Explore the structure and business process of structured derivatives in the cryptocurrency market


 47 total views

At present, structured products in the cryptocurrency market mainly focus on financial management, but as the industry develops, more structured products will gradually appear.

Author: Gate, founder and CEO of 1Token and BitLink

Since Matrixport launched structured financial derivatives in the third quarter of last year, many domestic and foreign companies have launched related products. Although there is a significant gap in the popularity of structured products compared with DeFi, its own characteristics make it a financial tool that is widely used among institutions, whether in the traditional market or in the currency circle.

Good development prospects for structured products

As stated in the previous article, ” Understanding the Market Structure of Cryptocurrency Institutions and Asset Types “, there are many different types of assets in the currency circle, and each asset has its own unique asset return curve. Generally speaking, before investing in a certain asset, investors, especially large-scale institutional investors, will have their own expectations of the asset’s trend, and at the same time, they will think clearly about how to respond if the trend deviates from expectations. . This response can either wait until something happens before responding, or it can be conceived in advance. Structured financial derivatives are often used in advance planning.

For example, if institutional investors want to participate in mining, but cannot withstand the large losses caused by the sharp drop in currency prices, they can immediately buy structured financial derivatives, such as put options, to protect 90 % Of principal. At the same time, considering that institutional investors do not have such a large demand for income, they are willing to give up large increases. For example, if the part that has risen by more than 30% is willing to give up, then the corresponding call options can be sold to reduce the overall cost of buying financial derivatives. .

In the traditional field, there are still many industrial and agricultural institutions that need to use related structured financial derivatives to manage costs/sales risks such as raw materials and products. Considering that there are few relevant examples in the currency circle, we will not list

With the continuous expansion of the scale of the currency circle and the steady progress of the global compliance process, more and more large funds have entered the currency circle and mining circle, and the demand for structured financial products has also continued to expand. All kinds of financial institutions that have access to large funds have a “foundation” to share a slice of this financial business line, whether it is institutions close to funds/assets in the original industry chain of the currency circle, or gradually entering the currency circle Institutions close to funds in traditional financial markets.

Say “both have a foundation” because if these two types of institutions want to carry out related businesses, there is a high probability that they will lack a little gene/cognition. The original institutions of the currency circle lack the knowledge of the nature of financial products and business, and the traditional institutions lack the knowledge of the currency circle. This article focuses on the former, and the purpose is to briefly introduce the overall market structure that needs to be known to develop structured financial derivatives business in the currency circle and what talents/departments need to coordinate and cooperate with each other to help the currency circle have a business foundation. Institutions can better establish business lines.

READ  Where do your clothes really come from? Rebecca Minkoff turns to blockchain to find out

As an over-the-counter product, the market participants of structured financial derivatives are basically three categories: buyer, seller, and custodian. The financial products traded range from simple single-leg options to multiple-legged products, such as shark fins and other products with knockouts. Although some products seem to be very complex, the essence is to adjust the yield curve according to demand. We will not expand the structure of various products here.

Buyers are mainly the various institutional investors mentioned in the previous article, who purchase corresponding products for their own risk/return preferences. If there are some standardized requirements, they can be completed directly on the exchange. If it is a complex product, a professional seller organization is generally regarded as the counterparty.

At present, the mainstream structured products in the currency circle are mainly in the form of financial management. The buyer sends all the funds to the seller, so the buyer needs to trust the seller. However, with the development of the industry, structured products in the form of non-financial management will appear. In this case, the buyer will only put the margin on the seller’s side, so the seller will also need to trust the buyer. In the traditional market, in the early stage, it relied on mutual reputation. However, as the market volume became larger and the reputation was not enough to cover the transaction volume, higher-level and better-reputation financial institutions gradually appeared, generally large banks. The role of the middleman, both buyers and sellers trust this institution.

At present, the currency circle is still in its early stage, and there is no custodian bank with a large number of structured products. Moreover, considering that the responsibilities of the custodian bank, such as calculating risks, profit and loss, etc., are separated from the seller. So the follow-up is mainly to introduce the seller’s business process.

The seller’s organization needs the corresponding talents to complete the 5 major links of sales, quotation, risk control, transaction, and liquidation

The entire seller’s business process includes four modules: quotation, transaction, risk control, and clearing.

Quotation link: including the definition of financial products according to customer needs, such as cycle, linked subject matter, margin rules, whether to support redemption, etc., as well as specific pricing based on the defined product. In addition, taking into account the company’s sales process, in addition to the core product pricing, various related expenses will be added. At the same time, the quotation needs to be communicated to the customer, that is, the inquiry. Depending on the sales method, it includes a manual inquiry system directly facing customers/sales personnel and an API system that supports automatic system docking.

