A thread on option pricing
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1. Order book vs. Automated Market Makers (AMMs): Traditionally, pricing assets in centralized finance relies heavily on order books, which efficiently reflect market demand.

However, order books pose challenges for decentralization due to storage requirements and high price adjustment rates. DeFi often relies on AMMs, which use mathematical formulas instead of order books, simplifying the process and reducing the need for extensive on-chain storage.

2. Option Pricing Models: In TradFi, options are priced using complex algorithms like the Black-Scholes model, which consider factors such as spot price, strike price, time to maturity,and implied volatility.

However, implementing these models on-chain in DeFi presents challenges due to computational costs and the difficulty of obtaining off-chain data such as spot price and implied volatility.

3. Computational Complexity: Executing expensive computations, like those required by option pricing models, is challenging within the resource constraints of smart contracts on blockchain platforms like Ethereum.

The limited computational resources are in place to prevent network congestion and potential attacks.

4. Off-chain Data: Option pricing models rely on off-chain data, such as spot price and implied volatility, which may not be readily available on-chain. While solutions like Oracles exist to bring off-chain data on-chain,

obtaining certain parameters like implied volatility can be particularly complex, especially for assets without an established market.

5. Innovative Solutions: Despite these challenges, there are innovative approaches emerging in DeFi, such as maintaining an on-chain implied volatility surface updated after each trade.

This approach aims to provide a fair and decentralized mechanism for pricing options without relying on external oracles.

Overall, pricing options in decentralized finance requires overcoming significant technical and conceptual hurdles, but ongoing innovation and the development of new solutions are driving progress in this space. learning more from our kibo Academy docs.kibo.finance/kibo/the-kibo-…