What on earth is SQUEETH?

2021 was an exciting year for DeFi derivatives, we saw the growth of DeFi 2.0 through self-repaying loans, tokenized volatility, composable yield tranches and staked derivatives. Other examples of innovative DeFi composability for derivatives came from protocols like Tracer DAO; their leveraged tokens built on top of Balancer Pools on Arbitrum brought on an exciting new wave of delta-neutral strategies. Low-risk strategies like these are exactly what is needed in order for DeFi to scale and attract greater user adoption in an otherwise drastically volatile market.

The year also saw a steady increase in the number of users trading perpetuals on decentralized exchanges like Dydx and Perpetual Protocol. Despite this, the perpetual swaps market has yet to recover from its all-time high trading volumes from May 2021. Protocols like Ribbon Finance and StakeDao are now offering structured products with covered call and put option selling strategies providing fixed income. These vaults demonstrate how DeFi composability can help distill complex strategies with simplified front ends and meet user demand for low maintenance strategies.

*dydx

Building on this demand, Opyn recently announced the launch of a new DeFi primitive- Squeeth. The instrument is an evolution of Everlasting options which will enable hedging strategies for non-linear impermanent loss for liquidity providers on Uniswap v3. Squeeth or squared ETH is a new class of Power Perpetuals, a concept first introduced by the Paradigm team in August (Dave White, Dan Robinson, Zubin Koticha, Andrew Leone, Alexis Gauba, Aparna Krishnan).

How does it work?

In a power perpetual ETH² , if the price of ETH doubles — SQUEETH 4Xs. Just like in a perpetual option a funding fee mechanism is used to force convergence of prices between the perpetual contract and its underlying asset. In the context of a power perpetual, this is called a premium yield, where longs pay the shorts for option-like exposure. Joseph Clark explains, similar to perpetual options, Squeeth will trade at a premium to the price of ETH. The ERC20 token which will be minted is oSQTH. A normalization factor is set to manage the impact of funding costs accumulating to oSQTH resulting in its price divergence from the price of ETH² over time. In short:

% funding rate = % difference between Squeeth and ETH²

How can it be used?

In its most simplistic form as a quadratic instrument, short Squeeth positions will allow traders to earn a funding rate and long Squeeth positions will provide traders leveraged positions and protected downside without risk of liquidation. Squeeth also enables LPs to Hedge against Uniswap v3 due to the quadratic nature of impermanent loss. The hedge works to within 1% accuracy.

Power perpetual also provide a way to consolidate liquidity with a single market instrument in current fragmented liquidity markets. Some important considerations are funding costs, the need to rebalance frequently, and hedging errors. Short Squeeth positions may also be at risk of liquidation if they fall below the safe collateralization threshold.

What is next?

With the launch of Squeeth, Opyn announced The Crab Strategy, a contract that will automate rebalances to ensure delta neutrality — allowing users to deposit ETH to earn yield with little maintenance. The strategy is profitable as long as ETH moves less between rebalances than the premium of the Squeeth short position. Future development for bullish and bearish ETH positions as foundational strategies are also in the works. Opyn also hinted at the deployment of Squeeth on L2 on the roadmap.

It will also be incredibly exciting to see these power perpetuals extend to serve staked ETH and low-maintenance DeFi primitives that may transpire. As traditional financial products give way to innovative DeFi-native delta-neutral strategies, more sustainable yield patterns will start to emerge, providing a safe haven for the risk-averse investor.

Written by 0xZoey