1 month financing of 70 million US dollars, why are encrypted derivatives favored by institutions?
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, Author: Indigo, reproduced by Odaily with authorization.
On February 6, Bitcoin broke through $40,000 again.It is said that 2020 is a watershed year for cryptocurrencies. Uncertain factors such as the ongoing COVID-19 pandemic and the “short squeeze” of WallStreetBets retail investors have always plagued the traditional financial market. With the crazy increase in positions of institutions such as Grayscale and MassMutual, the "brainless shouting" of MicroStrategy CEO, and the "blessing" of Elon Musk, the world's richest man and Tesla founder, the bubble in the cryptocurrency world is rapidly expanding.From the end of 2020 to the present, it is certain that more and more institutions have set their sights on the development of cryptocurrency derivatives.According to incomplete statistics, starting from 2021, several derivatives platforms including dYdX and Opyn have received tens of millions of dollars in financing within one month, which shows the attention of institutions on this track.So, what are derivatives of cryptocurrencies? What are the innovations in cryptocurrency derivatives? Why are institutions optimistic about the development of encrypted derivatives?
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Starting point: replication of traditional financial derivativesIn traditional finance, risk management has always been the unshakable core, and financial derivatives are the core tools invented to achieve risk management.The essence of the cryptocurrency derivatives we often say is similar to that of traditional financial derivatives. It is to separate a certain risk factor in the cryptocurrency market, such as the US stock market, lending interest rates, commodity prices or price volatility, and agree on a contract of cash The flow is linked to this risk factor, so the trader of the contract can accurately obtain the risk factor he wants on this contract.Therefore, derivatives are a concept corresponding to traditional financial products, and their value is based on the variables of other benchmark assets. Futures, options and swaps are more common derivatives in traditional finance.But crypto derivatives are far from that simple.We can temporarily classify cryptocurrency derivatives into two categories: one is centralized encrypted derivatives, and the other is called DeFi innovative encrypted derivatives.The so-called centralized financial encrypted derivatives are designed to solve the same problems as traditional finance. They are generally a simple copy and transfer of traditional finance, such as some encrypted currency futures, options, and volatility products.As we all know, centralized exchanges are fast, convenient, and have good liquidity, such as the growing derivatives exchange FTX, and the derivatives exchange Deribit with stable trading volume and transaction scale. But at the same time, users need to bear risks such as information leakage, price manipulation, trading restrictions, and exchanges "running away".At this time, we have to mention the DeFi derivatives that have grown wildly in the encrypted world, and narrowly regard DeFi encrypted derivatives as innovative encrypted derivatives.Taking the Ethereum chain, the main ecosystem of DeFi, as an example, aside from the innovation of derivatives, due to performance constraints, it is impossible to simply copy the matching engine based on the order book of the centralized derivatives exchange. Therefore, the early pathfinders made trade-offs and compromises in several aspects:1. Put the core part of the matching engine, which requires a lot of calculations, on the centralized server off-chain, and only upload the matching results to the chain. This is a semi-centralized solution, represented by dYdX, a decentralized derivatives exchange. dYdX is a decentralized derivatives exchange for "high-end players". It has margin trading, synthetic asset functions, and more flash loan services for developers.2. Implement the matching engine on Layer 2, and only write the matching results into the Layer 1 blockchain. A representative case is the Injective Protocol, a second-tier DeFi derivatives protocol that is still being tested. Injective Protocol is an order book-based decentralized derivatives exchange including spot, delivery futures, perpetual contracts, CFDs, etc., that realizes the expansion of Ethereum through side chains.These trade-offs clearly present different problems. Since the encrypted world in which DeFi lives is built on a brand-new technical infrastructure, its implementation of derivatives must be different from traditional finance.secondary title
