Lyra Finance’s revolutionary automated market maker (AMM) technology makes it the most popular DeFi options protocol in Web3.
In June of 2023, Lyra Finance is currently the most popular DeFi options protocol in existence. In this article, I’ll pull from my 15 years of experience in the options markets to show you how this revolutionary options trading platform matches up liquidity providers with option traders.
🍒 tasty takeaways
Lyra Finance is the most popular decentralized finance (DeFi) options protocol in August of 2023.
Lyra is a DeFi protocol that uses automated market maker (AMM) technology to provide liquidity for decentralized options contracts.
Lyra consists of the Lyra Protocol, the Lyra Interface, and Lyra Governance.
Lyra adapts a variation of the AMM model for options trading.
Users can connect their self-custody crypto wallets to the Lyra protocol to trade options and become liquidity providers, earning fees from trading activity.
Lyra Finance Summary
|Lyra Finance||DeFi options protocol leveraging AMM technology. Comprises Lyra Protocol, Interface, and Governance.|
|Automated Market Makers||Users provide liquidity in decentralized exchange pools earning fees from trading activities.|
|How Lyra Works||Connects to self-custody crypto wallets, allowing trade on options after bridging to supported Layer 2 blockchains.|
|Lyra MMVs||MMVs hedge their delta exposure using Arbitrum or Optimism, offsetting risks in options trading.|
|Liquidity Providers||Anyone can deposit cryptocurrencies to earn a percentage of trading fees from MMVs.|
|Lyra Ecosystem||Polynomial, Toros, DeDeLand, Kwenta, Brahma, and dHedge leverage Lyra's technology.|
What is Lyra?
Lyra can be broken down into three segments:
The Lyra Protocol
The Lyra Interface
In this article, we are going to focus on the Lyra interface, which of course includes the Lyra protocol.
Note: Lyra is currently not available to US citizens, but this will hopefully change soon.
🏃 Let’s go!
What Are Automated Market Makers (AMMs)?
AMMs like Uniswap are the backbone of DeFi. Users that wish to buy or sell crypto in DeFi connect to a decentralized exchange (DEX) and tap into whatever liquidity pool they are trading.
For example, if you want to buy ETH and sell USDC, you would access the ETH/USDC pool, which is stored on a smart contract.
So who provides the crypto in these pools that you are trading from? Anyone. You could be a ‘liquidity provider’. All you have to do is deposit an equal value of two cryptocurrencies into a liquidity pool. As traders trade from this pool, you earn fees!
📚 Read: Liquidity Pools for Beginners
The AMM model is in contrast to TradFi, which employs order books and market makers (Citadel, Virtu) to provide liquidity.
Lyra: An AMM for Options
Lyra takes the Uniswap AMM model and tweaks it for options trading.
However, making markets in options is much more complicated than making markets in spot crypto, like Uniswap.
This is because options are derivatives: their prices are contingent upon a separate underlying asset.
Because of this, options are incredibly sensitive to many things. In options trading, these sensitivities are divided into the four ‘Greeks’.
Delta: How much crypto do the options represent at any given time?
Theta: How fast does the option decay over time?
Gamma: At what rate does the Delta change?
Vega: How sensitive is the option to changes in the underlying volatility?
Lyra is one of the first DeFi protocols to price options almost as well as traditional market makers – who have much more versatility. They’re not there yet, but they’re getting closer with every upgrade.
How Does Lyra Work?
To trade options on Lyra, you will need to first connect your self-custody crypto wallet to the protocol.
📕 Read: Arbitrum vs Optimism vs Polygon
Lyra: Selecting a Strike Price
After you are connected to the Lyra interface you can choose to trade either call options or put options.
📈 Need a refresher course on options? Check tastylive’s out here!
After you have chosen an option to buy (or sell), you need to select the way in which you will be paying/ putting up collateral for that option. Lyra currently accepts two stablecoins:
Note: Lyra allows options traders to sell (go short) options on a partly collateralized basis.
Lyra Market Making Vaults (MMVs)
So you have placed your trade. The less inquisitive mind may be content to leave it at that. But in DeFi, ignorance is NOT bliss, so let’s see what happens under the hood at Lyra.
Options trading is a risky business. Whenever you buy an option, a party is on the other side selling you that option. Being short call options is not a very pleasant experience as the loss is unlimited.
The process of offsetting this risk in options trading is called ‘delta hedging’. If you are buying an option with 90 delta, the market maker needs to offset that risk by selling 90 delta.
According to the Lyra website, this protocol’s MMVs hedge their delta exposure in two different ways depending on the Layer 2 being used:
Optimism: Creating a spot synth position on Synthetix
But where do the funds come from to buy and sell these synths and perpetual?
From liquidity providers.
Let’s learn about ‘LPs’ at Lyra next.
Note: In order to hedge an option, you have to price an option. Lyra uses the Black-Scholes model to price options. On this page, Lyra goes into more detail about how they price their options.
Lyra Liquidity Providers
Anyone can be a liquidity provider on Lyra. As users trade from the MMVs, you earn a percentage of their trading fees.
In order to be an LP at Lyra, you must first deposit one of two different cryptocurrencies.
Once your crypto is in an MMV, it can be redeemed at any time (following a short waiting period).
Providing liquidity for Lyra does come with risks:
Lyra has measures in place to protect LPs against two major risks:
Delta Risk (changes in the underlying)
Vega Risk (implied volatility changes)
To learn how Lyra mitigates these risks, check out this video from Greg at AD Derivatives.
Many different DeFi options protocols leverage Lyra’s technology.
Polynomial: Options vaults
Toros: Options vaults
DeDeLand: Options and perpetual trading
Kwenta: Options and perpetual trading
Brahma: Uses Lyra for leverage and hedging risk
dHedge: Digital asset management platform integrated with Lyra
‘LYRA’ is the native governance token of the LYRA network. In June of 2023, LYRA has a market cap of $30m and a TVL (total value locked) of $46m
Lyra has proven to be a safe and user-friendly platform to trade the decentralized options market. However, currently, both liquidity and trading volume have fallen from their peaks.
Lyra runs on Arbitrum and Optimism, which are Layer 2s to the Ethereum mainnet.
Yes, Lyra Finance is an open-source DeFi project.