How to Katana — The yield machine on Solana • A deep dive

For ANYONE looking to generate yield on their crypto assets, Katana is there for you.

The Katana protocol enables users to passively access the best risk-adjusted yields in the ecosystem by offering a suite of packaged yield products across the risk spectrum. This makes Katana THE yield generation layer for Solana.

Katana caters to anyone looking to generate yield on their crypto assets

This is a deep-dive into Katana, their Vaults 🔐, What and How do they generate those yields? a Complete breakdown ☑️, and of course going from the basics of Options and How the strategies pay off in real life. + some exclusive stuff🛣️

A fun fact 🧐: Katana is a Japanese sword that was used by samurai 🥷 in feudal Japan.

LFG 🎢

Katana was started as a project by two incredibly experienced folks Ayush Menon who is an experienced Solana developer, a two-time Solana hackathon winner, and Eric Nie who is also a seasoned DeFi developer, who previously built a DeFi protocol on Ethereum, managing the full-stack from idea to product execution.

They participated in the Solana Ignition hackathon, won the Grand Prize, and then, ended up not only winning it but scaling the product further with a rapid pace of development and then raising a whopping $5 Million from the world’s leading investors🤯.

What does Katana do?

The main feature is their VAULTS 🔐. This is where anyone can simply deposit into their desired vault and start earning yield and, that without any active management from your end. Then from where the yields will come from?

Katana implements some complex strategies into the Vaults and makes it simpler for the end-user to earn a diversified and more sustainable source of yield 📈.

While some might think that this is yet another liquidity-mining led program, It is NOT! Katana’s yields are not dependent on liquidity mining programs but Simply the price action 📊 and that’s how it is able to offer a diversified and a more sustainable source of yield.

But What are those strategies ??, How katana is able to do that, and Why it’s a Big deal?

Let’s understand by going from the basics of How this works in Traditional markets, Some quick basics about what are the strategies, their pay-offs, and then How KATANA implements these to generate those yields.

Samurai! 🥷 Ready?
Here you go 🚀

A sneap peek into Traditional markets 🏦

Here’s my new finance understanding of this, in Wall Street, there are firms that have access to high net worth individuals. The firms have certain types of structured products that are somewhat complex and allow them to earn a yield by combining those instruments with strategies that those either funds or bankers run for them, and the strategies may typically involve, the sale of options and some hedging with some asset.

This is what has been restricted to those folks. Well, not because it’s Wall Street, but because it requires some capital upfront to begin with. Katana is able to democratize access to this.

But what does Katana do underneath? Options Strategies!

Options basics 💰

Derivatives in simple terms are a bet between two parties about an ‘underlying asset’ without actually owning that asset. Futures & Options are two major classes of derivatives, which derive their value from an underlying asset like stocks, commodities, or even cryptos!

More precisely Options contracts give the choice to the traders to either buy or sell an underlying asset at a specified price on a predetermined date with a fraction of the price upfront. Unlike spot trading which is based on the current market price and has linear returns.

Options allow creating complex and more non-linear returns while having the market view.

A Simple visualization of options fundamentally (source: original)

So what are the components and entities associated with Options? let’s understand.

As the name depicts, Options are literally the “Option” to buy or sell an asset at a future date! For example, buying Solana (SOL) Options at a strike price of $100 would mean, you will have the right to buy Solana at $100 after 3 months (it’s the expiry), whatever be the price of Solana.

So, if the price of the SOL is $200 after 3 months, a trader will simply buy the SOL at $100 from the options derivatives, and then sell it at $200. Simply, a profit of $100.

Now, if the price of SOL is $50 in the market, the trader wouldn’t like to buy the SOL at $50. He will simply reject the option to buy. This is simply the ‘call option’.

It might seem like, the option buyer is in a win-win situation because they can only exercise options when it benefits them?🧐

Obviously, there’s no “free lunch” in finance. So, every option has a price that the buyer pays to the seller. This is called the premium and is paid regardless of whether the buyer exercises the option or not (You can think of it as the price you have to pay to get into this type of Contract). Let’s suppose, in our example, the premium is $10.

But why that? Because fundamentally the seller was holding the contract before you who has this choice of exercising them in future but as you are taking that from the seller you are paying the seller for that.

Continuing on the above example, let’s consider three scenarios:

1. If the price of SOL is less than $100 on the expiry date, it would not be profitable for us to exercise our option at $100. This option is called an out-of-the-money option (OTM). The loss will be equal to the premium of $10, which is paid to the “Option seller”.
2. If the price of SOL is $100 on the expiry date, that option becomes the At-The-Money option (ATM).
3. If the price of the option is more than $100, then the option becomes In-The-Money. But, we will make a profit only if the price is above $110 since we have already paid a premium of $10.

