Lyra V2

Published: August 26, 2023

Introduction

As DeFi’s TVL continues to bleed, more and more protocols are starting to work on infrastructure, as that’s where most VC investments are currently going. 

While this might suggest that the rate of innovation in DeFi is starting to stagnate, this is not necessarily the case. Instead, this could be an indication that if protocols truly want to compete against their respective centralized incumbents, they might want to build their own appchain. 

Ribbon already set the precedent with Aevo, a custom rollup that leverages the OP stack in an attempt to compete against centralized giants like Deribit. 

Like Ribbon, Lyra also started out as an options protocol, and is now transitioning to a custom OP stack rollup that will enable trading for options and perpetuals with an orderbook exchange as well as spot trading with a CEX-like user experience. 

Overview

With its most recent upgrade, Lyra v2 introduces an advanced and decentralized spot, perpetual, and options trading platform. Moving forward, Lyra will consist of three fundamental components: the Lyra Protocol, the Lyra Chain, and off-chain matchers. 

• The Lyra Protocol serves as a decentralized settlement mechanism, facilitating spot, perpetuals, and options trading. Through this update, users gain access to various trading options and can utilize different collateral modes, including portfolio margin, cross-margin, and multi-asset collateral.
• The Lyra Chain is an OP Stack Rollup for low-cost transactions. This integration ensures a seamless trading experience without compromising on cost-effectiveness and still achieving high throughput.
• Off-chain matchers will efficiently match traders and market makers. Subsequently, they will settle orders to the Lyra Chain, further streamlining the trading process while ensuring optimal execution.

In the upcoming months, Lyra will roll out a series of incremental changes and an advanced feature set that will include:

• Portfolio margin, which translates to:
  • Increased buying power and leverage – from the netting of positions and consideration of the state of your overall portfolio.
  • More dynamic and responsive risk management through strategic hedging – which reduces margin requirements.
• Capital efficient spreads, which will unlock the following:
  • Convex payoff functions.
  • Passive income opportunities.
  • The ability to trade volatility.
  • Implicit leverage.
• Multi–asset collateral to increase flexibility and reduce friction for traders. For example, you will be able to collateralize options and perpetual positions with a variety of base assets. This way, traders will be able to start opening positions without converting their holdings to a specific quote asset, such as $USDC. This unlocks use cases such as:
  • Long a $BTC perp with $ETH as collateral.
  • Short an $ETH call with $BTC as collateral.
  • Borrow against $stETH to sell $ETH covered calls.
• Loss-minimizing partial liquidations, which offers advantages such as:
  • Reduced market impact from liquidations when closing over-extended positions – decreasing the likelihood of insolvency.
  • PnL preservation, since liquidating positions incrementally allows traders to maintain a portion of their exposure and redeploy released capital.
  • By staggering liquidations across price levels, the platform can reduce the risks of incurring costs as a result of low-liquidity conditions. 
• Seamless and frictionless user experience with features such as:
  • Gasless transactions.
  • Instant confirmations.
  • Seamless deposit/withdrawal flow from Ethereum.
  • Advanced order types: market orders, limits orders, good-till time orders, post-only, reduce-only, stop losses, take-profit.

Why V2

The rise of Layer 2 solutions (L2s) and appchains is witnessing a remarkable proliferation, providing a robust infrastructure to support high-performance, cost-effective financial products. The distinguishing factor relative to Traditional Finance (TradFi) lies in their ability to maintain essential features of Decentralized Finance (DeFi), such as composability, self-custody, and decentralization. 

This surge in L2s and appchains has led to a growing awareness of the flaws in the traditional monetary, political, and financial systems. One significant concern is the opacity and lack of transparency in these systems, which has serious implications for various stakeholders.

In the traditional banking sector, profits often stem from risky bets made with customers’ savings, putting their hard-earned money at stake without adequate disclosure. Similarly, governments generate revenues by taxing debt holders and salaried workers, often resorting to money printing and currency debasement, leading to economic instability. 

The global economy, facing an increasingly fragmented landscape, calls for a credible and neutral global settlement layer. This necessity arises from the need to establish a trusted platform that can facilitate cross-border transactions, bypassing the complexities and inefficiencies arising from fractured financial systems.

