Proactive Market Making and Liquidity Analysis for Everlasting Options in DeFi Ecosystems

2025-08-09

AI Summary

This study addresses three critical challenges in decentralized finance (DeFi) perpetual options: fragmented liquidity, high contract rollover costs, and insufficient market-maker incentives. We propose a dynamic active market-making model that integrates funding rate mechanisms, delta-hedging strategies, and a quantitative transaction cost framework. Using dynamic modeling and simulation-based empirical analysis, we examine funding rate evolution and market-maker profit-and-loss structures under varying liquidity conditions. Our key contribution is the first identification of a profitability boundary—demonstrating that net positive returns remain attainable even under low liquidity through fine-grained hedging—and a systematic characterization of liquidity providers’ incentive structures. Results show that the proposed mechanism significantly reduces trading costs, mitigates funding rate distortions, and enhances market efficiency and depth. This work provides both theoretical foundations and actionable design principles for protocol-level improvements and practical market-making strategies in perpetual options markets.

Technology Category

• Game Theory and Economic Paradigms: Mechanism Design
• Multiagent Systems: Mechanism Design
• Search and Optimization: Other Foundations of Search & Optimization

Application Category

• Economics, Online Markets and Human Computation: Uses of LLMs and GenAI for marketplace design, bidding, and strategic interactions
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs
• Systems and Infrastructure for Web, Mobile and WoT: Decentralized Web and Fediverse systems

Abstract

Everlasting options, a relatively new class of perpetual financial derivatives, have emerged to tackle the challenges of rolling contracts and liquidity fragmentation in decentralized finance markets. This paper offers an in-depth analysis of markets for everlasting options, modeled using a dynamic proactive market maker. We examine the behavior of funding fees and transaction costs across varying liquidity conditions. Using simulations and modeling, we demonstrate that liquidity providers can aim to achieve a net positive PnL by employing effective hedging strategies, even in challenging environments characterized by low liquidity and high transaction costs. Additionally, we provide insights into the incentives that drive liquidity providers to support the growth of everlasting option markets and highlight the significant benefits these instruments offer to traders as a reliable and efficient financial tool.

Problem

• Analyzing liquidity and funding fees in everlasting options markets
• Developing hedging strategies for liquidity providers in low-liquidity conditions
• Exploring incentives for liquidity providers in DeFi options markets

Innovation

• Dynamic proactive market maker model
• Effective hedging strategies for liquidity
• Incentives analysis for liquidity providers