When describing Bumper to new people I’ve just met I normally begin with a very simple, big picture, one-liner, such as “it’s crypto price protection that stops you getting utterly Rekt when the market bombs”.
Of course, after this massively grandiose headline, almost always the very next question asked is generally some derivative of “okay, so how does it do that?”.
But occasionally, some curious big-brain chucks out a superb curveball question, and last week whilst attending a crypto event, I was hit with one that was phenomenally insightful, and which took the conversation in an altogether different direction — and actually made the whole value proposition behind Bumper even more clear.
I was asked, not how” it worked, but "why”we built it.
This is such a profound question, which goes well beyond talking about exactly what features it has, and its’ basic mechanics, instead getting deep into the motivation and some of the core philosophy of the protocol and the team behind it.
My answer was that we wanted to make a risk market that was actually both efficient and fair and didn’t disadvantage of one set of users over another.
This is the absolute core of Bumper’s philosophy, and really allows you to get into thinking about Bumper in a more nuanced way, and it’s worth unpacking it a little.
What is Bumper?
Bumper is designed to be an autonomous software market which facilitates the trading of price risk, allowing one participant to shift their risk to another in return for paying a premium.
In other words, it’s core function is as a tool for hedging against downside risk, something which is a really good idea in such a volatile market as crypto.
Even before Bitcoin was released, in fact for many decades prior to the first cryptocurrencies, the tools used by traders to hedge risk have changed very little.
Setting Stop Losses on exchanges and buying “Puts” on Options Desks remain the two most widely utilised hedging techniques. Although the advent of digital trading made them more accessible to the average retail trader, these tools have been around for a very long time and the basic way in which they work has hardly changed at all.
Stop losses are obviously great for many traders, as they allow them to trade out of positions when a market crash happens, but there are some serious downsides and occasional unintended consequences which can (and frequently do) occur. The biggest problem, as every trader who has experience of them knows, is that markets do tend to have an uncanny tendency to trigger your Stop, and then rebound upwards again, leaving you chasing the upside.
Similarly, Put Options have existed for over 100 years, but again, how they work hasn’t changed in decades, and it’s in examining the downsides of Options trading that Bumper’s real differentiator shines through.
Put Option Pricing: Not Fair!
In the Options market, two individual participants engage in a combative game against one another.
A strike price, expiry date and the premium which will be charged are agreed by the Buyer, and the game begins.
If the price of the asset is below the Strike price at expiry, then the buyer has the option (but not the obligation) to either sell 100 units of the asset at the Strike price to the seller (who is obligated to purchase them), or they can simply pocket the difference.
This makes buying Put options a great hedge against downside volatility.
Both sides naturally want to win the game, as winning means you claim all the profits, whilst the loser, well, they get nothing meaning it’s always adversarial — You don’t want the other side to win!
However, Sellers of Put Options have a huge advantage over Buyers, as they alone decide how much premium — the cost of the contract — the buyer will pay.
The method by which they price the premium is solely at their discretion. They may employ a mathematical model such as Black Scholes, Monte Carlo or the Binomial method, or perhaps they might pick a number by throwing a dart at a board randomly. Either way, the method used to price an Option is known only to the Seller, not the Buyer.
Naturally, as sophisticated Options sellers intend to make a profit, this logically implies that Sellers believe they have priced their contracts to win. And the kings of this game tend to be institutions, with loads of liquidity, and people who are very good at Math.
Of course, you don’t know how volatile a market will be in the run-up to the expiry date, so there is always some risk a Seller will lose the odd game. And it would be logical to assume they factor these occasional losses into their pricing calculations — i.e. you, as a Buyer, might well be paying an additional cost to cover potential losses the Seller incurs playing against other people.
Conversely, this now means a sophisticated Buyer must ascertain whether their personal risk pricing information and methodology is superior to the Sellers — and that’s extremely difficult, if not mostly impossible, especially if you’re up against experts at this game.
Thus, Bumper holds that the pricing of risk throughout the world’s most widely used hedging method is basically unfair, in that it inherently puts one side at a disadvantage.
