Buffer Finance And What Can Offer To Its Users
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At a Glance
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In this series, we take a look at the latest news, developments and innovations within the ever-changing decentralized finance (DeFi) space. We will dive deep into the nitty gritty details to better understand how protocols within the DeFi space work, the problems plaguing the ecosystem, as well as how builders intend to overcome them.
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Buffer Finance is a decentralized binary options trading protocol on Arbitrum that allows traders to create, buy, and settle options against protocol owned liquidity (POL).
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Despite its BLP model (modeled after GMX’s GLP) failing, the team successfully migrated to a POL model.
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The protocol has generated over $130k in fees since its launch, earning BFR stakers 15% APR as of the time of writing.
Preface
On October 14, 2022, Buffer Finance launched their V2 protocol on Arbitrum mainnet. As of the time of writing, the protocol is still in beta and documentation and audits for the new protocol is yet to be released. Thus, this quick dive will cover the protocol based on available information from their medium articles as well as from speaking to a member of the team.
What is Buffer Finance?
Buffer Finance is a decentralized binary options trading protocol, allowing traders to create, buy, and settle options against a protocol owned liquidity (POL) pool. Buffer Finance first launched on Binance Smart Chain in December 2021, before migrating to Arbitrum in October 2022.
GMX’s success has inspired a number of protocols and Buffer Finance takes a page out of GMX’s book by forking their staking architecture, allowing users to stake BFR, the protocol token, for a share of protocol revenue in the form of BFR, esBFR (escrowed BFR), and USDC. Unlike GMX, which uses GLP to incentivize users to provide liquidity to the protocol, Buffer Finance has implemented a POL model to replace BLP (modeled after GLP) after it experienced significant volatility — more on this later.
How Buffer Finance Works
In V2, the protocol has two key participants:
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Options Traders — traders customize strike price, expiry, and options size to purchase a put or call option. Traders pay an option premium (strike fee + option fee) and a settlement fee, and can exercise the option any time before the expiry date against the POL pool.
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BFR Token Holders — BFR token holders can stake their tokens to earn a share of protocol revenue and participate in protocol governance.
A trader purchasing binary options is essentially betting on the trading direction of the underlying asset. If positions expire or are closed in the money, then the trader earns the payout (a percentage of the initial investment). If positions expire or are closed out of the money, then the trader loses their initial investment. Since the counterparty of the trade is the POL pool, if the trader wins, the POL pool pays out the profit. Conversely, if the trader loses the trade, the POL pool keeps the trader’s investment.
Trading
Let’s look at an example.
buffer.finance
On Buffer Finance, the current payout is 70% when using USDC (BFR trading will launch soon) and the maximum time frame is four hours. The price of BTC is at $15,793 but Henry thinks that BTC price will continue to fall in the next four hours. Henry then opens a position with $1,000 and chooses “Down”. If the price of BTC continues to fall within the specified time frame and the option expires or Henry closes the position, Henry earns $700 from the POL pool, which is a 70% payout. If the price of BTC instead increases and the option expires out of the money, then Henry loses his $1,000 deposit to the POL pool.
As of the time of writing, maximum trading size is set to 0.2% of available liquidity in the POL pool while max utilization is set to 10% of total available liquidity in the POL pool. This is done to safeguard the protocol and reduce volatility of the pool. Soon, users will be able to choose either an exact price or a range to bet on, rather than just deciding on the direction of the trade (“Up or “Down”).
Protocol Revenue
One of the main reasons why GMX gained significant traction is because of the potential for token stakers and liquidity providers to earn a share of protocol revenue. Similarly, Buffer Finance allows BFR token stakers to earn a share of its revenue.
Fees are generated from the following:
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Strike fee — intrinsic value of the option; for a call option, it is MAX(0, strike price - current price), while for a put option it is MAX(0, current price - strike price).
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Options fee — calculated using an option pricing formula using current price of the asset and Implied Volatility (IV) as the key inputs.
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Settlement fee — 4% of the total amount of the asset being covered under the option
As of the time of writing, the protocol utilizes a USDC POL pool (BFR POL pool to be launched soon). 40% of fees generated are sent to BFR stakers while the remaining 60% is sent back to the POL pool.
Recent Developments
On October 25, 2022 the protocol halted trading after just 12 days of the V2 beta launch. Although successful, a number of large winning trades caused significant volatility to the price of BLP, causing panic among BLP liquidity providers. In order to prevent a bank run, the team halted trading and quickly seeded a USDC POL pool with $75k USDC and restarted trading. Since then, the pool has increased by almost 60% to ~$119k, accruing over $15k in fees.
On November 8, 2022, the team launched an OTC sale for esBFR, a non-transferrable token that matures into liquid BFR over a period of one year in order to seed the POL pool. As of the time of writing, over $90k has been raised.
Protocol Comparison
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BFR |
GMX |
GNS | |
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Annualized Fees | |||
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Annualized Volume |
$19,851,552 |
$88,450,000,000 |
$25,460,000,000 |
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Fees/Volume |
15.00% |
0.15% |
0.05% |
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Staking APR | |||
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LP APR |
- | ||
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FDV |
$24,920,000 |
$468,210,000 |
$100,000,000 |
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P/E |
8.37 |
3.63 |
7.63 |
Source: As Linked
Let’s compare Buffer Finance with two protocols that have been trending in the #realyield movement recently: GMX, a decentralized spot and perpetual exchange and Gains Network, a synthetic leveraged trading platform.
While some have compared Buffer Finance’s Fees/Volume ratio with the other two protocols, it is not a relevant metric since GMX and Gains Network both offer leveraged trading, which inflates the volume traded metric. Thus, we revert to a familiar metric — the Price-Earnings ratio. Dividing each protocol’s FDV with its annualized fees generated, Buffer Finance is currently trading at 8x P/E compared to GMX and Gains Network, who are trading at 3.63x P/E and 7.63x P/E respectively.
As of the time of writing, BFR stakers earn 15.53% APR, while GMX and GNS stakers earn 17.76% and 8% respectively. Where Buffer Finance differs from the two other protocols is their liquidity provision model. Since migrating to POL, Buffer Finance does not have any liquidity pools for users to provide liquidity. Thus, users looking to earn yields by providing liquidity might stake GLP at GMX or provide DAI liquidity on Gains Network.
Final Thoughts
Despite moving from its BLP staking model (modeled after GMX’s GLP model), Buffer Finance still provides “real yield” seekers a significant APR from its profitable model. Since its V2 launch, Buffer Finance has accumulated over $130k in protocol fees. It is also important to note that Buffer Finance, GMX, and Gains Network all operate in different niches so users have ample choice in strategies. With the DeFi landscape on Arbitrum continuing to pick up speed, Buffer Finance offers a decent product to users looking for yield opportunities, both from options trading and BFR staking.
While the recent FTX meltdown has brought crypto sentiment and prices lower, the Buffer Finance team continues to ship updates as they move towards the full launch of their V2 protocol. Furthermore, the team has also shown their commitment and competence via the handling of the BLP failure. Thus, we look forward to seeing Buffer Finance continue to grow and carve out its place on Arbitrum and beyond.
Disclosure: Members of Bybit may be invested in some or all of the tokens and projects mentioned within the following article. This statement discloses any conflict of interest and is not a recommendation to purchase any token or participate in any of the mentioned ecosystems. This content is purely for educational purposes only, and should not in any way be construed as investment advice. Please exercise caution and practice your own due diligence if you are planning to partake in any of these projects in any way. The views expressed in this article are that of the author(s) and do not represent the views of Bybit.
