Friktion Options Strategies: “Build a portfolio to perform across market cycles”.
Friktion is a Solana-based crypto app that provides custom “volts” or option vaults. In short, users deposit assets into offensive or defensive options strategy vaults created by Friktion. These strategies are designed to help investors earn recurring yield and to hedge investments.
In other words, Friktion provides prefabricated & recurring options strategies that serve a growing subset of non-technical Web3 investors.
Below is high-level research of the platform in advance of its potential token launch.
Investment Thesis:
There’s a growing segment of investors using the expanding Web3 ecosystem to grow and preserve their capital. Within that segment, investors are constantly adapting their crypto allocations to preserve capital, hedge positions, and generate income.
It’s normal behavior for investors in maturing markets to leverage a variety of tools to earn income and hedge their positions. And crypto is no different in that regard. But despite the desire, there is often a technical barrier that prevents most investors from generating income and hedging their positions.
Friktion addresses this technical barrier by designing and executing options strategies for a variety of situations using pooled investor capital. Investors deposit the capital and Friktion provides the technical infrastructure and execution.
The options vault helps investors make directional bets on assets without needing specific technical knowledge. ie: Investors don’t need to know how to execute options strategies.
The Bottom Line:
As the size and scope of the Web3 ecosystem grows, non-technical investors want access to risk management and yield-generating options strategies.
Friktion has a clean, easy-to-use product that is well-positioned to capture value from this opportunity. The launch of a native token represents an interesting investment opportunity.
The Business:
How It Works:
Friktion provides 4 options strategies that are ideal for different market conditions. These strategies execute weekly and bi-weekly options contracts for a variety of crypto assets.
Each strategy vault is time locked. Deposited funds can only be removed as the weekly options contracts expire and before the following week’s contracts begin.
As contracts expire and before the new contracts begin, any deposited funds can be withdrawn. Profits from the contracts are subject to the vault maintenance fees which represent a major source of Friktion’s revenue.
The Options Strategies
Vault 1 Covered Call:
The Covered Call is currently available across 14 different tokens and is the most popular option vault by Total Value Locked (TVL).
The Covered Call strategy sells weekly out-of-the-money call options. The goal is to generate income from options premiums and then reinvest the premium income into the following week’s strategy.
If the value of the token increases above the strike price, the contract will likely execute, selling the asset and buying it back at a loss.
Users that opt to invest in the strategy week-over-week will have their assets plus premiums auto-compound. This is also impacted by any losses.
An interesting point: there are three covered call vaults that support 3 Solana-based derivative tokens. These strategies provide a way to earn more yield on liquid-staked Solana tokens. This is a unique opportunity available to Proof of Stake tokens and represents an interesting opportunity to capture more TVL for Friktion. In particular, the options contract market for liquid-staked tokens is an opportunity with growing demand as more staking as a service operators emerge and provide tokens as collateral.
Vault 2 Cash Secured Put:
The second most popular option vault is a cash-secured put strategy with the ability to use a variety of stablecoins as collateral.
Vault 3 Crab Strategy:
Designed to capture yield from range-bound markets. Currently, only a bitcoin vault is available.
Vault 4 Delta Neutral:
A strategy designed to earn yield without betting on the directional price of the underlying asset.
Options Strategies & Vault Revenue Model:
The option vaults use a fee structure that creates mutually aligned incentives between investor and platform.
Friktion charges a 10% fee on profitable positions and a .1% fee on withdrawals. Ie: they win when their investors win.
The investor is relying on Friktion to select an ideal strike price each week to create a profitable position. And Friktion is incentivized to manage risk because they take payment only when the vault produces profit.
If the contracts don’t make money, they’ll drive away users and Friktion loses revenue. This creates a let’s get rich together incentive.
Obviously, some strategies are better suited for some market conditions than others. During those periods, it would make sense that TVL would fall on strategies that are misaligned with market conditions. To that end, it’s important to see that Friktion expands the variety of its options strategies across assets and market conditions. The goal is to see TVL shift between products rather than off-platform. Otherwise, there could be prolonged periods of revenue decline.
VC Funded
Frikition is VC funded with several industry powerhouse names supporting it.
Because there are no public details about a token launch, it’s unclear what VC investor token allocations and lockups would look like at the moment. However, based on the Solana ecosystem token launches to date, VCs will likely get preferential treatment with modest lockup periods.
The Market Landscape
This image by Messari Research was originally published in Janurary 2022.
The Structured Options Landscape
Psyoptions – American-style options and treasury management.
Opyn – focused on Ethereum options and structured strategies that cater to ETH2.
Both Psyoptions and Opyn provide options infrastructure that permits decentralized options transactions. Structured options products (like Friktion) can be built on top of this infrastructure.
These products are necessary for the growth of the structured options ecosystem but could easily become direct competitors to Friktion.