READ  Why can DeFi prime brokers make DeFi erode the centralized exchange market? What are the risks?

Transaction link: When the seller and investor’s order is completed, the two parties actually complete a bet. For the seller, one option is to hedge the risk and make a difference between the middlemen. The other is to bear the risk entirely. Of course, you can also hedge a part and bear part yourself. The seller decides which financial instrument to use for hedging, spot, futures, or option, on-exchange or off-exchange, and the degree of aggressiveness of the specific transaction execution.

Risk control link: Before trading with the customer, the seller needs to determine the impact of the order on its own risk. If hedging, during the hedging process and after hedging is completed, it is necessary to understand the risk situation in real time. The specific risk parameters that need to be monitored include not only the current margin, β risk situation, but also through stress testing to understand the possible future changes in price/volatility, and the impact on the overall profit and loss, margin, and whether it is within the seller’s desired threshold. If the threshold is exceeded, the transaction will generally be involved to reduce risk.

Clearing and settlement link: When the product expires or the investor redeems it, the seller needs to calculate the profit and loss of the investor and the seller based on the signed product agreement and current market conditions, and determine whether to collect or allocate the corresponding amount funds.

In fact, there is another very important link, which is sales. As a seller, it is of course important to be able to build products and manage risks, but also to be able to sell them. In fact, whether it is a traditional financial circle or a currency circle, sellers can be divided into two categories according to the sales target. One is that the above 4 links are completed by themselves, and the other is that only 1-2 links are completed. That is sales and liquidation. At present, there are some institutions in the currency circle that have established a sales platform, and the specific products are handed over to the partners to complete. It is also a way for a company with customer resources to start early.

As the scale becomes larger, system support is essential

As the business becomes larger, each of the above-mentioned links needs system support. Just as some seller companies choose to outsource product pricing + transaction + risk control to a third-party professional company in the early stage, and do the sales themselves. At the system level, this line of business has a lot of wheel-making things, but in fact, each company does not need to do it separately. The only thing where the necessity of doing it yourself is relatively high, even if it is a price.

Of course, considering that the current currency circle is still small, in the long run, every type of institution that has the potential to succeed in the currency circle must have its own customer resources of one acre and three quarters of land inside or outside the circle, so the pricing is actually not competitive. The intensity of the traditional market. At the same time, the pricing of derivatives is already an area with a mature system. Instead of setting up the system completely on the pricing side, it is better to focus on financial engineering. Which pricing model and specific model wheels to choose, you can completely use third-party providers. of.

READ  Automate Your Social Media Strategy (Online Workshop)

In fact, the three major modules of transaction, risk control, and clearing are mainly supported by various scenarios, whether various trading venues and subdivided financial product types support comprehensively, and whether the system is stable and reliable, which is very suitable for products. This has been proven by traditional financial markets. For example, for risk control, what the seller’s risk control person has to do is to select the risk parameters of the relationship, determine the threshold, and the hedging/lightening method after the threshold is exceeded. Among them, risk parameters are limited, and the target of hedging is limited. The degree of hedging aggressiveness can be clearly defined through pending orders, and the effect of hedging is still measured by risk parameters. All of these are limited and can be clearly quantified and defined. As more cases are supported, the more complete they become.

1Token’s system can help the seller focus on the core link/work

This situation is exactly what the third-party provider’s product system can support. As more and more organizations serve, the system will support various scenarios, various trading venues/counterparties, and various financial product. As a solution provider focusing on the asset management system of the currency circle, 1Token covers all major types of mainstream assets in the currency circle, and financial derivative structured products are one of the focuses. 1Token supports all links such as quotation, trading, risk control, clearing and settlement, wallets, etc., covering various types of institutionalized products, and fully benchmarking the front, middle and back-end systems of financial derivatives in traditional markets. 1Token hopes that all companies that enter the business line only need to focus on the top-level rules of sales, quotation and risk control. All other management can be done on the system.

In addition to 6+ years of experience in currency trading, risk control, clearing, and quotation systems, the core team of 1Token has also hired 2 financial derivatives consultants in traditional markets. One of them is currently the president of the risk subsidiary of a well-known domestic futures company, and is fully responsible for the company’s over-the-counter derivatives, futures and options market making, and futures options proprietary trading. Darshan Vaidya has 12 years of experience in options market making and customized options products in the United States and the United Kingdom.