The Risks and Returns of Premia Pools
Yields, IL, and everything you need to know
It’s been almost 3 weeks since we launched Premia v2 and the team thought it would be prudent to explain some key details about the Premia pools, what kind of yields to expect, and how impermanent loss works.
Premia Pools
Premia v2 launched with 6 pools:
- WETH Call Pool
- WETH Put Pool
- WBTC Call Pool
- WBTC Put Pool
- Link Call Pool
- Link Put Pool
The Call pools require LPs to deposit their native tokens: WETH, WBTC, and LINK. The Put pools require LPs to deposit DAI Stablecoin.
Yields
A large portion of the yield for providing liquidity to Premia options pools comes from underwritten option premiums. So you collect DAI, WETH, WBTC, or LINK depending on the pool you underwrite volatility risk for.
You collect DAI, WETH, WBTC, or LINK premiums from selling options, depending on the pool you underwrite volatility risk for.
LP yields are also supplemented with a small amount of $PREMIA token rewards, as per the Premia Liquidity Mining (LM) program. At the time of writing this, the emission rate is 0.5 $PREMIA per block, distributed evenly between the 6 pools (16.67% per pool).
Each emission stream is distributed pro-rata based on the ownership percent of the individual LPs within that pool (i.e. if a liquidity provider owns a 10% share of the WETH/DAI pool, they would receive 10% of that 16.67% reward emission, ~0.008335 PREMIA per block). However, this is just a portion of the yield for LPs in a pool, as they also receive yield from premiums, minus exercise payouts (PnL).
At the time of writing this, the estimated annualized yields for Premia pool LPs are currently:
- WETH Call Pool: 144.81% from PnL (+31.41% from LM) = ~176.22%
- WETH Put Pool: 25.8% from PnL (+65.49% from LM) = ~91.29%
- WBTC Call Pool: 113.53% from PnL (+51.87% from LM) = ~165.4%
- WBTC Put Pool: 47.94% from PnL (74.37% from LM) = ~122.31%
- LINK Call Pool: 52.83% from PnL (49.69% from LM) = ~102.52%
- LINK Put Pool: 3.4% from PnL (91.5% from LM) = ~94.9%
Keep in mind that these annualized yield percentages can fluctuate based on the realtime PnL of the pool and the price of underlying tokens.
The majority of yield in pools comes from the risk of underwriting options. This means that as pools grow and the yield from liquidity mining is distributed across larger amounts of liquidity, the majority of the yield that a Premia LP receives will be in the form of the token they deposited in the pool. LPs provide single-sided liquidity to pools to earn premiums in the token they’ve deposited, in exchange for taking on the volatility risk of options they sell.
This means you can currently earn an estimated 176.22% annualized yield on your WETH (paid mostly in WETH) by providing liquidity to the WETH Call pool and underwriting options.
The Premia pools operate in a First In — First Used order, so when an option gets purchased, whichever LP added liquidity first would receive their portion of the premium before the last person. Because of this, please be patient with your dashboard — if you see $0 in fees, it’s because your liquidity hasn’t been utilized to underwrite an option yet. This means your liquidity is likely close to the front of the queue.
Keep in mind there’s a 24-hour minimum to stay in the pool after providing liquidity. In addition, if your liquidity is currently being utilized for an option, you won’t be able to withdraw your liquidity until that option expires, or you Remove the option from your Underwritten Options by paying the current premium of that option back to the pool.
However, you can always state your intent to Gradually Divest withdraw so that your liquidity doesn’t get utilized for any new options.
So what’s all this about volatility risk? Let’s talk about IL.
Impermanent Loss
It’s a concept that is often thrown around in DeFi, but not everyone is familiar with what it actually means. There are different kinds of impermanent loss.
Traditional Impermanent Loss
You may be familiar with the concept of impermanent loss from providing liquidity on Uniswap or Sushiswap. But if you aren’t, here’s a quick primer on what it’s all about:
Impermanent loss refers to the amount of money a user loses by providing 2-sided liquidity to a traditional AMM versus just holding the 2 assets, without LPing.
Impermanent loss occurs when the assets in a liquidity pool diverge in price.