Why use Options

Again going back to the point, Options are a type of derivative, meaning their value relies on an underlying asset. So with options, you can go for

1. Hedging: Minimizing and securing your loss in your current positions.
   along this line, there is something called *Delta* which katana uses to choose the strike price of options.
   tl;dr: A “delta” is the amount a derivative’s price changes as the referenced underlying asset changes in price.
2. Leverage
3. Non-Linear Returns

Options in a Nutshell (source: original)

Covered call & How it works

Covered calls are a popular options strategy in which a trader sells an out-of-the-money call option on an asset while simultaneously holding the asset.

This strategy allows traders to maintain their existing assets while generating instant yield from the contract’s premium. This strategy is generally employed when your outlook on the assets price is neutral to moderately bullish.

If the price of the asset remains below the strike price at expiry, the options are worthless and the user has earned the full premium as their return for the period.

if the price of the asset exceeds the strike price at expiry then the options will be exercised by their owner at a lower strike price instead of the current market price. As a result, the trader has now sold the underlying asset at a lower price point instead of benefiting from its full price appreciation.

Source: investopedia

These things fundamentally make up for the behind-the-scenes with Katana’s strategies. But Why Katana?

Why Katana?

Previously, if one wanted to execute a yield farming or options strategy, they would have to do so manually — a tedious process that requires a high level of sophistication to optimize profitability. Katana automates and optimizes yield strategies through vaults, allowing anyone to passively invest and generate high yields.

If you look at DeFi, none of the options protocols have natural liquidity, so these strategies are actually impossible for retail to execute and let alone at like sort of an optimized scale, right?

And that’s where Katana comes in!!

Key Features of Katana 🔷

Vaults 🔐

In DeFi vaults are referred to as to describe a pooling of funds. Here in Katana, there are Vaults that pool user funds and put them into work by executing automated yield strategies. So users don’t have to execute those complex strategies manually also trying to get profitability and instead Katana’s vaults is giving access to a given strategy by simply depositing their assets into the vault.

What happens after you have deposited your assets?

As Katana’s vaults, today run in weekly round structures, as assets are locked over the course of the week while the yield strategy is being executed.
And assets are automatically rolled over and auto compounded into the next period, thereby requiring no involvement from the user until they wish to withdraw their funds.

So what are the other benefits you might be thinking?

Simplifies access to complex strategies: As it is fully automated with complex optimized strategies with algorithms you don’t have to manage your funds manually and instead get a sustainable yield in return

Built on Solana: As Katana is built on Solana it is incredibly Fast with low transaction fees, improved user experience so Wider design space of strategies.

Yes, But How do all things work here? How it is executed to give such Yields? 🤔
Let’s understand

How does it work?

Let me make it clear up front! You will be amazed at what goes on under the hood to give this seamless experience and those sustainable yields.

None of the options protocols have natural liquidity, so these strategies are actually impossible for retail to execute. and scale is a nightmare in this manual process.

So what the vault does is it does exactly that, it pulls capital, that’s the one strategy now, so the vault operates by a certain policy. Katana targets a delta of 0.1 which is just a certain amount of out-of-the-money where it’s a careful balance between, what you earned and the likelihood of you getting exercised. so like covered call? it’s essentially selling potential upside on an asset for guaranteed yield today.

And when you look at executing this strategy yourself, you can’t because you can’t actually sell rate calls for example or whatever mango calls. Nobody will buy them from you. So what katana does is that it has a partnership of market makers that bid on Katana’s vault assets via an RFQ(Request for Quotation) process. So every Friday katana initiates, with these weekly strategies.

This means Katana mints options on Zeta markets and sells these options in a Dutch auction to market makers. So that’s how katana gets the liquidity. So Katana brings its own liquidity to katana itself and is then able to get really really good pricing on these options because Katana has a competitive market essentially right through this Dutch auction that Katana runs with the largest crypto option market makers in the space. So that’s generally the big value.

That’s the Big deal here 🤯

What’s in it for you? 💁

Added to that, you get perpetual option exposure by simply depositing into a vault.

So number one, you don’t need to know how to execute these strategies yourself. You just need to understand the benefits and also the risks right before depositing in the vaults.

After that, you can come back 52 weeks later and you’ll have earned 52 weeks of the covered call on whatever asset you deposit or the cash-secured 👍.

This essentially offers you a way to passively express market views and generate additional earnings in the vault format, and generally what Katana looks to provide.

so this requires users to be on-chain right?

Yes! you can’t be on a centralized exchange, so I imagine this is an excellent example of why users should go on-chain versus keep their assets on centralized exchanges. Of course security, and not holding your keys, not your coins, has been the meme forever. But this unlocks truly known use cases of that.
This is also driving a lot of hard change for users to participate in this type of on-chain activities of excellent products.

