Trade without Liquidity Pools? Overlay Protocol | TKX Research

by @Guaaronnnn
editor @FriedWagyuu

Part I. Study on Overlay Protocol


Overlay Protocol is a DeFi protocol that enables users to trade on streaming data without the need for traditional counterparties. Its goal is to allow people to bet on any data streams like on-chain data, financial, political, natural markets, etc. Users can take long/short positions with leverage by staking the native ERC-20 token — $OVL. Data streams are offered by the protocol and obtained via manipulation-resistant oracles.

Trading Mechanism

When traders want to enter a trade, they need to stake $OVL. Users can swap $ETH for $OVL through Uniswap or SushiSwap by OVL/ETH pool and lock up $OVL in long/short positions. When a trader exits the position later with profit/loss, the protocol dynamically mints/burns $OVL and settles the position. Thus, every trade will modify the supply of $OVL.

The Liquidity Problem

Liquidity is always critical to DeFi protocols. Fair trading experience (tiny slippage) usually comes along with deep liquidity pools. The problem with DeFi protocols is that they don’t have much liquidity for certain assets. The liquidity of trading streaming data could be extremely bad in traditional ways.

Overlay solves the liquidity issue by its minting/burning model. Traders simply trade long/short positions using $OVL and exit their position. Then, $OVL will settle the net gain/loss and mint/burn token from the system, which makes $OVL holders the counterparty to all trades in the system.

For example, when the net closed positions are dominated by losing trades. The system will burn more $OVL than minting. The total supply of $OVL decreases and $OVL holders result in wins from $OVL inflation. Thus, $OVL holders are betting against the traders.

Where the Liquidity Comes from

So we now know that Overlay highly relies on the swap between $OVL and other tokens to run the game. Why would $OVL holders hold or even provide liquidity for it?

The first step to trade on Overlay is swapping $OVL on UniSwap or SushiSwap. To incentivize DEX LPs, Overlay will emit $OVL tokens to existing LPs of UniV3. Then incentivize them to transfer to the $OVL/$ETH pair by providing them with higher $OVL rewards. If the $OVL price is volatile, no liquidity provider would like to farm because of impairment loss. So LPs will be forced to use Overlay to build a neutral position so the risk is hedged. Now we have the first batch of LPs and users for the ecosystem.

$OVL also act as the governance token. It can be used to propose new streaming data pools (trading pairs) and parameters like transaction fee and leverage ratio.

Any Risks?

Although Overlay’s inflation model can solve liquidity issues that many DeFi protocols face, the backfire on it is inflation. To control the inflation issue, there is a funding rate that balances the long and short sides. Also, Overlay sets caps on open position sizes and payoff prices, it can effectively control the size of the imbalance trades in the system, therefore, decreasing the risk. Spreads and transaction fees for every trade can be raised to control abuses as well. The fees are the revenue of the protocol and they will be distributed to LPs.

Oracle Attack
If a user can manipulate the oracle feed or front run the news for any market Overlay provides, they take the advantage and rekt the system. To prevent oracle attack risk, Overlay has its risk management model. It calculates the attack costs given a certain amount of liquidity and leverage. The model is used to evaluate the oracle risk of the market pool and determine if the pair can be provided for trading.

Price Spiral
Another thing that needs to keep in mind is when a black swan event happens, $OVL might get into a death spiral. How might that happen? When people lose faith in Overlay and $OVL, people will widely dump $OVL, therefore people who short $OVL would earn $OVL minted from the system. More circulating supply will drive the price lower. Eventually, Overlay might collapse. There is no official solution for $OVL dumping scenarios, but we think the risk management model will manage $OVL oracle risks as a part of it.


Overall, Overlay is an innovative DeFi protocol, allowing people to trade on streaming data without counterparties and liquidity. It is easy to understand and can be a bet-whatever platform in the near future. However, its mint/burn mechanism creates potential systematic risks.

Part II. Market Updates

SEC Files Complaint Against Dragonchain for Unregistered Initial Coin Offering
The U.S. Securities and Exchange Commission (SEC) has filed a complaint against blockchain startup Dragonchain for failing to register more than $16 million in crypto asset securities offerings over five years.

Crypto Venture Capital Firm Dragonfly Buys Hedge Fund MetaStable Capital
Venture capital firm Dragonfly has acquired MetaStable Capital, one of the oldest crypto investment funds, for an undisclosed amount. MetaStable was started in 2014 and once counted Dragonfly Managing Partner Haseeb Qureshi among its general partners, had over $400 million in assets under management as of July 31.

Crypto Lender Celsius On Pace to Run Out of Cash by October
Celsius filed for bankruptcy protection in July, which is also short of $2.8 billion in crypto assets, the court filing reveals. A new court filing included financial projections that Celsius will run out of cash by October.

CME Group to Add ETH Options Ahead of the Ethereum Merge
CME Group, the world’s largest derivatives exchange, would launch options on Ethereum futures on September 12, just days before the long-awaited merge upgrade to the Ethereum network completes, pending regulatory review.

Coinbase CEO: We’d Shut Down Ethereum Staking If Threatened by Regulators
Coinbase CEO Brian Armstrong responded to a hypothetical scenario on Twitter today, saying that in the event of regulatory threats, his company would shut down its Ethereum staking service to preserve the integrity of the blockchain network.

Part III. Fundraising News

Datawisp — B2B no-code Data Platform
Raised $3.6 million in the seed round led by Coinfund. Other investors include Spartan Capital, Mirana Ventures, Dweb3 Capital and Play Ventures.

Gearbox — Composable leverage protocol
Raised $4.15M in a DAO strategic diversification round with participation from Placeholder, Zee Prime, LedgerPrime, Polymorphic and GCR.

Tessera (Fractional Rebrands) — Collective NFT ownership platform
Raised $20M in Series A round led by Paradigm. Other investors include Focus Labs, Uniswap Labs Ventures, E Girl Capital and others.

dWallet Labs — Blockchain security firm
Raised $5M in a pre-seed funding round co-led by Node Capital and Digital Currency Group. Other investors include Amplify Partners, Lightshift Capital, Liquid2 Ventures, Collider Ventures, Lemnsicap, Heroic Ventures, Impatient Ventures, Zero Knowledge, Dispersion Capital, Token Bay Capital and others.

Satellite IM — Decentralized communications platform
Raised $10.5M in a seed funding round led by Framework Ventures and Multicoin Capital. Other investors include Solana Ventures, IDEO CoLab, Hashed, and Pioneer Square Labs Ventures.

About TKX Capital

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Note: TKX Capital do not offer any financial advice for retail investors and we have no affiliation with projects in this research.



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