DYMMAX liquidity pools and how do they function

To understand the mechanisms inside the DYMMAX protocol, we want to talk first about the classic mechanism for maintaining the option contract quotes on centralized exchanges. This will allow you to visually feel the difference in the proposed technology.

Standard quotation mechanism

Quotation in decentralized protocols

АММ in DYMMAX protocol

The whitepaper of the protocol describes in detail a model that allows you to create instruments whose behavior in a certain range is completely similar to the European Call and Put options. For clarity, let’s consider an option strategy that corresponds to a Call option and is called Bull Spread in the protocol.

Chart 1 — payment distribution by states for the Call option

As we can see from Chart 1, the largest payments are made in the upper states. Accordingly, the prices of options in the auction will depend on the distribution of payments by states, and the preponderance of orders for one contract will change prices throughout the auction.

Chart 2 — distribution of payments by states for 3 strategies in one auction.

Chart 2 clearly shows the distribution of payments for a balanced auction, in which there is an equal number of bids for all contracts.

To reduce the impact of the discrepancy in the number of orders, we decided to introduce liquidity providers, since the parimutuel betting with fixed odds model implies the presence of participants with certain payments. We can use this component to create liquidity pools. Let’s take a look at the simplest distribution for a demo pool.

Chart 3 — distribution of assets by states from the liquidity pool in the auction.

The fact that we do not know the final payments for the liquidity component, but we can estimate them at the moment, depending on the aggregate state of the auction, allows us to perform dynamic balancing using an automatic market maker implemented in the DYMMAX protocol.

Users familiar with options trading will, of course, notice the resemblance to the “Volatility skew”. In this case, we can argue that the further the state is from the current price, the lower the probability that the price will be at this point in the future. This allows us to raise the stakes on these conditions. At the same time, as we can see from Chart 2, these states account for the greatest weight from submitted bids, which ultimately allows us to change the price balance towards parity of Call and Put options with different strikes, thereby leveling the possibility of arbitrage within the same auction.

For each case, within the price band and at the extreme points, we can calculate the maximum possible values ​​of profit and loss, which allows us to calculate the maximum values ​​for the auction as a whole. Based on this data, the DYMMAX AMM protocol controls the risks and rewards for each liquidity pool, keeping risk minimization as a priority over balancing option prices. Risk levels are initially set when the traded asset is added to the protocol and can then be changed using the DMX control token.

Pools tokenization and risk control

Scheme 1 — depositing USDT tokens into the pool and issuing dmUSDT tokens instead of deposited ones.

Scheme 1 shows the path from deposition to distribution of tokens at auctions held for a selected traded pair. The process consists of several stages:

  1. Depositing a token from a participant to the liquidity pool;
  2. The emission of protocol tokens is carried out at the current rate to the base token; for example, if the pool premium is 10%, then the participant must deposit 1.1 USDT to trigger the issue of 1 dmUSDT;
  3. Once deposited, USDT tokens become available for use in auctions through AMM;
  4. Transferring USDT tokens to the auction in accordance with the current profit / loss parameters;
  5. USDT tokens are locked in the auction until contracts expire;
  6. After the contract expires, the tokens remaining after payments on USDT options are transferred back to the liquidity pool. This amount consists of the results of expiration at a given rate, as well as commissions paid by the participants.
  7. Free tokens in the pool can be converted back by the token holder.

A participant at any time can convert the pool tokens back to the base tokens at the current rate, which is determined by the result of the pool. Conversion is carried out in an amount no more than the current amount of base unblocked tokens in the auction.

Circulation of dmX tokens

The dynamic market maker pool tokens are freely tradable and can be used in trading on decentralized platforms such as Uniswap. At the same time, a market maker may be present, which quotes tokens with a spread from the price calculated based on the current premium or discount to the base token, depending on the accumulated payments in the pool.

Role of the DMX Governing Token in the DYMMAX Ecosystem

This connection is carried out using a simple rule: in order to add a certain amount to the liquidity pool, you must simultaneously block DMX tokens for staking for the same amount. At the same time, all holders of DMX tokens benefit from the size of the liquidity pool — the larger the size of the liquidity pool, the less DMX tokens in circulation. The same mechanism ensures the minimum size of the liquidity pool. DMX token holders who want to multiply their capital through staking must put a comparable amount in the liquidity pool.

The resulting unbreakable link between dmX and DMX tokens provides the maximum reward for active participants in the DYMMAX ecosystem — they profit from both DMX token staking and commissions paid by auction participants.

Website: https://dymmax.com

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The DYMMAX protocol includes a platform for making transactions and working with an auction is in beta.