UMA’s Long Short Pair Financial Primitive

Published on: 19.06.2021

UMA has built a new contract template called the Long Short Pair (LSP) contract.

The LSP is simple in its design (around 300 lines of code!) It allows for the creation of arbitrarily complex derivatives with fungible short and long positions and without the need for active position management.

Below is a walk through the LSP’s design and why we’re excited about it.

How the LSP Works

As stated previously, the LSP is simple. There are only three main actions a user can perform.

Mint new pairs of long and short tokenized risk.
Redeem pairs of long & short tokens before the contract has settled.
Settle positions of long or short tokens after the contract has settled. They would be redeemable for an amount of collateral determined by the contract’s settlement price.

At any time, a minter can deposit an amount of collateral, collateralPerPair, to mint one short and one long token. At this time, the minter will be fully collateralized and will have a risk-neutral position. Regardless of how much the long and short tokens respectively settle to be worth, the summed value of the two will still be worth the total amount of collateral used to mint, which means that at any time, the minter can also close out his/her position by redeeming a pair of long and short tokens for one share of minting collateral.

When someone mints the long and short pair of tokens, those two positions cancel each other out in terms of exposure. It is only by selling either the long or short tokens that they get directional exposure. Another user could also gain directional exposure simply by purchasing one of the tokenized sides.

Numeric Example

Let’s now walk through how an LSP would be used to create a covered call option.

A minter deposits 100 WETH as collateral and receives 100 ETHc3000–0721-Long and 100 ETHc3000–0721-Short tokens in return. The amount of collateral needed to mint 1 pair of long and short tokens is determined by the LSP’s collateralPerPair parameter. She deposits them into an AMM to be a liquidity provider.
Trader A buys 10 long tokens for 0.05 ETH per token. Trader A now has the right to buy ETH for 3000 USD if ETH/USD is greater than 3000 at expiry.
Trader B buys 10 short tokens for 0.95 ETH per token.
The minter decides to unwind the remainder of her position. She withdraws her liquidity then does so by calling redeem on the LSP and burning 90 long and 90 short tokens in exchange for 90 WETH. She can do this without an on-chain price because the total maximum payout of any long/short pair is capped at collateralPerPair.

Interplay with UMA’s Optimistic Oracle

UMA’s Optimistic Oracle is live and providing bespoke pricing for myriad live products. It can trustlessly return any deterministic information on anything while being manipulation resistant and acts as the settlement mechanism for LSP contracts.

The LSP contract helps to unlock the power of the OO. Developers can combine the LSP and OO to build traditional or long tail products.

For examples, today, the Optimistic Oracle can provide pricing information for: