Intro
OpenDelta is building the OpenDelta Perpetual Bond (OPB), a variable-rate on-chain bond designed for stable value accrual. This bond operates independently of traditional fiat banking systems, allowing users globally to hold and transact with it on an open network. OPB incorporates a built-in mechanism for yield generation that allows users to earn on their holdings.
OPB represents a structured product, a hedged trading position that OpenDelta manages. This position hedges against bitcoin volatility while simultaneously earning market-based yield. The end result is a dollar-denominated, yield-bearing token that offers stable value accrual. In this post we’ll go over exactly what this means by covering the product’s mechanics, operations, and risks.
OPB and USDO
OPB is built on top of a synthetic dollar called USDO. When OpenDelta hedges BTC with a delta-neutral strategy, it creates a position that is price-stable in dollar terms. This product is known as a synthetic dollar, which we call USDO.
USDO on its own offers synthetic exposure to USD-denominated value without the need for fiat rails. But because the method used to create USDO produces yield via the derivatives market funding rate, USDO can also be converted into OPB, which allows the holder to access this yield.
While USDO can be utilized on its own, OPB is a secondary token that incorporates the product’s yield. OPB can only be created using USDO– you can think of OPB as a “staked” version of USDO that allows USDO holders to access yield. But there are no staking requirements or lockups. Once a user converts USDO to OPB, they can move OPB on-chain, transact with it, utilize it in DeFi and much more without having to stake or lock their funds. OPB creates an extremely efficient way to bring this native yield on-chain, allowing users to automatically and programmatically earn yield just by holding the token.
OPB offers the best of both worlds– users’ initial capital is held stable and protected via the hedging mechanism, and they earn sustainable, market-driven yield from the basis trade.
The Product Lifecycle
When an OpenDelta customer deposits funds, they receive USDO, a synthetic dollar, with the option to convert it into OPB, a perpetual bond that accrues yield on top of the synthetic dollar. These tokens exist on-chain, which allows users to easily access and transfer them. But on the back end they are powered by OpenDelta’s strategies that bridge CeFi into DeFi in a trust-minimized way.
After the user deposits collateral, OpenDelta enters and operates a delta-neutral strategy like the basis trade (also called “cash-and-carry”), and the user receives USDO. In its most basic form, this trade is a crypto spot holding with a short futures product. If the user wants to receive yield, they can convert the USDO to OPB. OpenDelta manages the position and returns the position’s P&L as yield to the OPB holder. Later, we’ll go over later just how the P&L works in OpenDelta’s Structured Products.
Initially, OpenDelta will be exclusively using inverted perpetual products to keep the customer’s funds hedged. This delta-neutral strategy gives USDO and OPB protection against bitcoin volatility. However, the trade is not riskless and OpenDelta will have an insurance fund to bring hedged positions back to their invested capital amount in case extenuating circumstances lead to original capital loss.
OpenDelta’s Structured Products
OpenDelta’s variable rate perpetual bond is a structured product that offers a market-driven interest rate. The position consists of a bitcoin spot amount (the delta amount) that is used as margin for selling/shorting inverted perpetual swap contracts for the equivalent bitcoin delta amount. This opposite delta “hedge” gives a level of stability against bitcoin volatility. When the price of the bitcoin spot goes up, the price of the contract goes up around the same price. This means that the gain in one is about equal to the loss in the other.
This product holds a long position bitcoin spot, but is short the perpetual swap contract. The perpetual swap has no expiration and nothing enforcing a basis convergence. Instead, the perpetual swap has “funding periods” that incentivize aligning the perpetual swap price to the spot. Whenever the perpetual swap is above the underlying spot price, longs are considered on the wrong side of the market and are penalized during a funding period and shorts are rewarded (“positive funding”). And whenever it’s below the underlying, shorts are penalized and longs are rewarded (“negative funding”).
Our research into historical perpetual swap data from 2020 shows that the basis premium has a minor effect on the P&L for longer positions and that about 74.5% of the funding periods are positive and should generate income for our short perpetual positions.
As the business expands, OpenDelta will plan to structure other products with variations of these contracts to create different properties of risk and reward.
How Our Product Operates
At its core, USDO/OPB consists of two positions: one long and one short, both balanced in delta amount. This balance is critical for mitigating price risks while capturing the benefits of the basis (the difference between futures and spot prices) and funding rates.
The operation lifecycle of USDO/OPB is as follows:
- User deposits collateral.
Users deposit collateral, which is held in an off-exchange MPC wallet with an institutional-grade custodian. Users will have the option to deposit a number of different assets (BTC, SOL, USDT, etc), which will then be converted into BTC to enter the trade.
- OpenDelta enters the position.
Once the funds have been deposited into the MPC wallet, OpenDelta can utilize those funds to enter into a position on the exchange.
- OpenDelta mints USDO to the user.
Once OpenDelta enters the position, we mint USDO and send that to the user who deposited the funds.
- Users can optionally convert USDO to OPB.