• By enabling self-custody, users gain greater control over their assets, reducing reliance on intermediaries and enhancing financial sovereignty.
• The composability of DeFi allows various DeFi protocols and applications to interact seamlessly, fostering innovation and expanding the range of available financial products.
• Options indeed hold a unique and versatile position in the financial world. Their power and flexibility make them an ideal choice for various use cases, whether for hedging or speculative purposes. A well-constructed basket of options can be tailored to achieve virtually any desired payoff structure.

The vast array of possibilities offered by options makes them foundational instruments in a financial system that values programmability, interoperability, and open-source principles. Recognizing this potential, the first version of Lyra was born. 

After two and a half years, Lyra has made significant strides, pioneering the options Automated Market Maker (AMM) and achieving notable milestones: 

• The Lyra v1 options AMM has accounted for an impressive 60% of the on-chain options volumes among Ethereum-based decentralized exchanges (DEXes).
• The protocol has evolved into a liquidity layer that has attracted different teams to build products on top of it, such as Toros, DeDeLend, dHedge, and Brahma. 
• Even during challenging market conditions, Lyra’s flagship $ETH pools have historically delivered substantial profitability for liquidity providers (LPs), with an average real yield of 6-8% over 1.5 years.
• Since its launch, the protocol has generated, priced, and settled over $1.5 billion in notional volume.

Despite these achievements, Lyra recognizes that there is significant potential for further growth in the DeFi options space. The protocol’s scalability has been limited by capital inefficiency due to the AMM consuming substantial collateral per option sold. Additionally, the monolithic architecture has made upgrades cumbersome, and the on-chain user experience has faced challenges with wallet integrations, gas fees, and bridging.

Sector Overview – Options & Perps

Notwithstanding these challenges, Lyra has maintained an average of approximately $3 million in notional volume per day over the past three months. It’s difficult to estimate the exact volume of DeFi options, but if we exclude protocols that merely settle on-chain (with pricing, collateralization, etc. being manually agreed off-chain), this accounts for at least half of the volume (and up to 70-80% on any given day/week).

However, when considering the total options volume in the broader crypto market, the on-chain DeFi options currently represent only about 1% of the total volume. Centralized exchanges continue to dominate, facilitating around 99% of the volume, particularly in perpetuals trading.

At the same time, spot volumes in crypto are approximately 30 times larger than options, and perpetuals trading boasts a staggering 68 times more volume than options. In contrast, in traditional finance, options volumes are typically higher than spot volumes.

However, the smaller market size is not indicative of a lack of demand. On the contrary, Lyra has experienced high demand from users and firms looking to trade $ETH options in substantial quantities ranging from $1,000 to $10,000. The limitations of the v1 AMM, however, have led to the protocol occasionally turning away such users.

When comparing the total notional value of global options traded in 2021, which was estimated at $1.2 quadrillion, the current state of DeFi derivatives, including Lyra’s contribution, remains relatively small. Lyra’s annual notional value of $1 billion represents just 0.0000833333% of the global options market. This underscores the immense untapped potential for growth in the DeFi derivatives space.

The Road Ahead

In the context of an industry often focused on infrastructure and pick-and-shovel projects, Lyra believes that DAOs like itself have a responsibility to prioritize user experience and customer acquisition. While these aspects might not always grab headlines, they are crucial in onboarding new users to DeFi and encouraging broader adoption.

Understanding the needs of options traders is paramount to delivering the right solutions. Through engaging with professional options traders and community members, Lyra has identified key elements that they care about:

• Self-Custodial Exchange without Counterparty Risk: Traders seek a self-custodial exchange that eliminates the credit risk associated with centralized counterparties. Decentralization ensures security and trust while avoiding reliance on intermediaries.
• Streamlined Onboarding and User Experience: A seamless and user-friendly onboarding process is crucial, abstracting away the complexities of on-chain interactions, gas fees, and other pain points to provide a smoother trading experience.
• Trust and Security: Traders value a secure and transparent product backed by a reputable and trustworthy brand, ensuring confidence in their interactions with the protocol.

To carve a path forward and capture more market share, Lyra aims to address these critical needs and build products that can compete effectively with centralized counterparts based on merit and user experience alone.

Charts

Coingecko – Price

Coingecko – Mcap and FDV

DefiLlama – TVL

Lyra V2

Lyra V2 represents the culmination of the volatility engine’s development, integrating the best of on-chain capabilities with a user experience akin to centralized exchanges (CEX). 