Early attempts at DeFi derivativesOn the DeFi stablecoin track, MakerDAO successfully synthesized the fiat currency USD by over-staking. The DeFi world also gave birth to the first real native blockchain, USD-anchored over-collateralized stablecoin - DAI. MakerDAO's approach inspired DeFi developers to implement the concept of "derivatives" in a similar way.Since the U.S. dollar can be anchored in the way of over pledge, it is also possible to anchor other assets in the way of over pledge. So the Haven team made some adjustments to their stablecoin project, turning the anchoring of the US dollar into an anchoring of any asset, such as BTC. This is the later synthetic asset protocol Synthetix, which realizes the function of derivatives in the form of synthetic assets.Specifically, users can hold the token SNX, and use SNX to over-collateralize to generate some kind of synthetic asset, such as sBTC anchored to BTC. However, due to the lower liquidity of SNX compared to ETH, its price is usually more volatile, so in order to solve this problem, the minimum initial mortgage rate required by Synthetic is 750% compared to the minimum 150% mortgage rate required by Maker. %.However, Synthetix's approach also has the following problems:The over-collateralization rate of 1.750% limits the overall leverage of participating traders. In fact, the 750% mortgage rate makes it impossible for Synthetix's total derivatives transaction volume to exceed 0.13 times the total market value of SNX;2. Synthetix currently forces users to accept SNX as a transaction medium, which is not in line with the concept of DeFi open finance;3. The transaction execution process of Synthetix is relatively complicated, especially the special fully collateralized overall debt system of Synthetix is too high for ordinary investors.But in any case, Synthetix, as a solution for early cryptocurrency derivatives, provides a new idea for DeFi derivatives - DeFi derivatives solutions do not necessarily need to match buyers and sellers based on order books to form multiple Open positions with symmetrical short volumes.In addition to providing new ideas, Synthetix also demonstrated how important it is for a project to be composable in the DeFi world: the reason why Synthetix synthetic assets are so valued in the DeFi world is largely because the synthetic assets provided by Synthetix can Like Lego blocks, they are used as basic functional modules by other DeFi projects to achieve their own financial purposes, which perfectly fits the composability and interoperability between DeFi protocols. The composability of Synthetix is achieved through the tokenization of the underlying assets. Whether it is Bitcoin or gold, they are all tokenized into ERC20 tokens, sBTC or sXAU (synthetic gold) within the Synthetix system.At the same time, the DeFi world has also made some attempts to correspond to over-the-counter (OTC) derivatives in traditional financial markets. For example, the synthetic asset agreement UMA, which provides convenience for both parties to enter the same smart contract. However, this kind of OTC derivatives needs to be paired by traders before they can use the UMA protocol to generate smart contracts. Before the development of the derivatives field matures, due to the lack of derivatives seller business, it is difficult for users to find matching counterparties within the UMA system, so the usage scenarios of UMA are relatively limited at the current stage.secondary title
Liquidity pools - another successful attemptWhile the DeFi world is exploring derivatives solutions, the revolutionary progress of spot trading has brought the entire DeFi world into a new stage. The automatic market maker (AMM) based on the liquidity pool carried forward by Uniswap realizes the transaction between tokens in a minimalist implementation. All of a sudden, various "Swap" based on liquidity pools emerged. This trading method based on liquidity pools has become the mainstream mode of DeFi spot trading, and it has once again provided a new idea for DeFi derivatives trading.Under the wave of liquidity mining sweeping the DeFi world, a new DeFi derivatives route suddenly became clear - based on liquidity pools, automatic market making for derivatives demand. However, unlike the constant product market maker used by Uniswap, the financial nature of derivatives determines that it must rely on the price input of the underlying asset.In other words, the derivatives solution will inevitably rely on the oracle machine to feed the price. Like the liquidity provider (LP) in Uniswap's liquidity pool, the liquidity provided by LP to the liquidity pool acts as the counterparty of the derivatives trader However, it exists to passively provide active traders with the derivatives they need. The upcoming decentralized derivatives trading protocol Deri and Molly's on-chain options trading protocol Hegic are innovative DeFi derivatives solutions based on this idea.The decentralized derivatives trading protocol Deri is a derivatives trading protocol that, like Uniswap, uses the liquidity pool as the counterparty of the trader and all trading logic is implemented on the chain.Under normal circumstances, passive counterparties in the financial market will always face the risk of loss when trading with active traders who have market information