For example: If you are providing liquidity for WBTC/ETH and both go up exactly 3% in a day then you suffer no impermanent loss since the assets are moving the same amount. But if ETH were to go up 10%, while WBTC didn’t move, then you would suffer a loss compared to just holding the assets outside of a liquidity pool. That loss is determined by the AMM’s pricing algorithm.
You can play around with the impermanent loss calculator to get a feel for how it works. Impermanent loss is usually offset by fees earned in the pool and additional liquidity farming rewards offered by the protocol.
Now, what about Premia?
Premia Impermanent Loss
Premia offers single-sided liquidity pools, which means users are not exposed to the traditional form of IL, but this does not mean that Premia pools are free of risk. The risk profile is distinctly different and more similar to traditional option underwriting, as opposed to DeFi liquidity providing.
The following scenarios can often be offset by premiums, which are collected by LPs for taking the risk to underwrite options. Whenever a user purchases an option from the Premia AMM, they will pay a premium (the price of the option) in order to incentivize the LP to take on the underwrite risk.
Let’s break it down for a Call Pool:
Say you provide liquidity to the WBTC Call Pool in the form of 1 WBTC deposited, and your liquidity gets utilized for Calls expiring in December 2021 with a strike price of 60,000 DAI. You would receive a premium, in this case let’s say the premium was 0.15 WBTC (~$9,000). Then Bitcoin rips up 25% from here to $75,000 per coin in December and the call you sold is exercised.
This means you would effectively sell 1 Bitcoin at the strike price of $60,000 (paid in WBTC), despite the current price in December being $75,000, essentially taking on impermanent loss of $15,000 before account for premiums. For this complete transaction, your total IL would be (+$9,000 — $15,000 = -$6,000).
Calls on Premia are settled in the underlying, meaning you would not actually sell WBTC for DAI, rather, as an LP you would pay out the difference in WBTC as if you were sell WBTC at the strike price.
You can of course run this same example assuming Bitcoin stays below $60,000, in which case the LP would profit the entire premium of $9,000.
Looking at the Put Pool example:
Let’s say you provide 100,000 DAI to the WETH Put Pool and your entire liquidity gets used to underwrite a 40 WETH Put with a strike of 2,500 DAI, expiring in January 2022. Then ETH drops by 20% and at the time of expiration ETH is sitting at $2000… when the option gets executed, you would essentially purchase 40 WETH at $2500 despite the price being 20% lower. If this loss is higher than the premium, the difference is the remaining IL.
Puts on Premia are cash-settled, meaning you would not actually purchase WETH with DAI, rather, as an LP you would pay out the difference in DAI as if you were purchasing WETH at the strike price.
So how is this impermanent? Well the price could return to where the option executed, and funds in the pool can be exposed to further gain in the future. However, ultimately there is no way to eliminate the risks inherent to underwriting options, this is why the market is said to provide risk-based yield.
The Final Rundown TLDR
In case you just don’t have the time to read this article, here’s the high level points:
- With Premia you can provide single sided liquidity for WETH, WBTC, LINK, and DAI
- The majority of the yield you earn in those pools is in the token you deposited (WETH, WBTC, LINK, DAI), in addition to PREMIA LM rewards
- These yields come from the premium that an option buyer pays when an option is sold utilizing your pool liquidity
- Estimated yields are currently some of the best available in the DeFi market for these assets
- Premia pools operate in a First In — First Used order, so if you see $0 in fees in your dashboard, it’s because your liquidity hasn’t been utilized to underwrite an option yet. Your time is coming!
- Once you deposit in a pool, you must stay in for a minimum of 24 hours
- If your liquidity is currently being utilized for underwriting an option, you won’t be able to withdraw the liquidity being utilized until that option expires or you pay to remove the option from your underwritten options
- When providing liquidity to Premia pools, there is a risk that the option gets exercised in-the-money, resulting in either opportunity cost or unrealized, impermanent loss
That’s it. Hopefully now you have a better understanding of Premia liquidity pools and the risk/reward of providing single-sided liquidity with Premia.
If you have any questions, don’t hesitate to reach out in our Discord server.