Any user who holds USDO can convert USDO to OPB in order to access the yield-bearing element of the product.
- OPB holders earn continuous yield.
Users who hold OPB will earn yield whenever funding rates are positive. This yield is paid out automatically to all OPB holders via a Solana smart contract using the native interest-bearing token extension. This means that all OPB holders earn yield without having to stake or lock up their tokens.
- Users can redeem at any time.
When a user wants to redeem USDO or OPB for their collateral, they can initiate a withdrawal. To do so they must redeem the USDO or OPB with OpenDelta, which triggers the liquidation of the positions backing the products. Users then receive their principal and accumulated rewards, net of OpenDelta’s fees.
OpenDelta will use the insurance fund to pay out negative funding and to cover any losses that bring us below the principal amount. We will continue to optimize the execution and management of these strategies and positions in order to further increase the efficiency and P&L/yield of the offerings.
Risks
OpenDelta strives to make our products robust and safe. However, these products are inherently exposed to a range of risks. Our approach includes a robust risk management framework that actively monitors these factors, adjusting strategies as necessary to protect against capital loss.
Let’s go over what each risk is and our mitigation strategies.
Counterparty Risk
The Risk
In order to create and manage the positions backing USDO/OPB with sufficient liquidity, OpenDelta must use centralized exchanges. This opens up the risk that the exchanges where positions are hedged could become insolvent, get hacked, or go offline.
Our Mitigation
OpenDelta has multiple strategies to combat the risk posed by centralized exchanges. First and foremost, we limit our exposure to any single exchange by distributing our positions across multiple different venues.
OpenDelta also utilizes an innovative system of off-exchange settlement that allows us to access centralized exchange liquidity with minimal counterparty risk. When users deposit crypto, that collateral is held in an MPC wallet controlled by OpenDelta, the exchange, and a third party institutional-grade custodian. These funds never actually touch the exchange– instead, the exchange credits those funds for trading and we perform periodic settlement of PnL with the exchange. This means that even in the event of an exchange hack or default, the collateral funds are not at risk.
Finally, OpenDelta operates an insurance fund to guard against all types of losses.
Basis Risk
The Risk
The trading strategies behind USDO/OPB are subject to execution risk on the basis price. For example, if at entry we go long BTC at $100 and short the perpetual swap at $105 but at exit we buy the perpetual swap contract at $110 and sell the BTC at $100, we would sit at a 5% loss for the position. If we have not earned enough in funding payments by then, the position will face a loss.
Our Mitigation
We mitigate this risk through a dedicated trading strategy and operational procedures that allow us to enter and exit positions at the best prices possible. We will continue to improve how we execute over time, but in very challenging circumstances the insurance fund can be used to bring the position back up to its original value.
Extreme Illiquidity and Slippage
The Risk
In some cases, OpenDelta may need to enter or exit positions when the market has limited liquidity, causing slippage or poor pricing for the positions that results in a reduction in PnL.
Our Mitigation
OpenDelta will add timing buffers for redemptions that give us flexibility to enter and exit positions at the best possible prices. We will continue to optimize our execution over time, improving how and when we send orders to the market.
Funding Rate Loss
The Risk
The native yield of OPB is generated when the short inverted perpetual swap position is paid through funding. While we expect funding to be positive and yield generating most of the time (about 74.5% in our studied historical data), OpenDelta’s position may face a negative funding, which will reduce the P&L and yield.
Our Mitigation
OpenDelta operates an insurance fund designed to pay out when negative funding leads to losses beyond the principal. This means that users will earn yield during times of positive funding, and they won’t incur any losses during times of negative funding.
OpenDelta has conducted research based on historical funding rates to determine the optimal amount that should be held in the insurance fund relative to the total value of positions held. We will continue to update this ratio based on current market data and conditions.
The Insurance Fund
OpenDelta’s insurance fund is one of the core components of our system, covering unforeseen losses beyond the original invested amount and ensuring the stability of our structured products. This fund serves as a financial buffer, safeguarding OpenDelta and OPB holders from adverse market conditions and operational risks.
Our historical research based on data from the past four years shows that the perpetual swaps in our exchanges of interest have little sensitivity to basis risk but are susceptible to adverse funding periods. About 74.5% of the funding periods should generate income. With Monte Carlo simulations focused on an extended losing funding period, we’ve determined that 30% of TVL is a good upper boundary for the insurance fund. At 30%, it can withstand funding period losses for 1.3 years. The same study shows that 20% of TVL should provide ample stability.
The market environment will continue to evolve and with that, OpenDelta will continue to conduct this study and update our numbers and insurance fund amounts as needed based on TVL.
Looking Forward
After OpenDelta’s variable interest products, OpenDelta will plan to explore other structures that change the risk, reward, and efficiency. Regardless of how our product offerings expand over time, our goal will continue to be to provide a well-operated and well-managed set of structured products that are as safe and as robust as possible.
If you are interested in learning more, please see our documentation.