Loan and Call Option Model

The mechanics are straightforward. The issuer lends a quantity of tokens for a defined term. The market maker uses that inventory to quote both sides of the book. At the end of the term the market maker either returns the tokens or exercises call options to buy some portion at pre agreed strike prices, typically set at a premium to the price at the time of the loan. The issuer pays no cash, which is why the structure is attractive to teams with limited treasury. The incentive question is what makes the structure contentious. Under a cash retainer the market maker is paid to quote, and quoting quality is the whole of the service. Under a loan and call option the firm's largest source of return is the option, whose value rises with the token price and with volatility. A firm holding options struck well above the current price has a different relationship to price movement than a firm on a flat fee. That does not make the structure wrong. It makes the quoting obligations, and the ability to measure them, more important rather than less. The terms that matter most to an issuer are strike ladder, option coverage, term length and return mechanics. A strike ladder spread across several price levels is generally better aligned than a single low strike. Option coverage well below 100 percent of the loaned amount keeps some of the firm's return tied to the service rather than the option. Term length should match the period over which the issuer actually needs liquidity support. Return mechanics should say exactly how unexercised tokens come back and on what schedule, since a large unstructured return can itself move a thin market.