Report Summary
Squeeth is a new financial primitive launched by Opyn. It offers the ability to trade an index that tracks the price of ETH squared, and is built on the concept of “power perpetuals.” Like any other perpetual, Squeeth uses an index price and funding rate to ensure the contract trades close to equilibrium at all times. However, Squeeth is a tokenized perpetual that users can buy on Uniswap or by minting oSQTH against ETH.
The utility of such a primitive is wide-ranging. Squeeth can be used as a means of levering up on ETH, hedging options positions, hedging Uniswap V3 LP positions, and as a volatility oracle. Opyn is also launching automated strategies that leverage Squeeth. The first of which is the Crab Strategy – a delta neutral way to earn yield during low-volatility regimes.
Higher upsides, lower downsides and asymmetric payoffs are Squeeth’s most defining features. Other advantages include no strikes, no expiry and no need to ‘roll’ positions, reducing the cost of gas and removing the loss in spread paid to market makers. Importantly, however, If you are long Squeeth, the normalization factor will reduce your oSQTH value over time. It is therefore important to note that holding Squeeth over extended periods during sideways and bear markets may cause a loss in ETH^2 exposure due to funding rates.
Squeeth offers traders and investors alike a unique opportunity to supercharge their returns. And the emergence of an instrument that can hedge Uniswap V3 LP price risk without eating into yields is a welcome advancement.
Squeeth & The Crab Strategy
Earlier this year, Opyn released a new financial derivative Squeeth (Squared ETH). Pioneered by the research team at Opyn and Paradigm, Squeeth is a progression from a perpetual swap with option-like exposure wrapped in a single ERC20 token, oSQTH. The most basic functions of Squeeth is to provide traders with a leveraged position, protected downside and no liquidations. Beyond this, the derivative can also be used to hedge Uniswap V3 positions, hedge ETH/USD Options and provide the substructure for automated yield strategies. This new power perpetual derivative is the first of its kind and opens up a wide range of potential DeFi derivatives.
What is Squeeth?
Where derivatives like futures and options allow investors to speculate on assets with strikes and expiry dates in traditional financial markets, everlasting options allow traders to hold contracts without an expiration date. A funding rate mechanism is paid periodically between traders, and is used to incentivize long and short traders instead of premiums used in options.
As a progression on the concept of everlasting options, power perpetuals like Squeeth provide exposure to ETH squared. In most basic terms – if the price of ETH 2Xs, Squeeth 4Xs.
How does it work?
To understand Squeeth deeper as a tokenized derivative product we must be aware of these key elements:
- The Index Price is ETH squared.
- The Mark Price is the trading price of Squeeth.
- The Funding Rate is the cost of holding long Squeeth positions. It is determined by the demand and supply for the contract . Although there is no direct value transacted between long and short positions, the relative traded price of Squeeth reflects funding payments.
Funding rate = Mark Price (Squeeth) – Index Price (ETH^2)
- oSQTH is the ERC20 Token minted to reflect the price of accumulated daily funding rate since contract creation. oSQTH has been scaled by 10,000.
squeeth price = 10,000*(oSQTH price in USD)/(normalization factor)
- The Normalization Factor is the variable in which is adjusted to implement daily funding of your position of oSQTH.
In short, oSQTH is minted to provide exposure to an index tracking ETH^2 and is traded at the Mark Price. The normalization factor manages the funding rate, which over time causes the divergence between ETH^2 and oSQTH.
How does it perform?
Long Squeeth positions offer the opportunity for unlimited upside, protected downside with no risk of liquidation. Protected downside is possible due to the nonlinear nature between ETH and Squeeth, this is referred to as convexity. In options, this is known as gamma.
Higher upsides, lower downsides and asymmetric payoffs are Squeeth’s most defining features. Due to convexity, we can see how Squeeth can outperform a normal 2x Leverage token.
Other advantages of Squeeth include no strikes, no expiry and no need to ‘roll’ positions, reducing the cost of gas and removing the loss in spread paid to market makers. This chart below indicates the historic P&L of Squeeth vs ETH.
If you are long Squeeth, the normalization factor will reduce your oSQTH value over time. It is therefore important to note that holding Squeeth over extended periods during sideways and bear markets may cause a loss in ETH^2 exposure due to funding rates. The chart below simulates the effect of holding a constant funding rate over the period of a year, in this scenario the performance of ETH 10x, oSQTH 50x and ETH^2 90x.
How else can it be used?
Short Squeeth
Short Squeeth positions are collateralized with ETH. Traders instead earn a funding rate paid by long Squeeth holders. Short Squeeth positions are prone to the risk of liquidation if the Squeeth position becomes undercollateralized. If you are short Squeeth, the normalization factor will reduce your debt over time.
Uniswap V3 LP Hedging
In order to hedge a Uniswap V3 position, a Squeeth amount with the same gamma needs to be bought along with a short position on ETH perp futures. With the quadratic nature of impermanent loss, it is possible to hedge down to 1% accuracy with Squeeth. However, this strategy does come with hedging errors, range restrictions, funding costs and rebalancing requirements.