Again owning your own keys is not for everyone, right? And there is like a market that we can tap into today because katana is uniquely on-chain, unlike any centralized infrastructure. Recently in a Twitter space, **Ayush,** the founder of Katana also said,

“I’m interested in exploring maybe the fintech layer that could sit on top, that potentially could abstract away some of the complexity, enable a wider market to access our products without necessarily having to set up a phantom wallet.
Remembering those 12 words and writing them down somewhere results in some drop-off in user conversion. So yeah, I’m interested in exploring how we can kind of mitigate that.”

What katana aims to do 🎯

In the future, Katana will implement governance processes by which anyone can submit strategies and products directly to the protocol itself.

Katana looks to transform yield generation for the better. In building a truly decentralized and permissionless protocol for yield generation,

• Democratize access to sophisticated and optimized yield strategies
• Enable anyone to contribute strategies and products to the core protocol layer
• Allow developers to permissionless build products and protocols on top of Katana that source yield from the base layer
• Transfer ownership to the community
• Better align incentives and distribute upside to all stakeholders of the protocol

Using katana 🚁

With the simple design of Vaults in Katana, it’s very easy to interact with the vaults

1. go to app.katana.so, and Connect your wallet

Landing page Katana

2. Select the vault you’d like to deposit into. For now let’s go with the first one, SOL covered call.

All vaults

You can also see the description of the vault along with the risks.

Vault description

3. Enter an amount to deposit and Click Deposit

Depositing SOL into the vault

4. Done!! Now start earning yields.

And for withdrawing you can go to the Withdraw tab and withdraw your assets whenever you like.

Analytics

And here in the Analytics tab 🤑, you get the amazing analytics of the vaults with their credentials.

Analytics of Katana Vaults

Some more Info and terminologies

Shares: In Katana “shares” represent their ownership in the vault. These shares can be claimed at any time and are only necessary to initiate a withdrawal. Whether they are claimed or not, the shares change value over time to reflect the performance of the strategy. Thus, if the strategy is profitable over a given period, the shares will be worth more than when they were minted to the user.

Rounds: Katana vaults operate in a weekly round structure, meaning funds are locked in the strategy during the course of the period. Each period begins on Friday morning EST when the strategy rolls over and new options are minted. At this time, deposits in the deposit queue are initiated into the strategy and begin earning yield.

Timing: If a user deposits anytime before the start of the period, their funds will remain in a deposit queue and will only begin earning yield starting Friday morning EST. So Thursdays are recommended for deposits in order to ensure their funds are not sitting idly for an extended period of time while guaranteeing they are incorporated into the strategy for the upcoming next round.

How the strategies pay off 📈

As we already discussed how options work, now let’s explore how the strategies reflect from a use case of Katana.

Covered call
Take this example. (one tip while understanding: Just go one step at a time and take time. I know it’s a bit of advanced stuff)

Call Covered option
Strike price: 150
The market price at expiry: 200
Weekly performance Premium: 0.27%
Suppose, an investor purchased 1 SOL@ 120 (Entry Price) and deposited it in the vault.
Investor receives premium
The option is ITM and exercised
This means the option buyer can exercise the option at 150 whose market value is 200.

If exercised,
1 SOL sold to option buyer at 150. These proceeds will be used to buy SOL.
150 is immediately converted to SOL at settlement price at expiry (European options since moving to zeta)
200 = Market price of 1 SOL at expiry
1 = 1/200 SOL
150 = 150/200 = 0.75 SOL
Premium = 0.27% * 1 = 0.0027 SOL
Total SOL added back to vault = 0.75 + 0.0027 SOL = 0.7527 SOL

Initial Position:
1 SOL
USDC value = 120

Final Position
0.7527 SOL
USDC value of SOL = 0.7527 * 200 = 150.54

Upside potential loss in SOL
Loss in SOL = 1 -0.7527 = 0.2473 SOL
Gain in USDC = 150.54–120 = 30.54

✅ That was a scenario of a strategy.

And the followings are the What-ifs 👇

About cases

1. If the strike price is not reached at the expiry date, the options are deemed as worthless and the vault keeps the premium paid.
2. If strike price IS reached and you had deposit let’s say 1 SOL at a strike price of 215$, then you will receive 215$ + the premium, but any upside after the 215$ is given to the option holder, as he has the right to buy your SOL at 215$ regardless of what the price of that SOL becomes prior to the expiry date.
   Your 215$ USDC + premium is afterward converted to the underlying asset again and added to the next round (auto-compounding vault)

If we say you had deposited 1 SOL and the strike price is 215$. If the calls are exercised at 225$, then you would end up with 215/225=0.955 SOL and you would also receive the premium. Premium is always received regardless of the outcome.