advantages. Therefore, in the traditional financial market, this is the core problem that market makers need to solve.In the DeFi world, this essential risk will not disappear because of different technical forms. Under Uniswap's constant product market maker system, the so-called impermanent loss is a concrete manifestation of LP's loss due to information disadvantage. Deri introduces a unique rate mechanism to attract arbitrageurs to participate in transactions to solve this problem. Under Deri's mechanism, arbitrageurs become LP protectors. Under the Uniswap system, the impermanent loss of LP is actually the profit of arbitrageurs.Hegic's design idea is also to let the liquidity pool act as the counterparty of the option buyer. The popularity of the Hegic project has demonstrated the great prospects of the liquidity pool route and the feasibility of becoming the ultimate solution for DeFi derivatives, but Hegic looks more like an early test product exploring DeFi options solutions. The main limitations of Hegic are:1. There are no protection measures for the impermanent loss of LP;2. Options are not tokenized, not ERC20 tokens, and cannot be traded or transferred;Of course, the attempts of encrypted derivatives are not limited to this. Whether it is the debut derivatives agreement Alpha Finance, or Yam Finance and Ampleforth, which are reorganizing and preparing to make a big splash on the derivatives track, 2021 is worth looking forward to.secondary title
Huge potential comes with risksAccording to data from the Bank for International Settlements, the nominal value of the derivatives market is considered to be the largest in the world, reaching US$660 trillion, even more than four times that of the global debt market, while its actual market value is only US$12 trillion. How could smart institutional investors fail to see the potential lucrative benefits of a huge bubble in the middle?In fact, the unclear size of the derivatives market stems from its opacity. Since the 2008 financial crisis, real-time risk transparency has hardly improved. In a famous investor letter from 2002, Buffett called derivatives "financial weapons of mass destruction."Take, for example, the Synthetic Asset Protocol and the US stock mirror market Mirror Protocol, which has regained market popularity recently due to the WallStreetBets incident. Users can mint and trade synthetic tokens of assets such as stocks, futures, and exchange funds through the Mirror Protocol. Users can directly trade various top assets around the world through Mirror Protocol, and 14 synthetic assets have been launched so far.Different from centralized exchanges, can users really own the equity of corresponding stocks? How to calculate the risk of decentralized protocols being exploited and attacked by hackers? Who will endorse derivative products? Who will play the role of "credit rating agencies" in the 2008 subprime mortgage crisis? For example, will encrypted derivatives of synthetic assets be the next mortgage-backed bond?"The core of traditional derivatives is to provide hedging and risk management solutions for those exposed to the corresponding assets, whether it is hedging against adverse price changes or excessive price fluctuations. American farmers began locking in sugar and wheat prices more than 100 years ago as a form of protection against lower future prices (i.e."futuresIn the years since, however, derivatives have attracted speculation and leveraged trading, which can spell disaster if regulatory safeguards are unclear and unenforced. In the 2000s, "Mrs. Watanabe" investors (the term was coined for the normally cautious Japanese housewife) were involved in the infamous yen (JPY) carry trade: moving yen markets around the world, making London Confused foreign exchange traders in New York and drained the life savings of many Japanese families.Therefore, traditional financial derivatives are considered to be the "black box" of the financial services industry, especially OTC derivatives, because so few people understand them. Most OTC derivatives transactions are private and bilateral, with extremely high barriers to entry.Since encrypted derivatives are still in their early stages, the trading of encrypted derivatives requires strict systemic risk management and monitoring.In recent months, the level of activity of regulators is obvious to all. They pay close attention to crypto derivatives, for example, in the UK, crypto derivatives are directly banned from being open to retail investors. We’ve also seen U.S. regulators turn to enforcement action against companies like BitMEX, which has been offering derivatives products on its platform for years.There are already some regulated cryptocurrency derivatives, such as CME’s Bitcoin futures, options on futures and the recently launched exchange-traded note (ETN) by Van Eck/Deutsche Boerse.With the possible tokenization of everything in the future, we may see real innovation and breakthroughs in the green economy, from green bonds to carbon credits to climate change indices.
