Providing liquidity

The counterparties to the trades described above are called liquidity providers. These investors occupy a similar role to market makers in traditional options and spot markets but are more passive.

One of the defining characteristics of InfinityPools is the fact that the options mentioned above are created from loans of spot liquidity. In other words, imagine if a trader was able to borrow limit orders on a spot orderbook (InfinityPools uses a concentrated liquidity AMM, which is conceptually similar). By borrowing these limit orders and paying a premium upfront, the trader would then reserve the right to buy or sell an asset at a given price for the duration of the loan. This is what defines an option.

A few particularities of concentrated liquidity AMMs before diving in deeper:

• Liquidity providers have something similar to resting spot limit orders at every tick across a given price range.

• Each of these spot limit orders is fully collateralized (a limit order to buy 1 ETH at 3000 USD will be backed with 3000 USD).

• These orders are also reversible (if a buy limit order is hit, it pops up as a sell limit order at the same price plus spread - and vice versa).

Traders looking to buy OTM options do so by borrowing these limit orders. As a result, liquidity providers are simultaneously providing liquidity to a spot market and selling covered options when required.

The interesting implication here is that InfinityPools liquidity providers do not have a lower bound on the length of the maturities of the covered options they are selling, but do have an upper bound (exponential with a half life of a day):

• The first insight is that liquidity providers' have the same payoff when selling very shorted dated covered options as when just providing regular spot liquidity (while getting higher yields in the former scenario). As such, liquidity providers have no need for a lower bound on the maturity of the covered options they sell. This is crucial to enabling higher levels of leverage as those trades require extremely specific maturities that would otherwise be hard to match.

• The second insight being that liquidity providers do not want to be "locked in" for long amounts of time (the exponential maturity in InfinityPools's case).