A persistent challenge in DeFi is the fair and efficient pricing of risk.
In this article, we aim to give a high-level overview of how Bumper, a radically different and innovative DeFi protocol, is redefining the pricing of risk.
The main methods by which crypto users currently minimize, or hedge against, risk have generally been by using a modern form of the same methods as are found in the traditional stock market, including:
These have served the community well until now, however, each one of these methods has its own limitations and challenges.
For example, hedging with traditional options can be complicated and costly, making it difficult for inexperienced traders to effectively manage risk, especially in such volatile markets and stop-loss orders may not always be effective in highly volatile markets.
Bumper’s innovative architecture, whilst complex under the hood, is engineered to be simple for users to hedge risk, or alternatively, to provide liquidity and assume risk in return for yield potential.
Bumper’s design features four liquidity pools, which sets it apart from most DeFi protocols which typically only employ two. This quadrature design enables the efficient calculation of premiums based on internal liquidity, while also helping to minimize costs such as slippage, spread, and transaction fees.
It’s inside this design that Bumper really stands out compared with options trading. When a user buys an option, they are effectively taking a bet on price action one way or the other (up in the case of calls, and down in the case of puts).
What they don’t need to do is to own the underlying asset. This is significantly the biggest difference between Bumper and a crypto options desk, and can be described as Bumper protects the value of the discreet coins and tokens you have in your wallet. Thus, if you have a total of 10 ETH you wish to protect, with Bumper this is the maximum position size you could take, however with options, you wouldn’t need to own any ETH to purchase a put.
In some ways, one could argue this makes Bumper more akin to a form of insurance on a physical product, with a kind of two-way stop loss preventing further loss in the case of a downside price action, but allowing the user to enjoy the gains if the price moves to the upside.
Bumper’s protocol not only monitors asset prices, but also keeps track of the protocol’s balances of assets and capital in relation to its liabilities. This information is used to automatically adjust the protocol’s internal adequacy targets for asset and capital liquidity, which in turn drives premiums and yields. This dynamic risk management system ensures that the protocol is always in a state of optimal risk management.
At the core of Bumper’s design is the idea that all risks, and profits, are shared.
This means that protection Takers are unconcerned about whether they are paying a fair price, and protection Makers do not have to compete with other Makers.
Bumper measures and dynamically respond to price changes and demand, shares liquidity risk among liquidity providers, and shares the cost of risk among protection buyers. With this approach, Bumper maximizes the efficiency of pricing (valuing) price risk and converting it to a stable yield.
The notoriously volatile crypto market, whilst attractive to some, is equally off-putting and scary to other potential investors, especially those who may have a limited amount of experience in traditional finance. These new retail users will likely be more motivated to enter the cryptosphere if they are able to guarantee their investments in terms they understand — that is, generally the dollar value.
Thus, there remains a dire need for a crypto hedging solution that’s easy for users to safeguard their investments from downside volatility whilst simultaneously allowing upside exposure, and we believe that Bumper’s unique design will be appealing to many crypto holders, and may actually encourage more would-be crypto enthusiasts into the market.
Bumper’s solution to effective risk pricing has the potential to rival traditional options desks, most of which are centralised, and may even take market share away from exchanges which are being used for setting stop losses.
As almost all crypto experts will tell you “if it’s not your keys, it’s not your crypto”, and for this reason, we believe that Bumper’s non-custodial and price-efficient solution for hedging and trading risk is something which will bring significant benefits to all crypto holders.
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