• Unmatched Capital Efficiency and Deep Liquidity.
• Flexibility: Adaptive to New Use-Cases and Market Paradigms.
• Industry Ready: Scalable to Embrace the Entire Financial Landscape.

These ambitions will be achieved with the following feature set:

• State-of-the-Art Margining Capabilities: Empowering traders with advanced options like portfolio margining for options, cross-margining between options and perpetuals, and the ability to use multi-asset collateral, such as borrowing against $wstETH to sell $ETH covered calls.
• Institutional Grade Order Matching: Ensuring efficient and seamless execution for traders. Lyra V2’s AMMs undergo a redesign and are intricately woven into the fabric of the Lyra Chain, providing a smooth trading experience.
• Open Source Commitment and Composability: The goal is to make it very easy for external developers to integrate their dApps and build on top of Lyra to come up with novel use cases such as:
  • Automated covered call selling vault on $stETH with 1.25x margin.
  • Capital-efficient AMMs built atop the risk engine, to 2-3x output per dollar of TVL relative to the current version.
  • Delta-neutral perp yield harvesting strategy vaults.
  • A licensed options orderbook catering to a specific region and industry.

Lyra Chain

Lyra V2 is built on top of the OP Stack. The main features are:

• High Throughput, Low Latency, and Low-Cost Execution.
• Seamless Interoperability: Users can easily deposit and withdraw assets between Ethereum mainnet and other Ethereum Layer-2 solutions.
• Enhanced Security and Reliability: Lyra Chain inherits the security of Ethereum mainnet and incorporates a reliable escape hatch mechanism in case of sequencer downtime or misbehavior, further safeguarding user assets.
• Improved user experience: Features like smart contract wallets and gasless transactions simplify onboarding processes and reduce friction for users.
• EVM environment for smart contracts.

Lyra Protocol

The Lyra Protocol introduces a risk engine and scalable backend that offers support for margin, clearing, liquidations, and settlement for both options and perpetuals in a fully trustless and on-chain manner.

• Modularity and scalability: By adding custom risk managers as “Lego blocks” to the stack, the protocol becomes adaptable to various forms of margin requirements. This design approach facilitates the creation of markets for riskier assets without compromising the risk profiles of established assets like $ETH and $BTC. 
• Permissionless integrations: Developers can now leverage the protocol in a permissionless manner to craft custom payoff structures and margin modules, unlocking a world of diverse applications and financial products. 
• Efficient capital utilization: The architecture of the risk engine enables the protocol to support the same high volumes facilitated by the v1 AMM using as little as $1 million in Total Value Locked (TVL), compared to the $15 million TVL currently employed.
• Trustless insurance fund: The new security module serves as a trustless, on-chain insurance fund, acting as a safeguard in case of any insolvency in the risk engine. 

Off-Chain Matchers

Atop the Lyra Protocol, the Lyra Matcher takes center stage, providing a robust order-matching service capable of handling orders at an institutional scale.

• Comprehensive Order Support: The matching service will support all essential order types.
• Developer-Friendly APIs: The Lyra Matcher will offer REST and WebSocket APIs, empowering developers to integrate seamlessly and build innovative applications on top of the protocol.
  • Modular and Reusable Design: The off-chain matcher is intentionally designed to be modular and reusable, allowing it to run on different environments, such as Mac, AWS, or GCP, without vendor lock-in.
• Fostering a Decentralized Matcher Ecosystem: Over time, the vision for the Lyra Matcher is to encourage multiple teams to run their matchers, all settling to the same protocol and chain. This approach diversifies the sources of trading volume, contributing to the liquidity and order flow moats that enhance the attractiveness of the Lyra Chain as a liquidity destination.

Technical Overview

At the technical level, the most notable features of Lyra v2 encompass its modular architecture, innovations in subaccount and asset management, on-chain risk checks and liquidations, and strategic considerations driving its path towards complete decentralization.

