Sep 23, 2021

3 min read

How Pharo eliminates Cover Jacking

Developing the Pharo algorithm has consistently surfaced two questions:

  1. How is this not betting?
  2. What stops bad actors and wild narcissistic estimates?

It’s fun to screw around when nothing else matters, every discord server gets hit hard by “wen moon” and “airdrop please”, but you can’t rely on them long term. IRL we can recognize narcissism by peoples’ actions and gossip, a couple of questions around what they’re looking for and what they’ll give is a great way to know their intentions, and this is EXACTLY what Pharo requires for participation. Pharo is an automated cover marketplace, and it will not match bad offers.

Bad actors want to manipulate marketplaces in their favor, and since price is determined by your rate estimate, why not estimate in their own favor? … But what exactly is in their favor? Rate estimate determines $PHRO rewards when the event is triggered, so they’ll wanna get that right… but why not collect AS MUCH in fees as possible before the event, or ask for INFINITE cover?

TL;DR: No one would want what they’re selling.

To participate in the Pharo market, the protocol ensures “self consistency” by asking Cover Buyers (CB) what minimum cover they require, and asking Liquidity Providers (LP) what *breakeven risk they’ll accept. These values are compared against their stake and rate estimate to determine “self consistency”, where CBs can’t ask for more cover than their rate and fees allow, and LPs can’t ask for less risk than their rate allows. In other words, Pharo looks at users’ answers and asks the question, “Is this user’s ask realistic, whether cover or risk ask, compared to their rate estimate?”, if the answer is “no” then they gotta go!

Now that all users are self consistent, is there market demand for their product? Pharo is an Event Volatility Swap, which works when CBs give their cover needs while agreeing to pay a premium for stability, and providers give their appetite for risk while agreeing to predictable short term losses due to volatility.

For those wondering if Pharo is really a betting platform, the CBs are agreeing to lose money just to enter the market, which sounds like a terrible bet to me. CBs are accepting a premium in exchange for long term stability, and LPs are accepting those premiums in exchange for short term instability. This acceptance criteria is built into the rate, stake, minimum cover, and maximum risk required to enter the market. So a CB could say protons will decay before the event happens, but the acceptance criteria allows Pharo to recognize that no LP has agreed to accept such an extreme risk, and so the CB’s offer would be rejected. Conversely, an LP could say the event is guaranteed to happen in an attempt to *breakeven asafp, but the acceptance criteria allows Pharo to recognize that no CB will accept THAT little cover, and so that LP’s estimate would also be rejected.

So be consistent with yourself, make a reasonable offer, and the protocol takes care of the rest, right? Yes, as long as the crowd’s wisdom prevails, yes… Prevailing wisdom is still a model of reality, Black Swans exist whether you’ve found them or not, so what then? Stay tuned 📻

* Breakeven means the time it takes for fees collected to match liquidity staked.