When it comes to the legitimacy and maturity of different financial instruments, derivatives have proven time and time again to be a crucial piece of infrastructure necessary to support the long-term growth of any asset class.
As it relates to the realm of digital assets such as Bitcoin ($BTC) and ether ($ETH), the introduction of future contracts provided a vital opportunity for investors to short a historically volatile asset. While those specific contracts were limited to Bitcoin, other institutions such as Grayscale have introduced derivatives such as the Ethereum Trust fund to allow for traditional investors to gain exposure to digital assets without fully onboarding to the blockchain ecosystem at large.
In short, the emergence of digital asset-based derivatives have paved the way for the next leg of growth for the market at large. With the framework being set for the largest assets on the market, the DeFi projects discussed below are taking this a step further, leveraging a variety of niche use-cases to further open new opportunities that blockchain technology and smart contracts provide.
What are Derivatives?
A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). Common underlying instruments include bonds, commodities, currencies, interest rates, market indexes, and stocks.
Derivatives are inherently secondary securities as their value is derived from the value of the primary security that they are linked to. In and of itself, traditional derivatives have no value. Example of derivatives commonly include futures contracts, forward contracts, options, swaps and warrants.
Thanks to the advent of smart contracts, digital asset-based derivatives can be created without the need of a third party. As such, counterparty agreements are programmatically encoded, drastically reducing the risk for malicious activity. As it relates to DeFi, we’ve seen a number of projects using derivatives to allow for retail investors to take advantages previously only available to those with brokerage accounts or specialized knowledge.
Originally launched as a stablecoin project called Havven, Synthetix has since pivoted their focus towards creating synthetic assets that track the value of real-world assets. At the time of writing, Synthetix currently has over $20M in Total Locked Value (TLV), making it the leading DeFi derivatives platform according to DeFi Pulse.
With more than 20 supported Synths representing various fiat currencies, commodities and digital assets, the platform is expected to expand its capabilities to include stocks, indices, and other derivatives in the near future. To interact with different Synths, it’s recommended to visit Mintr. It’s important to note that your wallet must hold sUSD in order to access the platform.
Synthetix utilizes a native ERC20 token, SNX, which is locked as collateral to mint Synths. Transaction fees from Synths exchanged on Synthetix’s non-custodial DEX go to SNX holders and Synth minters, incentivizing Synth creation and giving value to the underlying collateral.
Launched in May of 2019, Nexus Mutual is a decentralized insurance protocol built on Ethereum. Nexus utilizes a risk-sharing pool that allows anyone to purchase insurance for smart contracts or contribute capital to the insurance pool at large.
As it relates to derivatives, Nexus provides coverage over any smart contract via an automated quote system. In order to utilize Nexus, users must purchase a membership, granting legal rights to the assets of the mutual. At the time of writing, the membership fee is set a minimal amount of 0.002ETH (~$0.40).
Nexus utilizes a native token, NXM, granting governance rights in tandem with the ability to purchase cover while participating in claims and risk assessment. NXM tokens are issued via a tokenized bonding curve where tokens are priced according to the amount of capital the mutual has offset by the amount of capital needed to meet all claims within a certain probability.
Nexus is currently seeking a minimum capital requirement of 12,000 ETH necessary for the mutual to begin processing claims. To participate in the ecosystem, visit the NXM Dashboard.
Set Protocol is an emerging DeFi platform that creates and manages baskets of tokenized assets. Set Protocol has a competitive advantage over other asset management platforms such as MelonPort as portfolios are automatically rebalanced, making any trading strategy easily accessible simply by holding a single Set token. As a result, this #setandforget mentality allows passive digit asset investors to leverage price volatility using Sets such as the “ETH 20 Day Moving Average Crossover” all without having to stay up to date on every market movement that occurs on a monthly or even daily basis. Furthermore, the protocol will eventually provide the opportunity for skilled professionals to create and monetize their own strategies, effectively presenting an opportunity for any individual to tangibly display their asset management expertise in a decentralized fashion.
The core team has mentioned that upgrades will include digital assets outside of BTC and ETH with the opportunity for lending, short and margin strategies integrated from project such as dYdX, bZx and Compound. With the recent addition of Anthony Sassano of ETH Hub heading all marketing and growth efforts, it’s safe to say that Set Protocol will continue to establish a strong presence over the course of the next quarter.
Fortuna is a digital asset-based derivative platform offering a multitude of products including a digital asset trading system, a digital asset management system and an over-the-counter (OTC) derivative market.
At the time of writing, Fortuna offers spot, futures and options trading systems. Their digital asset management services include Robust, Aggressive, and Gain strategies with asset assurance from a professional quantitative strategy team and a 24/7 trading team.
Unlike the projects listed above, it appears that Fortuna currently relies on a slightly more centralized process to effectively manage and handle client requests. With this being said, Fortuna has ambitions to launch a native blockchain in which their utility token, FOTA, will be used for the registration of all smart contracts along with transaction fees and revenue for validation of all trading on the platform.
MARKET Protocol is an open source and non-custodial solution for creating tokens that track the price of any digital or traditional asset. Simply put, the protocol offers a framework for creating “Position Tokens” that track the price of any underlying asset. By doing so, Market wishes to provide any individual with access to modern financial instruments in an attempt to expand on potential investment and risk management products and opportunities.
By replacing the custody of collateral, accounting, and settlement with decentralized infrastructure, Market allows for intermediaries to be removed and the fees associated with them to be reduced.
In order to create a position token, creators must post collateral and pay an origination fee. Users who choose to pay said fee in the platform’s native token, MKT, will receive a reduced rate on the origination fee. Once created, Position Tokens are fully collateralized and tradable between any wallet or on any exchange supporting the ERC20 token standard. In practice, this could take the form of tokenized Apple stock, reserve currencies or debt that is no longer subject to geographic limitations. To see what’s currently available on Market Protocol, you can visit their customized exchange here.
DeFi Derivatives Summary
As mentioned above, derivatives play a vital role in ensuring the long-term stability and growth of the digital asset ecosystem at large. With different mechanisms in place to short assets and cover losses, it can be assumed that while the largest volatility swings are for the most part behind us, these instruments provide a solid foundation for more and more traditional players to feel comfortable entering the markets at large.
With DeFi continuing to push the envelope on the capabilities of smart contracts, 2020 is set to be an extremely exciting year. If you run or have heard of a derivative-based project that you feel would be worth adding to this list, feel free to submit an application here.