Defi Dives: Ribbon Protocol
Disclaimer I am a member of Ribbon DAO and use the protocol. None of what I say here should be taken as investment advice, this is simply an examination of how the platform works.
I want to start doing some dives into Defi protocols and products. This can be as much a learning opportunity for me as you dear reader. It gives me a chance to break down topics into concepts easier to understand and examine for those of us who aren’t far right on the IQ bell curve (I know where I am located…hint it’s not right and it’s not middle).
So what is Ribbon? Ribbon.finance is a DeFi protocol offering automated vaults of structured products…wait what? Ok, we will get into what that is. Initially built on Ethereum, it is now operating on Solana and Avalanche thanks to a team of bright buildooooors (Julian, Ken and many more).
Let's start with Structured products- what are they? To quote Ribbon’s website:
Structured products are packaged financial instruments that use a combination of derivatives to achieve some specific risk-return objective, such as betting on volatility, enhancing yields or principal protection.
I am trying to break things down to their base level so we will take another step back.
What are derivatives?
Derivatives are essentially a contract between two parties about another asset (it could be gold, oil, or Bitcoin for eg) where the value of this contract is derived (see) from the underlying asset. For example, you want to bet on the price of Bitcoin on a date 2 months into the future. You and a counterparty agree this bet and there is a price. You have just created a derivative.
There are many types of derivatives we won’t go into here, but they can be useful tools for hedging positions or for speculation.
In the trad fi world larger players (generally) have access to things called structured products- this is where different derivatives are combined into a package. In principle, you could combine these assets yourself, but it would take time, maintenance and effort most retail investors don’t have available.
The appeal of structured products is they can give appealing risk-adjust returns and can be customized to reduce or increase risk depending on the participant's appetites.
Ribbon uses derivatives known as ‘options’ to create structured products that generate yield for its users.
Yet again, I hear you ask, what is an option?
Options are a derivative that “give buyers the right, but not the obligation, to buy or sell an underlying asset at an agreed-upon price and date”.
When you have the option to buy the underlying asset it is called a Call Option.
When you have the option to sell the underlying asset it is called a Put Option.
Quick example: ETH is trading at $2700 today and you are bullish, you believe ETH price is UpOnly. So you buy an ETH Call option with a strike price of $2900. (You will pay a premium for this purchase depending on market rates, but it is significantly less than just market buying ETH). For example on Hegic right now it costs me $100 USDC to buy a 1 ETH call option that expires in 27 days.
My breakeven is now if ETH reaches $3000(strike price + premium). If ETH goes higher than this I can exercise the option and profit the difference. E.g Eth goes to $3100, I have made $100.
If ETH decreases in price you just let the option expire, you lose your premium, in this case $100, but that is a lot cheaper than having bought 1 ETH at $2900.
And how about Ribbon?
Ribbon offers a variety of different vaults for users to deposit their crypto. Currently they offer a suite of vaults across Ethereum, Solana and Avalanche:
- Solana Covered Call Vault
- Eth Covered Call Vault
- stETH Covered Call Vault
- wBTC Covered Call Vault
- Avax Covered Call Vault
- AAVE Covered Call Vault
- USDC/ETH Put Selling Vault
- YVUSDC/ETH Put Selling Vault
These vaults are the ‘structured products’.
They take a derivatives based investment strategy like we discussed earlier and they automate it. The user simply deposits their assets into the vault and Ribbon runs the process from there.
Each week the vaults will deploy the strategy and auto-compound the yeild made from the week before.
By doing this, Ribbon is able to offer some impressive yields.
The wBTC vault is currently offering an 18.66% APY currently, and then YVUSDC/ETH vault is at 37.77% APY.
A ‘Covered Call Vault’ sells out-of-the-money call options weekly to generate income.
A ‘Put Selling Vault’ means you sell the right (not obligation) for someone to make you buy an asset at a certain price. Ribbon does this weekly. For this, they pay you a premium (the yield). If you expect the price of the asset to continue going up, you earn yeld for holding it, while also giving you some downside protection.
Why would degens, sorry I mean people, use Ribbon rather than structuring these strategies and running them themselves? As Ribbon puts it:
The complexity of structuring this strategy in a perpetual way (strike selection, expiry selection, rolling over positions) make it difficult for the average retail investor to participate. Furthermore, structuring a strategy for yourself on-chain will be an extremely gas-intensive endeavour, making it a non-starter for most.
It is appealing as you get to pool funds with others, making it more gas efficient, and the protocol automates all the heavy-lifting while you get to sit back and collect yield.
Ribbon takes a performance fee of a 2% annualised management fee and a 10% performance fee. Worth noting this is only charged when the vault is profitable too.
What are the risks with using Ribbon?
As with everything in defi and crypto you have smart-contract risk. For the actual strategies the risks are different in the different vaults.
In the Covered Call Vaults the main risks are a swift rise in the price of the assets i.e ETH/USD. I can put it no better than Ribbon here, so I will quote from their FAQ again:
depositors could potentially give up upside in exchange for guaranteed yield. By selling a call option, users are basically promising to sell the asset at the strike price, even if it goes above it (a.k.a selling early). Because of this, if the price of the asset moves up significantly in a short period of time, it is possible for depositors to have “negative yield” on their ETH.
However, this only happens if ETH/USD appreciates significantly, so depositors will still be up in USD terms. The vault also sells call options that are very out of the money, which means there is a relatively low chance of the options getting exercised.
In the Put Selling Vaults the main risks are that the asset price e.g ETH/USD plummets and you are forced to buy the asset for the underlying price. However if you are long-term bullish the asset you are simply buying it at a discount. The more nuclear scenario is that the asset goes to 0 and you have to have to buy at the strike price and lose your investment. (This really is the nuclear scenario…hopefully).
Ribbon is a fascinating protocol that is backed by a great team and continues to build, in my opinion, a really strong brand and product. They recently rolled out V2 of their vaults which increased the decentralisation of the strike selection and options sales, brings improved capital efficiency, and no more withdrawal fees.
As mentioned there are risks involved, both smart contract risk and underlying asset price risk. Ribbon is trying to build for the long haul and to create sustainble yields. There are already other copycats coming a long, and whilst it is fair to say the strategies themeselves are not necessarily novel, picking effective strike prices, selling the options and create a trusted brand with recognised performace all accrue value in my opinion.
This is not an exhaustive exploration of options or Ribbon for the matter, but an introduction for the curious reader or those new to Defi.