Convexity is a generalized options protocol built on the Ethereum blockchain that allows DeFi users to create put and call options. Convexity also provides an easy interface to buy and sell options.
Put options work as insurance in traditional finance. A put option gives the buyer the right to sell a set stock at a specified price on or before a set date. This means that no matter how low a stock's price goes, the investor has the right to sell the stock for the agreed upon price. Convexity uses put options to provide option buyers insurance on their Dai and their assets on Compound (Dai and USDC).
Convexity allows options sellers to earn premiums on their collateral and allows options buyers to protect themselves against technical, financial and systemic risks in DeFi. These risks include hacks, bank runs, a DeFi crisis etc.
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The main use case of the options markets seeded on the Convexity Protocol is to provide insurance.
Every option supported by the Convexity Protocol is integrated through an oToken smart contract which is an EIP-20 compliant representation of options issued by the protocol. The insurance markets that exist are as below:
| oToken | Underlying Protected |
|---|---|
| ocDai | cDai |
| ocUSDC | cUSDC |
Consider the case of a Compound user, Afraid, who wants insurance on his $1 worth of Dai locked in Compound. He fears Compound getting hacked or having a liquidity crisis where the reserves left on Compound are insufficient to pay out all the suppliers if they all tried to withdraw their money. The insurance buyer, Afraid, pays the insurance provider, Brave, 0.02 ETH premium ahead of time to get access to ocDai tokens. In return, Brave, locks up 1 ETH of collateral on the insurance platform for 1 year.
The ocDai token protects Afraid from Jan 1 2020 to Jan 1 2021 against any technical or financial risks that Compound's cDai faces. The ocDai token gives Afraid the right but not the obligation to sell his cDai for $1 worth of collateral at any time during the next 1 year.
In the case of a disaster Afraid can turn in his ocDai and his cDai and in exchange take out $1 worth of collateral locked in the Convexity Protocol by all the insurance providers. There is no need for claim assessors to determine if a disaster happened because if the price of cDai ever falls below $1, Afraid can immediately exercise his right to sell his cDai for $1.
If there is no disaster, it is strictly worse for Afraid to give up his cDai (worth slightly > $1 because of interest earned) in exchange for ($1 worth) collateral locked on the Convexity protocol. When there is no disaster, the insurance provider, Brave, keeps her collateral and earns a premium on it.
Consider the case of a Dai holder, Afraid, who wants insurance on his $1 worth of Dai. He fears Dai losing its peg or getting hacked. The insurance buyer, Afraid, pays the insurance provider, Brave, 0.02 ETH premium ahead of time to get access to oDai tokens. In return, Brave, locks up 1 ETH of collateral on the insurance platform for 1 year.
The oDai token protects Afraid from Jan 1 2020 to Jan 1 2021 against any technical or financial risks that Compound's cDai faces. The oDai token gives Afraid the right but not the obligation to sell his Dai for $0.9 worth of collateral at any time during the next 1 year.
In the case of a disaster Afraid can turn in his oDai and his Dai and in exchange take out $0.9 worth of collateral locked in the Convexity Protocol by all the insurance providers. There is no need for claim assessors to determine if a disaster happened because if the price of Dai ever falls below $0.9, Afraid can immediately exercise his right to sell his Dai for $0.9.
If there is no disaster, it is strictly worse for Afraid to give up his Dai (worth $1) in exchange for ($0.9 worth) collateral locked on the Convexity protocol. When there is no disaster, the insurance provider, Brave, keeps her collateral and earns a premium on it.