Case in point:
PsyFinance – A structured “vault-style” product from the Psyoptions universe that could be considered a direct competitor to Friktion. But, it has major geographic restrictions which limit the scope of its ability to compete. Until those restrictions change, PsyFinance won’t be a major competitor.
Ribbon Finance – Built on top of Opyn infrastructure: “structured products on ETH, AVAX, USDC, and SOL which generates high yield through automated covered-call or put-selling option strategies.”
They offer fewer coins and fewer strategies, but recently introduced a “pause” feature. Ie: users can skip participating in the next options cycle without paying withdrawal fees. This will help the platform retain TVL if investors want to pause and reassess market conditions.
Katana – A more pure, direct competitor to Friktion. It’s native to Solana and offers structured options vaults. However, they appear to only offer one vault (a Solana-based covered call strategy) which appears to be a greatly reduced offering from what they originally provided. They don’t aren’t moving quickly on providing other options and seem to be stagnating as a platform. Should they begin to offer more products at any speed, they represent a relevant competitor to Friktion.
Notes on Landscape From A User Perspective:
Friktion provides a cleaner UI/UX for the non-technical individual with limited experience using options as a tool. But both Psyoptions and Opyn are more ideal for an advanced user.
One caveat is that there is significant room for improvement in Friktion’s withdrawal process. Ie: “mint a volt token” and then exchange the token for actual collateral is multi-step, confusing, and seems unnecessary. It’s likely that this volt token will have utility in the future but doesn’t seem to serve a purpose right now.
Sizing/Growth Opportunity
As of this writing, Friktion’s Total Value Locked (TVL) is around $50,000,000. An insignificant size considering the Solana market cap is $14 billion. And when compared to the entire crypto industry which recently contracted from nearly $3 trillion dollars to $900 billion in a few months.
But transactional volumes have grown at a nice pace across new product offerings. And it’s not surprising to see TVL to fall given the market carnage over the past 6 months.
It’s also clear that there is a large and growing market demand for Bitcoin and Ethereum Options Bitcoin Options Charts: CME, Deribit Volumes (theblock.co).
And because there is a strong overlap between Bitcoin and Ethereum users with the broader crypto/web3 ecosystem, it’s not hard to assume that demand for options products will cgrow as the ecosystem grows.
This should also be true of the Solana ecosystem which Friktion primarily serves.
Friktion’s product isn’t necassary for sophisticated high-net-worth investors because they can do it themselves with regular options. So, for the moment, the growth in smaller volumes makes sense. Given the expanding market, this is likely to change.
No Native Token, But…
There isn’t much to go on here beyond that the company had previously mentioned a token will be coming “soon”. They also recently removed this notation from their documentation page which may indicate it’s not coming as soon as initially stated.
But, if and when it does come, it’s probable that the token will look something like the Ribbon Finance governance token.
Given the revenue model, the token would be appealing if it provided a way to accrue value based on platform revenue earned.
Bull/Bear Signals
What are activities that would make me bullish or bearish on the platform’s potential token?
Bull Signals
- Expanded their DAO Treasury management business. DAO treasuries can have considerable size but due to price volatility, can also represent a risk to business continuity. Treasury management services are an expanding opportunity that represent an interesting way to accrue fees to the native token.
- More multichain expansion. Friktion has started to expand access to other blockchains beyond Solana. So far, this includes basic access to Ethereum and Avalanche in the covered call option vaults. But in time, it will likely expand these offerings. This increases the surface area that Friktion can use to generate fees and is especially useful for tapping into Ethereum’s more mature market of users.
- Token launch with voting rights and an ability to stake the token to earn yield as a percentage of platform revenue.
Bear Signals
- There is a chance that a token offering could lead to misaligned incentives and a “race to the bottom” mentality that is common in crypto. Ie: making product choices that are strictly designed to pump token price rather than attract and retain revenue-generating users.
- There is a scenario that could emerge where the launch of the token incentivizes the team to market to a user base only interested in holding the underlying token rather than pursuing the actual user base that will accrue long-term value to the platform.
- There may still be an issue with product-market fit. They don’t yet have messaging, how-to guides, and resources for what should clearly be their target demographic – non-technical individuals looking for yield and portfolio protection.
Ie: I’ll be on the lookout to make sure that user and platform incentives stay aligned and that marketing reflects this alignment. Should they come out of sync, I would not want to own this asset. **Caveat** If they lean into treasury management services I would be less bothered by this deviation.
Conclusion:
Friktion is a powerful DeFi application with growing use cases and a growing market opportunity. The platform is easy to use and provides non-technical investors with an ability to conduct a variety of important investment strategies.
Based on the organizations stated goal of launching a token, their revenue model, and the competitive landscape, this application would represent a worthy investment opportunity. That is of course assuming that the token would provide more than simple platform governance functionality.
Regardless of token utility, this is a platform that is worth following.