Modularity

Lyra V2 builds upon the foundation set by Lyra V1, which pioneered the options AMM space, but was hindered by a monolithic design. The new protocol addresses this limitation with a modular framework that emphasizes flexibility, adaptability, and performance. This approach facilitates rapid and cost-effective upgrades, allowing developers to seamlessly integrate new features as the crypto market evolves. The key components of the module architecture include:

• Subaccounts: Represented as ERC-721 NFTs, subaccounts group assets and define margin rules. Managers oversee the subaccount’s assets and their associated rules.
• Assets: These encompass collateral and instruments for trading. Assets are encoded with rules dictating balance interpretation and changes upon user interactions.
• Managers: Responsible for risk management, liquidations, and trade settlement. Managers maintain subaccount solvency and adapt to market conditions.

Subaccounts

The fundamental unit of Lyra V2 is the subaccount, represented by an ERC-721 NFT. A subaccount contains a collection of assets managed by a designated subaccount Manager. The innovative use of hooks empowers external function calls to pertinent contracts, controlling interactions within subaccounts. Manager hooks and asset hooks enforce valid subaccount states and balance adjustments, respectively. Importantly, a single account can hold multiple subaccounts, enhancing flexibility.

Assets

Assets are pivotal in Lyra V2, defining balance semantics and user interactions. Assets can represent collateral (e.g., USDC, ETH), instruments (e.g., perpetuals, options), and more. Each asset includes a uint96 subId to encode specific information. Assets can be categorized into traditional ERC721, ERC20, borrowable ERC20, and instruments, each with defined id spaces and balance capabilities.

Lyra V2 introduces four asset types:

• CashAsset: Acts as a primary collateral method with credit and debit balances, establishing an inherent lending market.
• WrappedERC20Asset: Represents wrapped underlying assets for hedging and collateralizing. Borrowing against these assets is also possible.
• OptionAsset: Features European call or put options settling to a TWAP of the index price.
• PerpAsset: Represents perpetual futures.

Managers

Managers oversee subaccounts’ interactions, encompassing risk management, liquidations, and trade settlement. By mandating margin requirements, managers maintain system solvency and deter dangerously leveraged positions. They also facilitate liquidations for under-margined users, mitigating risks. Furthermore, managers settle trades, ensuring efficient trade execution and management.

Lyra V2 introduces two risk managers:

• Portfolio Margin Risk Manager (PMRM): Evaluates holistic portfolios, catering to market makers and advanced traders.
• Standard Margin Risk Manager (SMRM): Assesses isolated position margins and supports multi-asset collateral, catering to retail traders.

Decentralization

Although decentralization is a core principle of Lyra V2, practical trade-offs have been made to ensure efficiency and safety. Parameters are governed by token holders within set ranges, with updates taking up to a week to implement. Verified integrations streamline gas-intensive portfolio margin computations off-chain while maintaining self-custody and reducing costs. Initial data feeds come from the firm Block Scholes, with ongoing efforts for data decentralization.

The Lyra DAO

The Lyra DAO plays a pivotal role in supporting and enhancing the volatility engine, fostering network effects, and ensuring the ecosystem’s long-term growth and success. The DAO’s key responsibilities include:

• Developing a Robust Security Module:  Trading fees accrue to an insurance fund to foster the robustness of the protocol and rollup. As the volume generated on the rollup and protocol grows, the security module scales proportionately to maintain ample coverage.
• Business Development and Partnerships: The DAO takes an active role in engaging with the broader crypto community, other DAOs, and institutions. Through strategic partnerships and collaborations, $LYRA token holders can expand the reach and adoption of the Lyra ecosystem. 
• Research and Development: The DAO encourages the development of new, efficient AMMs that are built atop custom risk modules. These AMMs contribute to the ecosystem’s diversification and further enhance trading experiences.
• Flexible, Community-driven, and Minimized Governance: This approach ensures that decisions can be made swiftly, allowing for prompt responses to evolving market conditions and user needs.
• Revenue Model: The DAO generates revenue to fund its activities through various channels.
  • Trading Fees: All transactions that increase the open interest of the protocol will be charged a fee.
  • Liquidation Fees: Users who experience liquidation will be charged a small fee that scales with the risk and market value of their position.
  • Interest Rate Spreads: A percentage of all interest paid by quote asset borrowers is taken as a fee.
  • Rollup Gas Fees: 50% of all Layer 2 gas fees generated on the rollup accrue to the security module, while the remaining portion benefits infrastructure providers.

The DAO’s governance framework has evolved over the last two years, leading to a state where the treasury and protocol are fully under the control of $LYRA token holders. Nevertheless, the Lyra Foundation will still play a key role in the development of the ecosystem.

