Overlay Protocol

Introduction:

Overlay is a protocol that allows users to trade nearly any streaming data without the need for traditional counterparties.

Community members will be able to propose and vote on any non-manipulable, unpredictable, on-chain data to become a tradable market on Overlay. This data can be nearly anything: DeFi tokens, sentiment analytics, Seattle’s crime rate, NFT indexes, political and natural markets, the list goes on.

While streamable data represents an explosive growth of new and fascinating tradable markets, our V1 will be centered around DeFi data streams. DeFi tokens represent the greatest use case as there are few direct ways to hedge price exposure to DeFi tokens on-chain. This is a serious issue, especially for users of nascent DeFi protocols that are exposed to the volatile price movement of tokens with largely illiquid markets.

Overlay is an elegant data trading system that aims to solve this problem while also opening access to a multitude of new markets for DeFi users.

What is Overlay?

Overlay is a protocol for trading nearly any data stream, long or short, with leverage, using price oracles and a native token (OVL).

The Overlay mechanism is simple: traders enter positions by locking up OVL tokens in long or short positions on various data streams offered by the protocol. Data streams are obtained via manipulation-resistant oracles. When a trader exits that same position later, the protocol dynamically mints/burns OVL based on their net profit/loss for the trade to compensate them. This is reflected in the total existing supply of OVL.

As an example, if a trader locks up 10 OVL in a position and the associated data feed increases 20% in value, the protocol would mint 2 OVL to the existing supply and credit the trader with a total of 12 OVL on unwind. Conversely, if the feed had decreased 20% in value, the protocol would burn 2 of the trader’s 10 OVL tokens from the existing supply and return 8 OVL to them on position unwind.

OVL token holders have the power to shape the future of the protocol. A dedicated Snapshot page will be live after launch to enable the OVL community to quickly signal support for or against governance proposals. On-chain governance similar to that of Compound will be the end goal.

What is Overlay’s monetary policy?

Overlay recreates the dynamics of trading but without the need for individual counterparties. It does this by solving the liquidity issue found in prediction markets and replaces it with a local inflation problem, where passive OVL holders effectively act as the counterparty to all unbalanced trades in the system (i.e. imbalance between longs and shorts on a market).

To manage the inflation problem, the protocol uses caps and fees. The Overlay system has caps and fees on the imbalance between longs and shorts for each market as well as caps on position size.

Protocol revenues come from trading fees charged on each trade. These fees are passed through to Overlay’s community governed treasury, which provides incentives for spot market OVL-ETH LPs in addition to our initial liquidity mining rewards. This spot market liquidity incentive creates a feedback loop to offer a reliable price feed for OVL-ETH on the protocol’s trading platform that traders can then use, if they wish, to hedge out a portion of their OVL price risk in each of their trades.

OVL tokens are created and destroyed dynamically upon unlocking, and so a user’s net OVL worth depends on the quality of trades that user makes.

Governance:

Since all PnL is denominated in OVL and the OVL token also serves as the native governance token of the protocol, it gives successful traders even more skin in the game. OVL enables holders to propose new markets on Overlay and determine per-market risk parameters such as trading fees and maximum leverage levels. Given all PnL is paid out in OVL and traders will initially need to stake OVL to trade on the system, OVL effectively becomes a liquidity sink for all trading activity on the protocol.

Our Values:

The core ethos of Overlay is to create a self-sustainable protocol with the community at heart. Overlay users are the most important stakeholders of the protocol and will have the power to decide what new markets are introduced to the system in addition to a variety of other key protocol parameters.

Global data sources and interest in monetizing data will continue to grow, with no end in sight. Overlay has enormous potential to serve as a go-to platform which offers investors, hedgers, and speculators exposure to financial instruments they cannot get anywhere else.

With enough momentum, Overlay could remove the need for traditional counterparties and give DeFi users the ability to turn nearly any data stream into a financial instrument.