$3 000 USD

MAY 2020

GLOBAL

HEGIC EXCHANGE

DESCRIPTION OF EVENTS

"Hegic is an options protocol taking a fresh approach to minting and trading options." "Trade non-custodial options for profits or to hedge your positions. Enjoy fixed price and unlimited upside of the options contracts. No registration, KYC or email required.". "Traders and holders can use options on Hegic to insure against price volatility. Consider ETH is worth $500, and a user buys an option contract, which enables them to sell one ETH for 500 DAI within some time window. If ETH price tanks to $400, the user can safely exercise the contract, liquidating their position for 500 DAI." "Hegic Protocol V1 code has been audited by @trailofbits. Security audit includes HegicOptions, HegicCallOptions, HegicPutOptions, ETHPool and ERCPool contracts."

 

"Hegic made its debut on the mainnet on 23rd April 2020, hours after going live, they claimed to have a bug in the smart contract. The bug locked user funds into expired options contracts, rendering them permanently inaccessible. Up to $48,000 worth of funds were forever locked up in the platform’s smart contract." "All found issues were fixed and now IT IS MUCH SAFER TO USE THE CONTRACTS!"

 

"Instead of a P2P orderbook based model, Hegic uses a pooled liquidity P2C (Peer to Contract) model for users to buy & underwrite options. Options buyers buy calls/puts that are underwritten by the collective funds provided by Hegic liquidity providers"

 

"However, not all LPs are created equal. Older LPs have accrued premiums over time while newer LPs have not and carry the same underwriting risk (their liquidity is also used to cover pre-existing options)" "In addition, LPs can remove their liquidity at any time, taking the revenues (not just premiums) from options paid for while relieving themselves from downside risk."

 

"New LPs take the burden [of old LPs], not having gotten paid premiums." "An opportunistic LP that understands this would provide liquidity early, accrue revenue, and remove liquidity before potential exercising of options. A clever one may even purchase options themselves to expedite the process."

 

"The code was reviewed by many talented individuals including @0mllwntrmt3, @trailofbits, and @samczsun, but the shut down of Hegic V1 resulted from a weak point in system mechanics."

 

"Someone did just that." On "May 21, 2020, Hegic Options was arbitraged out of $3K." "Over 13 transactions & 1.5 days, this LP netted ~$3,340 in profit."

 

"@HegicOptions has shut down again. Not due to an error in the code base, [b]ut from a fundamental design flaw that was exploited."

 

"Taking into account recycled capital, this was essentially a quick low risk 22% ROI." "The LP mainly profited from the DAI (put) pool. They went through the following process twice: (1) Deposit Liquidity. (2) Purchase Put. (3) Withdraw Liquidity. (4) Exercise Put. 1st Round = $500 Profit. 2nd Round = $2,843 Profit."

 

"To maximize profit, the LP bought DEEP ITM puts at strikes of $990 and $2,800 when $ETH was at ~$190. Doing so minimized the size of the premium of the option relative to the total price. The 2nd round contracts cost $2633/ea with the premium comprising 0.8% ($22/ea)."

 

"The actual profit is derived by looking at the LP capital withdrawn from pool, and subtracting the costs (premium + LP capital initially provided). In the 2nd round, $10,512 + $389 = $10,901 was withdrawn, $58 paid in premiums, and $8,000 initially deposited = $2,843 profit." · "The profit came from other LPs who suffered substantial % losses even though there was no price movement from option purchase to exercising. The time from Put purchase to Put exercise was ~30 min in both rounds."

 

The algorithm was changed on June 2nd. "This is how early exercising / "re-selling" of the options contracts to the pool works in v1.1 on https://hegic.co now." "Your profits" = net profits on this particular trade excluding the costs (premium + settlement fee): the price paid for an option."

 

"Molly is currently working on a V2, where a lock up period is added and premiums are only distributed after option expiry."

Hegic Exchange had an options service, which ran through a smart contract hot wallet and had an issue where newer liquidity providers missed out on potential upside, which earlier liquidity providers could capitalize on. It was estimated that $3k worth of additional profits were exploited before the protocol was upgraded. It does not appear that the Hegic team has done anything to make right the differences.

HOW COULD THIS HAVE BEEN PREVENTED?

It was unclear from the analysis performed whether any customers lost funds or were simply short on potential profits. Platforms in general should prepare for the full loss of any hot wallet funds, and have funds available to assist customers in such situations.

 

Check Our Framework For Safe Secure Exchange Platforms

Sources And Further Reading

 For questions or enquiries, email info@quadrigainitiative.com.

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