The Lyra Foundation

The foundation will be able to perform functions to assist the DAO in bootstrapping the success of v2. More concretely, it will be responsible for progressing the protocol and rollup through the remaining 4 phases of the roadmap, listed below.

Inspired by Uniswap’s Governance, a LRFC (Lyra Request For Comment) was posted in the DAO forum to formally introduce the Lyra Foundation, a not-for-profit legal entity designed to support the decentralized growth of the Lyra Protocol. 

The Foundation will be empowered to contract with other entities to provide services for the DAO, particularly in cases where direct on-chain governance is not feasible. Some examples include entities hosting off-chain infrastructure (e.g., rollup sequencer and order book), agreements to foster liquidity on the Lyra Chain, and providers related to licensing and compliance objectives.

Objectives and Key Results (OKRs) for the Lyra Foundation:

• Grow Protocol Activity: The Lyra Foundation will allocate 50% of $LYRA funding and 70% of $OP funding to construct long-term aligned liquidity agreements through market makers and protocol integrations on the Lyra Chain. 
• Success will be measured by metrics such as volume, new users, and security module fees generated per incentive.
• Support Continuous Protocol Development: To achieve this, the Foundation will allocate 20% of $LYRA funding, 30% of $OP funding, and 100% of $USDC funding to contract with relevant service providers, including core contributors, for protocol functionality development. This includes but is not limited to AMM design and development, automated strategy vaults, new collateral onboarding, and autonomous hedging vaults. 
• Success will be measured based on metrics like the number of new integrations, integration time for developers, and integration volumes.
• Act as an Advocate for the Protocol: The Foundation will proactively seize beneficial opportunities on behalf of the protocol, offering service providers clarity, accountability, and competitive contract opportunities.

If this proposal is approved, the Lyra DAO will transfer the following assets to the Lyra Foundation:

• $LYRA: 100,000,000 tokens
• $OP: 750,000 tokens
• $USDC: 1,500,000 tokens

Key Takeaways

• Lyra V2 is designed to provide a trading experience on par with centralized exchanges. The platform prioritizes user experience (UX) to attract a broader user base and facilitate easy adoption of DeFi trading for both novice and experienced users.
• The update incorporates smart contract wallets that leverage account abstraction technology, simplifying onboarding processes and improving private key management for users.
• The Lyra DAO governs the protocol, earning trading fees from Lyra Protocol and gas fees from Lyra Chain, ensuring community-driven decision-making.
• The options-specific sector of the crypto market is smaller compared to spot and futures trading, but Lyra V2’s goal is to expand its reach and capture a larger share of the market.
• The team acknowledges the need for manual effort and persistence to build network effects, onboard users, and attract stakeholders, and is committed to embracing this challenge.
• Whether or not these upgrades trickle through to $LYRA remains to be seen. That said, with these changes, Lyra is positioned for the long term as the go-to Dex for pro traders. .

Conclusion

The current crypto bear market has raised questions about user adoption in the industry. However, Lyra embraces this challenging phase to question long-held assumptions, build products with ambitious long-term visions, and explore unconventional approaches that may revolutionize the space. This includes:

• Engaging in manual and persistent business development and relationship building with both institutions and individuals.
• Onboarding traditional financial flows and real-world assets, undertaking the necessary legal and regulatory work to facilitate seamless integration.
• Prioritizing protocol engineering and user safety best practices, sparing no expense to ensure a secure and efficient ecosystem.

By setting these ambitious goals and refusing to be confined by limiting beliefs, Lyra v2 aims to pave the way for a 10x financial system that is radically transparent, universally accessible, interoperable, and highly efficient.

References

Revelo Intel

• Lyra breakdown 
• Lyra timeline 

Other Sources

• Lyra v2 announcement 
• Lyra v2 
• Lyra v2 technical whitepaper 
• Lyra v2 DAO proposal 
• Crypto derivatives – an ecosystem primer by GSR 

Disclosures 

Revelo Intel has never had a commercial relationship with Lyra and this report was not paid for or commissioned in any way.

Members of the Revelo Intel team, including those directly involved in the analysis above, may have positions in the tokens discussed.

This content is provided for educational purposes only and does not constitute financial or investment advice. You should do your own research and only invest what you can afford to lose. Revelo Intel is a research platform and not an investment or financial advisor.