Derivatives are synthetic financial instruments whose value is based on a function of an underlying asset or group of assets. A derivative could be based on the value of a stock, commodity, digital asset, at the present time or in the future. Options are one of the most popular derivative instruments in the world, according to Stastista, 21.22 billion option contracts were traded worldwide in 2020, up from 9.42 billion in 2013.
In traditional finance, option traders rely on various intermediaries to accept orders to buy or sell contracts. Traders submit their orders to their respective clearing member firms, which then conduct the trade on the traders behalf. The clearinghouse stands in between the two clearing firms and assumes the legal counterparty risk for the trade. It executes all the activities involved in clearing and settling the transaction.
On the other hand, blockchain-powered DeFi allows for options which are trustless, non-custodial, composable and programmable. It connects buyers and sellers directly, leveling the playing field and making the “black box” behind the pricing, trading, and risk management models into a transparent peer-to-peer model, accessible to anyone.
Introducing V Option Smart Contract
V Option Contract provides an opportunity for the interested parties to buy or sell an underlying asset based on the determined agreement, e.g., pre-determined price. It allows users to create option tokens on the V Systems blockchain, and buyers holding these option tokens have the right to buy or sell some underlying asset at some point in the future. The options themselves are also tokens that can be freely traded.
Different from the traditional option market, everyone can buy or sell option tokens to join the option market at any time without any contractual relationship with an exchange. These option tokens can be used at the expiration date to trade at strike price, which is done through the V Option contract without the need for any third party.
When registering a V Option contract, it takes in base token, target token, option token and proof token as inputs. The option token owner has the right to decide whether to execute the option contract to get the target tokens from the pool, and the proof token represents the percentage of ownership in the pool.
When initializing an option trading arrangement, the market maker requires to register both option token and proof token contract for use in V option contract first, and ensure they are FULLY issued. Then, market makers can register a V Option contract by specifying the token ID of those 4 tokens. After that, tokens need to be deposited into the V Option contract and it is necessary to ensure that option tokens and proof tokens are FULLY deposited (i.e., token issue amount= token deposit amount). Finally, users can activate the contract to deliver it to the next phrase.
Since V option contract is prepared in the previous phase, the people who expect they can get the potential profit from selling option tokens can mint option tokens (and proof tokens) for selling purpose. Those option sellers can also unlock the option tokens freely to get back target tokens from the pool before the execute timestamp.
After the execution timestamp, option holders have the right to execute V Option contract (with base tokens and option tokens) to get target tokens if they consider that the contract execution can bring them profit. They can also decide to give up the right to execute, in which case they will only lose the fees paid for the option tokens.
After the execution deadline timestamp, proof token holders can collect their own crypto assets (base tokens/target tokens) from the pool according to their owned percentage of proof tokens.
As the interested parties predict that the relative price of vBTC/vETH (vBTC and vETH are bitcoin and ether that have been converted for use on the VSYS ecosystem) will drop after 3 months, they will mint the option token with vETH tokens (i.e., target tokens) for selling purpose and they become the option seller.
Option sellers can take the option token to the exchange (i.e., stable swap contract) or through some Over-The-Counter (OTC) service, so the people who expect the price of vETH will rise after 3 months will be interested to buy the option tokens. If option sellers want to get back some target tokens or there are some remaining option tokens in the pool, they can unlock option tokens to get back VETH tokens before the execute timestamp.
After the execution timestamp determined in V Option contract, the option buyers (holders) have the right to buy VETH tokens at the strike price with the same amount of their owned option tokens if the price of V ETH token is beneficial to them.
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