Why Katana might fail :(

The risks are not subjected to those liquidity concerns, but it’s rather just, Do people actually care about this product? So these products will become less interesting if no one holds crypto, you can’t use them!

Yes and, tell me some other potential risks 🚧

The other potential risks include mostly technical risks. Katana is implemented as a set of smart contracts on the Solana blockchain. While the code has been thoroughly tested and peer-reviewed by top engineers in the Solana ecosystem, no codebase is perfect.

So It might impose these risks

• Smart Contract Risk
• Execution Risk
• Oracle Risk

Katana echoing its motto of being a decentralized protocol transparently states the potential risks to ensure users are fully informed when using Katana.

But will there be any issue with the competitors in the space? 🤔
If yes How will Katana execute on that basis? Let’s explore…

Competitor analysis 🏇

In this seemingly hyper-competitive space, How Katana looks to differentiate is

1. Katana doesn’t have fees although other protocols do
2. Using the product, you get the best pricing, you get the best execution and you also keep all your profits 🙌
3. How katana wants to outcompete other protocols is by truly offering the best UI UX, maximizing transparency and user education, and then lastly creating a community that people really want to be a part of 🏌️.

Why Katana might become a $100 billion dollar project 📈

And now we have turned the table to the Founder and asked him, Ayush If you woke up in three years and found Katana is a $100 Billion project, Why would that be?

1. Because it provides the best risk-return profiles across the board and offers the simplest user experience. That’s the whole value out of Fintech as well.

By offering truly the best user experience and being able to couple that with mass-market where today you are limited to a subset of slots to a DeFi ecosystem. So the defined market katana wants to gather towards is the subset broader than the crypto market,

2. Being at the color crypto layer where there’s minimal friction in order to access these types of products, katana by truly educating the users across the board and in terms of why these products are beneficial to have in one’s portfolio. And then secondly, like what are the risks as well.

3. Combine that with a good distribution strategy and the tech is there, but by continually improving on the tech, maximizing the UI, UX, and product experience. That might lead itself to a much larger total addressable market and therefore much more valuable protocol.

Community and Backers 🤝

Samurai!🥷 yes, that is what the Katana community is known as. Crypto is built by code but composed of people. And those people make up for a great community. Katana looks to become a truly decentralized protocol, boasting a diverse set of builders and contributors working toward a common goal.

With Decentralized community governance of its roadmap, Katana wants to align its wide range of stakeholders that interact with the protocol including Retail users, developers, traders, DAO Treasuries, DeFi protocols, Institutions, FinTech Applications, and other service providers, and mature into a DAO, where the best community can vote on the future direction of the best protocol.

Backers

Katana is backed by some of the top and prominent investors of the ecosystem starting from Framework ventures and including the esteemed Founder’s Fund, Electric Capital, Proto Fund, Coinbase Ventures, Alameda Research, Solana Ventures, and more. Not only that Backing from well-respected angels including Jason Choi, Darren, and Daryl Lau, Chris McCann, Zaheer Ebtikar from Split Capital, Joey Santoro, and many others.

Katana is rapidly scaling the organization and building out the dream team for growing Katana into a yield generation powerhouse 🦸.

What I’m taking a look at!

By embracing the ethos of Web3 and DeFi, Katana looks to transform yield generation for the better.

and here are the things that are on my watchlist for Katana protocol.

• Product: How is it going effectively to enable anyone to contribute strategies and products to the core protocol layer?
• Community: How it is going to make the Community more inclusive and Transfer ownership to the community?
• Incentives: Alignment and distribution of Incentives and Upsides for the stakeholders of the protocol?

Wrapping up the yield machine 🚀

Katana is on a mission to transform yield generation for the better. In building a truly decentralized and permissionless protocol for yield generation. Crypto is built by code but composed of people. So as more people start using Katana and get those exciting yields with a simple and good User experience, Katana is on its way to winning big not only in crypto and DeFi but broader than that.

Will that happen? How well is it going to happen? ⌚️

I’m ready with my watchlist 📔! Are you?

Until then…

That was the deep-dive into Katana exploring options and how Katana is making it big in DeFi.
If you have any queries or feedback, do reach out to me @inSitesh on Twitter :)

Exclusive references

• Our recent deep-dive on Zeta markets explores Options in-depth. Check it out here
• SuperteamDAO’s twitter space with Ayush, the founder of Katana (That’s some exclusive stuff right here!! 📦)
• https://docs.katana.so/
• https://medium.com/@katana_hq

Some of the Images and numbers are taken from Katana’s official sources and third-party references. If you want to know more you can also read their docs. The information contained herein is for informational and entertainment purposes only. Nothing herein shall be construed to be financial, legal, or tax advice, do their own research before making any decisions. Read the full Disclaimer.