How Do Decentralized Finance (DeFi) Protocols Utilize Options or Derivatives for Risk Management?

DeFi protocols use derivatives to hedge against price volatility and manage liquidation risks. Options, futures, and perpetual swaps allow users to lock in prices or speculate on future movements without holding the underlying asset.

For instance, a user with a collateralized loan can buy a put option on their collateral to hedge against a drop in its price, thus preventing liquidation. This introduces traditional financial risk tools into a decentralized environment.