As we all know, crypto markets are a lot more volatile than most traditional asset classes, which means they experience wilder moves with a higher frequency.
This means that Liquidity Providers (LPs) are exposed to potential bankruptcy when betting systematically. Nobody wants to lose their capital in the long-run – but is this just a risk we’ve got to accept in the crypto sphere?
Not according to PotionLabs. They believe the problem isn’t with crypto itself, but with the mathematics that has traditionally been used to price derivatives. Models based on Black-Scholes, which until now have been the gold standard in the industry, price crypto risk too cheaply in some cases and too expensively in others.
A New Mathematical Model for Pricing Crypto Risk
The Potion Protocol is based on the Kelly Criterion, a systematic allocation strategy used by some of the best risk practitioners in the world (including titans such as Taleb, Buffett, Simons, and Thorp). It provides a mathematical framework to make optimal capital allocation decisions under uncertainty and has been shown to work in practice.
In fact, it’s the perfect choice for LPs, because it is optimized for survival and growth over repeated continued risk exposure, as opposed to opportunistic single event risk tasking.
As Nassim Taleb puts it:
“Smoking one cigarette won’t kill you, but repeated smoking over years will. Kelly wouldn’t allow this.”
Kelly selects for trades that when performed repeatedly lead to consistent long-term gains, similar to the strategy of the house in a casino.
The one-of-a-kind bonding curve used in the protocol can price any asset depending on the LP’s risk. That means that it can mitigate the severe risk in long-term liquidity supply that currently exposes LPs to extreme capital losses. Furthermore, the curve has been integrated into a ‘Kelly Machine’, allowing LPs to exchange collateralized risk contracts openly and transparently on-chain, with all of the transactions being automatically risk-managed by the protocol.
In summary, compared to models based on Black-Scholes, the Kelly Machine:
- Is significantly less risky
- Has a lower maximum draw-down
- Leads to long-term positive alpha expectation
- Provides a more user-friendly experience for LPs and traders
- Allows for the formation of a market equilibrium
A Novel Approach to Open-Source the Protocol Into the Public Domain
Potion Unlock is a ground-breaking NFT game that encourages the Potion community to work together to release the protocol. With this one-of-a-kind strategy based on “aggressive decentralization”, Potion Labs seeks to avoid the dangers of a traditional project launch, such as a small number of users wielding significant power over a protocol.
