Introduction
The Omni Liquidity Provider (OLP) plays a critical role in Omni's functionality, acting as the sole market maker on the platform. This unique position offers users many benefits, such as zero-fee trading and a wide range of tradable markets, including exotic and novel assets. However, it also means that OLP can accumulate risk as it takes the other side of trades. This article explores how OLP manages this risk to maintain a delta-neutral position and ensure the stability of OLP’s yield.
How OLP Accumulates Risk
As the counterparty to every trade, OLP effectively takes the opposite side of any position opened by a user. While much of this risk is naturally netted out between users–especially with the help of our funding rate design that incentivizes balanced positions–OLP can still accumulate directional exposure. For instance, if a significant majority of users are long a particular asset, OLP will inherently hold a net short position.
OLP is designed to be delta-neutral, meaning it aims to minimize the directional market risk it holds at any given time. This is crucial to ensure that OLP’s yield is stable, and that Omni can continue to process trades effectively regardless of market conditions.
How OLP Manages Risk
To mitigate counterparty risk and maintain delta neutrality, OLP uses a combination of isolated settlement pools, risk limits, and hedging.
Isolated Risk By User
Each user's margin is held in an isolated, on-chain settlement pool, along with OLP's corresponding margin. This design isolates risk, preventing losses in one market from impacting other markets or users on the platform. This is particularly important for exotic or volatile markets, where the potential for large price swings is higher. For a deeper dive into isolated settlement pools and their role in risk management, see the article "Protecting Users from Bad Debt."
Risk Limits
OLP maintains platform-wide, market-specific, and account-specific risk limits to protect against averse behaviors.
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Platform-wide risk limits put a cap on OLP’s total notional position size and value at risk (VaR). The capacity for both of these risk limits can be increased as more capital is deposited into OLP.
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Market-specific risk limits set caps on the total open interest and skew of an individual market. These caps are calculated for each market based on factors like volatility, FDV, volume, and available liquidity in the rest of the market.
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Account-specific risk limits cap the notional position size and amount of risk that OLP will take on from a single user account, which can vary based upon user trading behavior. This helps OLP protect against bad actors.
Hedging
When OLP accumulates a directional position that is not balanced out through user flow, it can employ various hedging strategies to neutralize this exposure. OLP leverages a range of hedging avenues, including:
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Exchanges: Exchanges with deep liquidity like Binance, Bybit, and Hyperliquid are commonly used for hedging majors.
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On-Chain Liquidity Pools: For tokens without exchange listings, OLP can access on-chain liquidity in pools like Uniswap and Raydium to hedge its exposure.
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Over-the-Counter (OTC) Channels: For larger and more exotic positions, OTC channels can provide additional liquidity.
OLP's hedging strategy has a clear objective: minimize overall risk exposure as cheaply as possible. This involves more than just neutralizing directional (delta) exposure. OLP considers a variety of factors, including correlations between assets, liquidity conditions, and market volatility, to optimize its hedging decisions. This allows for a more nuanced approach than a simple 1:1 hedge of each position, further reducing hedging costs.
For example, if OLP has long exposure to one asset and short exposure to another highly correlated asset, external hedging may not be necessary. Similarly, if OLP has directional exposure to an asset with less liquidity, it may be optimal to hedge using a more liquid, correlated asset. This more sophisticated approach to hedging allows OLP to minimize costs while effectively managing risk, which translates to tighter spreads and a better trading experience for Omni users.
Conclusion
OLP's active risk management, including sophisticated hedging on other venues, allows Omni to provide best-in-market depth of liquidity. By accessing liquidity on exchanges, on-chain pools, OTC channels, and more, Omni can list more markets, offer as-tight-as-possible spreads, and maintain high yields for community depositors.
By removing the barriers to listing new and exotic markets, Omni is paving the way for a new era of trading, where everything can be fairly traded by all traders.
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