> For the complete documentation index, see [llms.txt](https://own-protocol.gitbook.io/docs/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://own-protocol.gitbook.io/docs/getting-started/own-protocol-101.md).

# Own Protocol 101

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### **Understanding How the Protocol Works**

At the heart of Own Protocol is a **Total Return Swap (TRS)** mechanism which is, permissionless, and fully collateralized.

#### What is a Total Return Swap?

A **Total Return Swap** is a financial contract between two parties:

* **Party A (the total return payer)** transfers the full economic return of an asset (e.g., a stock), to
* **Party B (the total return receiver)** in exchange for periodic payments, typically a floating interest rate.

In Own Protocol:

* **Sell-side LPs** act as **Party A**, offering asset exposure.
* **Buy-side Users** act as **Party B**, gaining synthetic exposure to asset performance by paying interest.

This swap is implemented as a **rebalancing mechanism** in the protocol.

***

#### How Rebalancing Works

Rebalancing is the core mechanism that mirrors a perpetual TRS and happens **every market day** when the underlying asset's market is open. It is split into two parts:

**1. Off-Chain Rebalancing (During Market Hours)**

During live market hours, LPs who wish to stay **delta-neutral** adjust their real-world asset positions based on:

* Their share of the pool
* Net deposit/redemption requests from the previous cycle

This off-chain period allows LPs to hedge before locking in the swap terms.

**2. On-Chain Rebalancing (After Market Close)**

Once markets close:

* **On-chain rebalancing** begins, for a defined duration (`rebalanceLength`).
* LPs “settle” the swap by executing a rebalance at a reference price called the **rebalance price**.
* If the asset's price increased since the last cycle, LPs **pay** the return to the pool.
* If the price decreased, LPs **receive** the loss amount from the pool.
* LPs also receive accrued **interest** for offering the exposure.

The **rebalance price** is validated using oracle-sourced OHLC data to prevent manipulation or deviation from real-world asset prices.

***

#### Active State

Between rebalancing periods, the pool is in an **active** state:

* Buy-side Users can submit **deposit** or **redemption** requests.
* These requests are processed in the **next** rebalance cycle.

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#### Deposits & Redemptions

* Once a **deposit request** is processed during a rebalancing cycle, the LP can **claim the synthetic asset** (called `xToken`), which is minted at the **rebalance price**.
* The minted xToken is a standard **ERC20 token**, meaning it can be **freely transferred, traded, or used across DeFi protocols**.
* To exit the position, the LP submits a **redemption request** by depositing their xTokens into the pool.
* After the next rebalancing cycle, the corresponding amount of **reserve tokens (e.g., USDC)** can be **claimed back**, based on the latest rebalance price.

***

#### Protocol Interest Rate

The protocol’s interest rate structure ensures that Users pay a fair fee for synthetic exposure:

**Formula:**\
**Protocol Base Interest Rate = Onchain Risk Free Rate** (eg: Aave’s USDC deposit rate) **+ 1%**

This design means that the **net effective cost to Users remains approximately 1% annually**, since reserve tokens (e.g., aUSDC) typically earn comparable yield to offset the protocol interest rate. This aligns user costs with market conditions while providing sustainable returns to Liquidity Providers.

***

#### Summary

Own Protocol continuously rebalances positions **on every market day**, effectively simulating a **perpetual total return swap** onchain.

* **Buy-side Users** gain synthetic exposure to asset performance via xTokens giving them indirect ownership to the underlying asset.
* **Sell-side LPs** provide that exposure and earn floating interest plus market-making opportunities, all while remaining delta-neutral if desired.