Hedging Options with Squeeth
Similar to impermanent loss in Uniswap V3 positions, options can be hedged with Squeeth due to the quadratic nature of the remaining delta hedge for ETH/USD. Where a typical delta hedge for an option captures the exposure for a small range of price changes, a Squeeth hedge has the ability to do so for wider ranges. Like holding any Squeeth position, users need to keep in mind funding rates through time decay of the option. For portfolios with more than one option position, a Squeeth hedge can be held for the aggregate.
Volatility Oracle
Squeeth can also be used to derive implied volatility, or how much volatility we expect in ETH over a short period. Uses cases for Squeeth as a volatility index for ETH can be compared to VIX for the S&P 500 index (SPX). Not only is the instrument tradable, it can allow pure volatility exposure as an asset class and a method to measure broad market signals.
Automated Squeeth Strategies
For the investors that are less inclined to design complicated strategies with Squeeth underlyings, single click ETH vault deposits will allow yield generation and hedging with smart contract execution. Automated Squeeth Strategies are a series of automated yield strategies created by Opyn, the first of the series is The Crab Strategy.
The Crab Strategy
The Crab Strategy is designed for a sideways market and handles the rebalance of Squeeth debt and ETH collateral for a delta neutral position. Yield generation is possible through the collection of funding rates (typically only possible when shorting Squeeth), whilst hedging with an ETH position to cancel the short position. The user can withdraw the deposit at anytime if they wish to exit the strategy.
The underlying architecture of the vault during a deposit is as follows:
- A contract obtains the ETH from the user
- It then flash borrows additional ETH
- The combined ETH is deposited
- Action 3 returns oSQTH and strategy tokens.
- oSQTH is traded on Uniswap to repay the flash loan.
- The strategy tokens are sent to the user which acts as a claim on the ETH collateral and short squeeth position.
During a withdrawal the position is unwinded in reverse to return ETH to the user. The hedge is triggered by either time or price movement since the last hedge and is presented as a Dutch auction or reverse Dutch auction to ensure market price convergence.
The Crab Strategy is most profitable when the price of ETH remains stable, therefore in order for the strategy to generate positive yield, ETH has to move less than the funding received from holding the short Squeeth position between each rebalance, currently set at every 24 hours. The presence of the Squeeth short position does mean that the user is exposed to the risk of liquidation if the safe collateralization threshold (150%) is crossed in between rebalances. Other important parameters of the strategy such as the Current Profit Threshold, Historic Funding and Collateralization Ratio are depicted on the Opyn dApp.
Like anything in DeFi it is important to consider the risks and fees associated with Squeeth. Aside from the liquidation risks previously mentioned, the technical feasibility of an oracle manipulation on Uniswap V3 geometric mean TWAP for ETH/USDC or ETH/DAI pools may inadvertently allow the minting of non-collateralized Squeeth. However, current research indicates that Uniswap V3 TWAP oracle vulnerabilities are considered impractical from both a single-block and multi-block attack perspective.
There are currently no fees charged by Opyn but users will have to consider gas fees associated with deposits and withdrawals into a Squeeth strategy. Despite having been audited and launched a ImmuneFi bug bounty, smart contract risk is non-trivial and should always be considered.
Watching Squeeth
On launch, The Crab Strategy vault reached its maximum deposit limit within just 90 minutes. The limits on vault deposits have since been raised, but as of writing still remains at max capacity. This perhaps is a good indication of the current sideways market sentiment. Aside from the Opyn dashboard, additional tools for traders to monitor Squeeth include visualisations from Squeeth Alert for funding rates and Dune Analytics dashboard from @momir for Squeeth trading volumes.
Conclusion
The ability for Squeeth to hedge against Uniswap V3 LP positions is a monumental development because a recent study by Bancor showed that hyper impermanent loss was responsible for 49.5% of liquidity providers left with negative returns. The only time horizon which managed to avoid significant loss was those flash LP-ing within a single block (Just In time Liquidity, JIT). Therefore the practical implementation of automated hedging strategies for LP positions integrated with active Uniswap V3 liquidity managers could potentially reduce these losses to 1%, if hedged accurately.
Not only does Squeeth enable the consolidation of fragmented liquidity markets it allows the hedging of non-linear risks in a single market instrument. Squeeth may be the first power perpetual instrument to launch but definitely not the last, the prospect of ETH cubed has already been raised. Although the volatility of Squeeth makes it an unlikely candidate as a stable collateral for lending and borrowing, opportunities for arb bots, quant traders and new novel strategies exist.
In the near future, we can expect to see the deployment of automated strategies more appropriate for Bull and Bear market conditions. Opyn has commented on the possibility of Squeeth on L2 which will reduce gas fees during deposits, withdrawals and re-balances thus increasing yield margins for future strategies.
Squeeth’s introduction as a crypto-native derivative, is completely new to both traditional markets and DeFi. It sets a new stage and example of how the power of DeFi can ideate, iterate and launch an exotic derivative in the short space of 5 months which would otherwise have been impossible in traditional markets.
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