Portfolio Spotlight: Sm:)ee

By Jerry Shi

Published May 11, 2023

By modeling liquidity provision positions as option selling, Smilee has figured out how to transform Impermanent Loss (IL) payoff into a portfolio of options. These options can then be recombined into any volatility-related payoff, creating a new kind of generalized on-chain vault: the Decentralized Volatility Product (DVP). As the first of these products, Smilee transforms IL from a bug into a feature, offering predictable premium generation and long volatility market exposure. Synergis is excited to support the Smilee team in building new derivative products and changing the landscape of the on-chain option space, for degens and institutions alike. In our view, Decentralized Exchanges and Automated Market Makers are here to stay and will expand by multiples in size as both crypto and traditional finance activity moves on-chain. As IL becomes more relevant, so will Smilee, by empowering on-chain derivatives and enabling efficient hedging tools.

Smilee started as a fork of Aave, where DEX liquidity could be turned into a long volatility product (Impermanent Gain) through a simple lend/borrow mechanism utilizing LP tokens. The team quickly realized that this approach limits the potential of building more advanced on-chain derivatives in the future based upon the concept of mimicking existing liquidity provision profiles. As the first suite of products, Smilee is offering a synthetic version of the initial idea through Real Yield and Impermanent Gain vaults. Real Yield vault will offer a short volatility exposure through a DEX-like LP payoff profile to earn yield in the form of USDC. The Impermanent Gain vault will take the other side and offer long volatility exposure with up to 500x leverage and no liquidations.

Short volatility DVPs are the ones paying” the Impermanent Loss in exchange for a premium earned from selling the options, while long volatility DVPs are the ones paying a premium to “earn the Impermanent Loss amount in the form of Impermanent Gain.

Analysis shows that AMM LPs are not adequately compensated for the risk they are taking. Their payouts are dependent on volumes, but the losses are a function of volatility instead. This mismatch frequently causes higher than fair losses to LPs’ inventory. The Real Yield product specifically targets LPs needs. Smilee turns liquidity deposits into new volatility-oriented products, with well defined, predictable returns, where both the gain and the loss are a function of volatility. This increases the stability and overall utility for liquidity providers without adding risks.

Thanks to the custom synthetic engine, Smilee can expand its offer in the future to create even more powerful strategies for the liquidity providers:

● Yield Boost Vault — where users can directly deposit LP tokens earning the DEX yield + a premium. This will expand the protocol composability and ensure to always outperform directly providing liquidity.

● Delta-neutral Vault — for providing liquidity with no direct market exposure.

 IL-capped Vault — where the Impermanent Loss is capped at a maximum reducing the overall exposure in extreme scenarios.

The ability to decompose arbitrary volatility dependent payoff into a portfolio of options and recombine those options into more complex derivatives will enable Smilee to offer many new on-chain derivative products to traders, such as:

● Options and option spreads

● Variance Swaps

● Certificates and Structured Products

● Insurance (depeg protection, Impermanent Loss protection)

Summing up, Smilee is the primitive that can transform DEX-like liquidity into any Decentralized Volatility Product. Impermanent Loss as a core part of AMMs, will get more and more relevant over time as traditional assets get tokenized and more of trading activity moves on-chain. Smilee is the first platform to leverage Impermanent Loss by decomposing it into a portfolio of options in order to build volatility products with arbitrary exposure profiles in an open, transparent, and permissionless way. DVP vaults, starting with Real Yield and Impermanent Gain, will unlock new opportunities for traders, liquidity providers, DAOs, and institutions.

To learn more, visit https://smilee.finance/