and will pay to borrow tokens from the RLPs.
Borrowing DIP tokens from RLPs will be uncollateralized, but the maximum market makers may borrow is capped by their long exposure to any DIP. Whitelisting any market maker to participate in RLPs and allowing them to borrow collateral from DIPs will be subject to DAO approval. Penalties will be charged if RLP borrows are not returned before option expiry. Further, in order to exercise any DIP, a market maker must first return in full any borrowed tokens to the RLP. DUAL tokens will backstop this process to purchase any required tokens to always return DIP funds in full. RLPs accomplish further capital efficiency for market makers, incentivizing them to provide tighter markets and give users an additional purely positive variable yield component on their DIPs.
Currently, there are teams working on implementing undercollateralized trading, but not necessarily rehypothecated trading. In the Solana Ecosystem, there are undercollateralized derivatives such as Mango Markets, Drift Protocol & Zeta Markets and more broadly uncollateralized lending/borrowing like Maple Finance & TrueFi. In the future, Dual Finance plans to partner with other protocols and exchanges to allow for cross-collateralization of DIPs, providing for further composability and capital efficiency for users and market makers alike.
Staking Options (SOs): Dual Finance is implementing a breakthrough liquidity incentive mechanism, Staking Options. As opposed to current yield farming and liquidity incentives, whereby users earn a share of the token rewards for free based on their share of a pool or other participation factors; SOs align incentives of users, liquidity providers, and the treasury by providing free upside optionality on DUAL. No more free tokens, but free options on tokens. SOs improve any protocol tokenomics that inflate away the value of the token and drain the treasury by forcing rewards to come with longer term right-way skin in the game. This novel SO concept has many advantages within Dual Finance and more broadly across all of Decentralized Finance.
1. General Staking Options (GSOs) Dual Finance offers two subcategories of SOs. First, General Staking Options (GSOs) are issued for users who lock up DUAL for fixed periods of time. As a reward, stakers receive free out-of-the-money (OTM) DUAL American call or put options. If the protocol token performs well and an Upside GSO is worth exercising at any point up to expiry, users will pay the exercise settlement amount in stablecoins to the treasury and in return receive DUAL at the strike price. The GSOs present value or premium can be modeled as an APY, opposite to DIPs which actually pay a premium modeled as an APY. This is a key distinction: instead of users only being compensated in stablecoins for selling optionality on their tokens, now you can stake to earn optionality on the protocol token. Dual Finance may implement Downside GSOs once the treasury is well capitalized to allow direct risk protection and greater confidence for DUAL holders.
2. Liquidity Staking Options(LSOs) Dual Finance’s second implementation of SOs is as liquidity incentives on individual DIPs, Liquidity Staking Options (LSOs). Users will receive free DUAL LSOs by having staked to a DIP. The LSOs will match the type of DIP, whether they are Upside or Downside. In the case of Downside LSOs, the treasury will buy back DUAL tokens thus boosting yield for users when the token performance is poor and allowing users to put back some of their risk. Downside LSOs will be subject to a DAO allocated balance of stablecoins and may be financed first through exercised Upside LSOs. If you assume any positive correlation between the protocol token and DIP eligible tokens, LSO will provide a natural hedge to the risk of being exercised.
For example, a user subscribes to a 1 month BTC 10% Upside DIP, depositing $1M notional of BTC (25 BTC @ $40,000) and receives a quoted ~33% APY or ~$25,000 premium payment. Additionally, the user receives based on a function of the voting escrow results in a % of the notional in DUAL 10% OTM Upside LSO. For simplicity, let’s assume that voting escrow determines that 25% of the BTC notional is awarded in DUAL LSOs. DUAL is trading $100 and is twice as volatile as BTC, so users are granted $250,000 of 1 month $110 strike DUAL calls. The present value in APY of those options is an additional ~27% APY or $20,000. Net the APY for participating in that BTC DIP would be ~60% without adding in RLP interest. Additionally, let’s consider the correlation of BTC & DUAL is 2. If BTC rallied 20% and were exercised, users would receive ($44,000*25 BTC + $25,0000 premium) = $1,125,000 just from the BTC DIP compared to the original $1M. However, they would have been better off just HODLing their BTC to make $1.2M = ($48,000*25). Although, users also now own DUAL calls and DUAL rallied 40% over the same month so that the value of exercising the LSO is $75,000 = ($140-$110)*$250,000/$100. Therefore on a net basis the position mark-to-market value is the same as if you had HODLed, $1.2M. Now assume, neither BTC or DUAL move during the month, the user would receive a $25,000 premium, hold 25 BTC and choose not to exercise the DUAL LSO, a total position worth $1,025,000 vs the original $1M in a market that didn’t move. There are other examples where BTC rallies through a strike, but DUAL does not (worst case scenario, same as any current SPP), and where DUAL rallies through a strike but BTC does not (best case scenario, unlimited DUAL upside). In all cases, the incentivized LSOs on DUAL, generate yield on inception and act as a natural hedge against the worst outcome for the DIP.
Token Liquidity A side beneficial effect of the SO concept is it naturally incentivizes protocol token liquidity. As a result of being issued long optionality on DUAL, the owners of these SOs are incentivized to gamma trade the options, thereby effectively market making for the DUAL token. If you participated directly in the GSO pool, or any DIP you would own options on DUAL. As DUAL rallies you’re naturally incentivized to hedge your long delta and sell DUAL into the market, likewise on any sell-off you’re naturally incentivized to buy your short DUAL delta back from the market. The positive gamma profile leads to natural market-making, bolstering liquidity and price stability for the DUAL token.
Base Layer Incentive Protocol The Staking Option innovation as first designed and implemented by Dual Finance naturally will become a standard for liquidity and participation incentivization across Decentralized Finance. Current and future protocols will no longer give away free tokens, but free token options. Further to that mission, Dual Finance plans to partner with any protocol looking to initiate or revamp their incentivization mechanism by hosting that token’s SOs. For providing the creation interface, infrastructure and strategy, Dual Finance will take a fee paid in the token SO. Therefore, the treasury will diversify its exposure across protocols and participate in the success of many different products and ecosystems. This management implementation enables Dual Finance to become the Web3 base layer incentivization protocol.
Future Vision The future scope of work for Dual Finance is broad and bold. Options as a financial innovation can be applied to replace any current incentivization or compensation mechanism with one that better aligns goals. Dual Finance believes Decentralized Finance provides the perfect experimental platform for new option-based ideas to proliferate and intends to be a driving force in their design, implementation and distribution. Throughout this engineering process, the Dual Finance DAO will guide and steward the DUAL token to be a requisite asset in any options-based incentive plan for new protocols.
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