VIP5 Part 1:
Who killed the coupon? A forensic analysis
Over the past month, coupons as a concept have quickly lost traction across the DeFi community. ESD has a massive debt but relatively few buyers, and DSD’s coupons were the first in the community to expire. Outside of the major coins, new forks seem to go into contraction and remain there as coupons seem to have lost all power as a counter to balance expansion cycles. Influencers in this space and veterans seem to want nothing to do with them. Most of you probably have this gut feeling that coupons are not worth buying. Then came a wave of “solutions” to the coupon problem, from raising yields further, to custom expiry dates, auctions for coupon prices , or draconian controls on liquidity on the dao to prevent the physical act of selling (https://algostable.medium.com/why-algo-stable-bonds-dont-work-cb218eb2e59e). But you have to be skeptical about solutions offered when no one has yet offered a convincing diagnosis of the problem at hand. Let’s go over point by point the death of the coupon.
Background: VTD team has a background in finance. We’re trying to keep this as understandable as possible, do excuse some gross oversimplifications here and there.
A Coupon is not debt, it’s a call option.
Since you’re in crypto, you’ve probably been in r/wallstreetbets for the last year and know all about options. If not, a call option is a contract that lets you buy something in the future at a set price. In other words, it’s a way of betting that the price is going up. The more it goes up, the more money you make. Let’s decompose a coupon in these terms, I promise it will make sense when I bring it all together.
A coupon has: (we’re just using the standard ESD coupon for ref)
- Strike price of $1.
- A duration of 90 epochs.
- A coupon premium of 55%, this means something that is potentially worth $1.55 is trading for 1 token. If the token is $0.5, it means this option is priced at $0.3.
The strike price in options is the most important thing, it means when you can exercise the option. You only make money when you can exercise it. Because the peg is always $1 and not variable, buying a coupon means you need to evaluate the probability of the token going up to $1. So when the token is at 95c, the coupon becomes much more attractive, because most people can see the possibility of it going up.
The second piece is the duration. Part of the value of the coupon is the time it is usable. The longer the duration, the more chances it could go into the money and become profitable. This is partly why no one likes buying the coupons at the start of a contraction, because everyone knows a typical contraction goes for quite a long time, and the longer you wait before you buy, better your chances that it will go into expansion before the coupon expires. You probably have an intuitive feel for this, if you held the coupon for awhile, your coupon is somehow less valuable.
Finally, the coupon premium is just another way of showing the coupon price. The higher the premium, the cheaper the coupon is.
So with all these explained, what if we priced the coupon like the option that it is?
A Coupon is dead because it’s Overpriced!
If we used a simple black scholes formula (the basic model that underpins stock option pricing). Using Jan 19th’s ESD prices: A spot price of $0.5, a strike price of $1, a duration of 30 days (90 epochs), and a volatility of 200~300%. The call option is worth about $0.07. It’s true that when it hits $1, the payoff has a immediate jump unlike stock options, but there’s also a penalty for redeeming the coupon early. Nevertheless, it’s selling for around 30c for something that’s probably worth 7. It’s not worth 4x that’s for sure.
The conclusion here is a straightforward one. It’s not about sell pressures or buy pressures, lock ups or liquidity, whales or retail. It’s simply the fact that buying a coupon is a bet that the token will go up to a $1, and many of you have had this gnawing feeling that somehow, you’re being ripped off! Add to that the opportunity costs from what you miss out and the risk of not being able to liquidate… That’s why coupons are dead.
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Since VTD added dynamic pegs, the bet the coupon is expressing has changed significantly. Because you’re simply betting that the token price will go up more than the momentum trend. Depending on the feel of the momentum, coupons can be really cheap, and worth a lot more than their price. Nevertheless, it’s a crude and clunky instrument. Which brings us to VIP5: If coupons are just call options, let’s make them more like call options!
