Can decentralized derivatives successfully start the second half of DeFi?


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DeFi is very important, but we only caught a glimpse of the Holy Grail.

DeFi-the narrow meaning of decentralized finance is “using decentralized networks to transform traditional financial products into a disintermediation, trustless, and transparent agreement”. We believe that DeFi’s more ambitious vision is to achieve “global market access”, that is, to allow all people in the world who can access the Internet to publicly hold or trade any financial assets.

Can decentralized derivatives successfully start the second half of DeFi? From the recent explosive growth of the DeFi market, we can see some notable features. From DEX, stable currency, leveraged lending, synthetic assets to emerging insurance products. With the strong momentum of liquidity mining, DeFi is turning traditional financial products into agreements 100 times faster than we have seen in the past. We have also seen that more complex principles and structured financial instruments have begun to penetrate the DeFi market. However, due to the lack of some basic products and services, the current DeFi as a “decentralized financial market” is still incomplete.

Similar to the development of traditional financial products, the current boom in the DeFi market is a typical “debt-to-debt” expansion, including the well-known excess mortgage interest rate and the most common multi-layer nested assets in liquid mining. In such a market, we can only rely on over-collateralization to avoid the subject’s credit assessment. However, mortgage bonds are essentially the least sensitive product in the financial market.

In the DeFi boom in the past few months, the basic assets supporting liquid mining can be roughly divided into three categories: transaction fees, loan spread income, and mortgage governance tokens. We have seen that when the return on basic assets (or “productivity”) is not durable enough to support the credit boom, there will be a risk rebound similar to the traditional “financial crisis”. Therefore, if the DeFi industry is to strive for real development, rich and solid basic assets are still the most important cornerstone.

Whether it is the traditional financial market or the DeFi market, the demand for “SAFU” assets and liquidity is always stable. In the traditional financial market, on the one hand, we see a large number of monetary assets secured by short-term debt, long-term debt based on sovereign credit, quasi-currency created by repurchase or asset securitization, or assets such as MBS and ABS. On the other hand, on this basis, a large-scale financial derivative product with rich tools has been formed, which plays a role in risk management, asset pricing and enhancing market liquidity, forming a systematic financial market as a whole.

Whether we expect the DeFi market to eliminate the CeFi (centralized finance) market or the integration of these two parallel fields, DeFi users have the same urgent needs for “SAFU” assets, liquidity and risk pricing. We do not expect DeFi to generate absolutely risk-free assets, but expect to generate alternatives such as asset securities through derivatives agreements as close to risk-free assets, and so on.

In the current DeFi market, we can see assets linked to fiat currencies, such as USDC and debt collateralized debt positions “DAI”-as nearly risk-free assets. But we still aspire to a more comprehensive yield and volatility structure. However, the market still lacks necessary financial tools and pricing mechanisms. In the process of mapping traditional financial market products, it is necessary to break through the challenge of building a comprehensive decentralized financial derivative product.

DeFi lacks derivatives, this market is always immature

We have been paying close attention to synthetic assets. Similar to financial asset positions, some synthetic assets have performed well as tokenized versions of financial derivatives. At the same time, we look forward to the native decentralized derivatives agreement, supporting DeFi with structured “SAFU” assets, trading, and risk/volatility hedging tools, and improving DeFi with richer risk management and liquidity enhancement tools field.

The concept of financial derivatives is actually quite broad, ranging from swaps and forwards to futures and options. Basic assets include interest rates, equity, foreign exchange, commodities and other asset products. They are widely used to balance position risk, liquidity, hedging, leverage, and other investment portfolio and liquidity management needs. According to statistics from the Bank for International Settlements (BIS), the scale of the global financial derivatives market is beyond imagination; its scale can reach more than 10 times the global GDP and continue to maintain a rapid growth level.


(Purpose of end users for derivatives transactions)


(Changes in product usage in the past year)

We are firmly optimistic about the decentralized derivatives industry-not only because of short-term business perspectives, decentralized derivatives agreements can get a share of profits from centralized derivatives giants (such as BitMEX, OKEX and Deribit); more importantly However, from the perspective of creating long-term value, the decentralized derivatives market has huge potential and is at the core of the entire DeFi ecosystem. This will be the most difficult industry to overcome and perfect for the DeFi industry, but it is also the most profitable piece of the puzzle.

The vigorous development of decentralized derivatives agreement will break the island of DeFi agreement; the combination of DeFi and Lego can generate more promising opportunities.


(Top-notch DeFi derivatives agreement)

Several trends that we think will happen are:

1. The combination of derivatives agreements will create financial products with rich risks and rewards

Decentralized derivatives agreements can enrich the basic financial product structure of the DeFi world. More standardized investment and financial products based on these agreements will appear to meet the investment needs of users. At the same time, by combining derivatives agreements, customized products or strategies that are more in line with specific risk and profit structure requirements can be developed.

for example:

MCDEX plans to launch structured products based on decentralized perpetual swaps, allowing users to obtain income through leveraged trading.

The FinNexus option agreement plans to introduce an option trading strategy to help liquidity providers hedge against the impermanent losses in the AMM market making process;

The emergence of IRS (Interest Rate Swap) agreements (such as Horizon.Finance) can be combined with option/future agreements to replicate the classic OBPI (option-based portfolio insurance) and provide fixed-income enhanced products for the DeFi market.

These mappings to the traditional financial market will provide a richer asset class for the DeFi world and make the yield curve of the current volatile DeFi world more stable.

2. The specialization and complexity of decentralized financial derivatives will redefine the business model of asset management

Traditional financial markets generally face trust challenges and the moral hazard of investment managers. With the emergence of DeFi’s non-custodial features and decentralized financial derivatives, the business model of traditional financial institutions with asset managers and third-party custodians will undergo revolutionary changes.

In the short term, the DeFi machine gun pool that now plays the role of “investment manager” will face the challenge of homogenization and lower expected rates of return, and they will soon start to compete with each other in product design capabilities.

The machine gun pool, which is limited to the “digging and selling” strategy of ordinary liquid mining, will soon lose market competitiveness. We can see the emergence of machine gun pools like DFI.Money and SashimiSwap, and other communities are already discussing richer investment strategies and planning to launch strategies based on financial derivatives to provide users with a richer risk-return matrix.

In the long run, the enrichment of financial products in the DeFi market and the increase in market depth will further increase the demand for professional investment consulting and services. Decentralized active asset management agreements and investment consulting agreements, such as dHedge and Set agreements, will have great development potential.

Merely mapping financial products in traditional financial markets in a decentralized way is not the true meaning of DeFi and decentralized protocols. The development of decentralized derivatives agreements will be unprecedented, redefining the essence of asset management. For nearly a hundred years, the existing business model has not been challenged. Through DeFi, our ambitions can be realized: “Everyone in the world who can access the Internet can publicly hold or trade any financial assets or transactions.”