ILV and Funding Rates
Buyers pay the Writer Pool funding payments at the start of a period in exchange for IL protection.
Funding rates are calculated based on token price volatility, demand for contracts, supply of collateral, and the impermanent loss risk associated with each NIL contract’s strike price.
Each NIL contract sets its own funding rate, and they are reset every 24 hours (i.e. the “Funding Period”). At the beginning of each funding period, the funding payments from Buyers are sent to the Writer Pool. In effect, when Writers deposit collateral into the Writer Pool, their ROI is a weighted average of the funding rates across all NIL contracts using their collateral asset.
As the token price moves away from the strike price, the amount of ILV claimable increases exponentially according to the impermanent loss formula. This replicates the inverse return of impermanent loss on a matching AMM LP position, making NIL contracts a perfect IL hedge.
A token's expected volatility, as calculated from historical volatility and implied volatility, directly impacts the base funding rate of a NIL contract (e.g. cost of IL protection) for that token. As the expected volatility of a token increases, the base funding rate increases exponentially.
For reference, annualized expected volatility of ETH typically ranges from 80% to 100%. So it would cost an LP ~9% annualized to protect a WETH-USDC LP position against impermanent loss, when paying the base funding rate.