In response to this, we built Bumper — a risk market in which pricing is achieved fairly. How? Well, instead of paying an opaque fixed premium at the front end, we use an ex post facto (retrospective) pricing method — in which premiums are charged based on what the market does in the future… as it happens, in real-time.
Whoa, dude, mind-blown… say that again?
To put it simply, the premium you pay as a Put Option buyer is an agreed price for someone else to assume your risk.
However, the buyer and the seller are pitted against one another in an adversarial game, where both attempt to maximise their individual profit (in other words, they want to win)…but one side possesses information which the other does not have access to.
Not fair, Right? Doesn’t that just sound like something which would be devised and dominated by large institutions who are experts at extracting money?
Bumper on the other hand doesn’t charge its premiums upfront.
Instead, the cost of protection is calculated and applied incrementally, based on the volatility of the market and the current state of the protocol, during the time you are participating.
Whilst neither side knows what the premium will be upfront, they do know the methodology for pricing risk and can trust it will be managed fairly via the smart contracts which are responsible for executing all the protocols functions.
Ok, got it… now we can talk about how Bumper works!
At this point, it’s worth introducing some Bumper terminology.
We call the participants Takers (who are comparable to Options Buyers in that they want to protect their crypto assets against downside volatility), and Makers (the yield-seeking liquidity providers similar to our Options Sellers).
Takers choose a term length (in days) and a floor price, which is akin to a Strike Price in Options trading. before locking their crypto into Bumpers smart contracts.
Makers choose a term length (in days) and a level of acceptable risk tolerance proportional to all the other Maker participants. Then they deposit stablecoins into Bumper.
One more thing — each side isn’t paired up against one another in adversarial combat. Rather each side interacts with a separate pool, with all the Takers depositing the same crypto asset into one pool, and the Makers all depositing Stablecoins into another.
When the protocols state changes (e.g. due to volatility), Bumper calculates a premium which is applied not to individual Takers, but across the entire pool, spreading the costs out more evenly.
During the course of a term, Premiums might be charged to the Takers pool many times, but each time it will be a fraction of what would have been charged had they paid a single premium upfront.
Takers exit by closing their positions and they either retain their original tokens (if the price finishes above their floor), or they leave their original tokens and instead claim Stablecoins (from the Maker’s pool) at the value of the floor should they finish below it.
Either way, the proportion of the premiums which were applied across the pool are deducted, and, along with any tokens left over when Takers made a claim, this forms the basis for the potential yield for the Makers.
Bumper Fair Pricing
Bumper’s risk market is not only provably fair but actually has the net effect of improving price efficiency by removing the guesswork from calculating the cost of protection. (including not having to pay extra for the other side’s lost gambles!)
Whilst we’re not going to go into the minutiae here (we recommend this article on how premiums are calculated if you want to know more), the basic crux of the methodology is that when volatility is low and/or the price of a protected asset is significantly above the floor, premiums are lower, due to the reduced risk that a protection Taker will end up under the floor.
However, when volatility strikes and the price starts to come to the floor, then premiums increase as the state of the protocol is updated, which in turn incentives a Taker who’s under the floor to exit with their profits.
This satisfies all protection Takers, as they know they haven’t paid a single penny more than the fair price for protection, and simultaneously Makers are happy because they derive a fair yield for assuming risk.
So, why did we build Bumper as we did? The long and short answer is that we wanted to use the powerful features afforded by Web3 DeFi technology to design a financial resource of great value — namely a totally fair and cost-efficient way to stop your wallet from getting totally Rekt.
Who wouldn’t want that… (except bankers — well maybe even some of them)?
Be like Big Brain… find out more!
Now, if you’re ready to really get your mind expanded, sign up to get updates and you’ll discover even more cool features of Bumper including:
- How Bumper lets you protect your crypto AND still use it in other DeFi protocols.
- How to use Bumper to earn seriously bodacious yields on your stablecoins.
- Why BUMP tokens are vital if you want to protect your crypto.
If you’re intrigued and a little curious about what else Bumper does, we'd invite you to follow us on Hive, as well as other social media, and definitely join our Discord community.