New Features: Interest Based Utilization Fee and Sell Feature
In our efforts to continuously make Premia the best on-chain option platform, we are implementing two new features: an interest-based Utilization Fee and the ability to Sell Options back to the Pool. Let’s walk through both of these features so you know what they’re all about.
Interest-Based Utilization Fee
Last week a core proposal passed with 100% support to replace the existing “Exercise Fee” on pool capital with a “Utilization Fee”.
So what does this mean?
Previously the Premia platform had a 3% Exercise Fee on the exercised value of an option, charged upon settlement for facilitating the service. The old 3% fee was only taken from the profit of the option. The first issue with this is that option buyers were already charged a protocol fee when purchasing an option, so this fee charged them a second time for the same transaction. The second issue is that no additional fees were collected if an option expired out of the money, no matter how long the capital was utilized.
This resulted in unbalanced fee incentives between traders, LPs, and the protocol. To rebalance the incentive structure, we are replacing the previous Exercise Fee with a new Utilization Fee. This previous 3% Exercise Fee is now replaced by a 2.5% annual interest-based Utilization Fee, determined by the amount of capital (notional value) and the length of time the position is held open, paid for with the collateral stored in the option.
This means that option buyers are only charged a single protocol fee when purchasing and exercising an option, and option LPs are only charged a single protocol fee when an option position is settled, based on the length of time the capital was utilized. This is a much more equitable system.
How does the Utilization Fee work?
The Utilization Fee is set as a 2.5% annualized interest rate on the collateral locked in an option (adjusted by the expiration date), reserved from the LP and paid as a protocol fee to $PREMIA stakers. If the option is settled prior to expiration (i.e. using the new Sell Feature), the Utilization Fee is adjusted for the final time period of the collateral’s utilization. Any difference is refunded to the LP.
This new fee will be charged upon settlement (exercise, sale or expiry) of positions. The factors that determine the amount of the total fee are:
- the amount of capital locked
- the period of time the capital was utilized
The formula can be represented as:
(notional value of option)*0.025= annualized Utilization Fee
or
(notional value of option)*(0.025 * seconds utilized / seconds per year) =Utilization Fee
Fear not, LPs! The pricing of options on the Premia protocol has a lower boundary set to a minimum of 30% APR, based on the notional value (not accounting for settlement losses) and the time to an option’s expiration. This means the Utilization Fee will be a small portion of the premium paid to the LP, i.e., the 2.5% fee for LPs will be small compared to the >30% premium they collect.
This also gives an incentive to LPs to lock up xPREMIA in the staking module to get fee discounts. Since xPREMIA holders collect 80% of the protocol fees, LPs staking their PREMIA will indirectly increase their yield by “collecting back” a portion of their fees.
LPs are incentivized to lock their Premia to potentially receive increased fee revenue from the fee discount, plus a portion of the revenue from protocol fees which are distributed to stakers. Once vePREMIA is implemented, LPs will be further incentivized to lock up their PREMIA, as locked vePREMIA will be able to vote to direct liquidity mining allocation points towards their preferred pools (i.e., pools with the highest expected utilization).
Where does the 2.5% fee go?
This change is the first of several upcoming $PREMIA tokenomics upgrades. Just like the old 3% Exercise Fee, the new 2.5% interest-based Utilization Fee will be distributed to $PREMIA stakers, to align the long term incentives of LPs with those of protocol supporters.
Protocol stakers receive the majority (currently 80%) of protocol fees.
The 2.5% interest-based Utilization Fee will ensure that long term supporters of the Premia protocol are rewarded for providing and incentivizing utilization of pool capital.
As we implement further tokenomics upgrades (such as vePREMIA), the Utilization Fee becomes more important: it ensures protocol stakers are highly incentivized to direct Liquidity Mining yields to the pools with the highest potential utilization returns. This will contribute to the long term profitability of the protocol (as long as the protocol is able to garner enough pool capital and utilization of that capital).
Example of the Utilization Fee in action
Let’s say that a 40-ETH put option with a strike price of 2,500 DAI is purchased for 10,000 DAI and held for 4 weeks. The price of ETH decreases to 2,400 DAI.
With the old 3% Exercise Fee:
The 3% fee was applied to the exercise value and paid by the buyer — 100 * 40 * 0.03 = 120 DAI.
With the new 2.5% interest-based Utilization Fee:
The new 2.5% fee is applied over time to the locked collateral and paid by the LP — 40 * 2,500 * 28 / 365 * 0.025 = 192 DAI.
Also note that with the Utilization Fee, the full APY fee is reserved up-front. If the option in the above example has a maturity of 2 months, then 100k * 0.025 * 2 / 12 is reserved, then partially refunded if the option is exercised early. An additional refund will be applied if the LP also has a fee discount at time of settlement.
The Sell Feature
The other new feature is the Sell Feature which enables LPs to earn additional (and more stable) returns by market-making within pools. This simultaneously enables option traders to sell their options back to market-makers within the pool, allowing traders to capture and monetize additional extrinsic value (theta) above an option’s exercisable intrinsic value when closing a position.
Market-makers are then able to immediately re-utilize their capital after closing the position below market price, earning a spread in the process.
The Sell Feature is the first of several steps towards increased capital efficiency and trader flexibility in the Premia platform.
The Sell Feature breaks new ground in market microstructure design; option traders will be able to sell their options back into the pool at any time to capture time value, in addition to the full intrinsic value of the option. Previously, for traders to sell their options prior to expiration to capture theta, they would need to find a willing counter-party to accept the trade on an NFT marketplace (since all Premia positions are represented as ERC-1155 NFTs).
Clearly this presents an issue for option holders, as buyers may not be searching NFT marketplaces to obtain open option positions.
The Sell Feature helps solve this liquidity issue by utilizing Premia’s unique peer-to-pool architecture and allows option purchasers to sell their options directly back into the pool at any time.
This will also allow for greater use of LP’s capital since their funds no longer need to be locked and committed to a single position for the same duration. This means LP’s could potentially collect premiums for several positions in the same amount of time they previously would have only collected fees for a single position.
This potential increase in fees paid to LP’s would be the result of ( a ) their capital is utilized for a position, ( b ) the option buyer closes that position, and ( c )their capital can then be utilized for a new position.
Additionally, the Sell Feature may allow LPs to exit the pool sooner if they wish, since the positions to which their capital is committed may be closed before expiration. Previously LPs would need to wait until exercise or expiration if their capital was being utilized by an option. Now those options may be closed earlier thus shortening the wait for LPs wishing to withdraw their capital.
Got questions about the new features?
Drop by our Discord server and chat with us, we’d be happy to answer your questions on the new features and what we’re building for new Premia releases.
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