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Authors: Andrey Belyakov (Opium Protocol founder); Deniz Yilmaz (Opium Protocol product and community leader);
Compiler: Zhan Juan
2020 is not over yet, but now it is safe to say that this year’s landmark event will be the ongoing COVID-19 epidemic, which has also exposed the fragility of our financial and monetary system.
However, if you look closely, we will find that 2020 is also a year in which DeFi broke all records and attracted widespread attention. In the past few months, the decentralized financial ecosystem has grown into a dynamic and fascinating sandbox for financial innovation. Although we see that the total value, transaction volume, daily active users, and online participation locked in DeFi have reached new historical highs, it still has a lot of room for growth.
However, which segment of the DeFi field will usher in the most explosive growth? We believe that decentralized derivatives are currently the most promising investment opportunity in the DeFi field. The following are five reasons:
1. The derivatives market is the largest market in the world
Did you know that the derivatives market is the largest single financial market in the world?
In fact, the derivatives market is approximately 10 times the size of the credit market and 20 times the global GDP. Derivatives are not only for professional traders, but also an important part of the financial services we use daily. Personal checking accounts, insurance and mortgage loans are all inseparable from the use of derivatives!
2. Derivatives are vital to every mature financial system
Let us consider why derivatives are used so frequently, and why derivatives are so important to any financial system.
This is because the financial system is composed of financial markets, and financial markets are all about risk-every transaction has a certain risk. Professional market participants, such as traders, banks, and investment companies, would like to offset or hedge these risks to prevent financial disasters in the event of unexpected events such as large price fluctuations. This is the purpose of derivatives such as options and futures. Derivatives allow market participants to manage their risks by limiting potential returns and losses. Simply put, derivatives can smooth gains and losses, thereby preventing financial crises.
3. DeFi will not mature unless derivatives grow
In any important financial system, the typical market size ratio between currency/debt/derivatives is 1/10/100. In today’s DeFi, this situation is almost non-existent. Let us think about these market sizes in the illustration below, just to get a feel for the numbers.
Where will the growth of the derivatives market come from? It will come from many aspects, and this article will explain them one by one. Let me talk about the growth from the current DeFi user base!
Today’s DeFi users face huge risks, and most of them have not realized it until another systemic failure occurs and people lose their funds again. Those users who are aware of the risks are already seeking to use derivatives to hedge their risks (for example: buying insurance on Nexus Mutual or buying put options on exchanges). As the field matures, the DeFi derivatives market will grow exponentially with the overall growth of DeFi. Therefore, derivatives are an incredible opportunity for builders and investors.
4. DeFi will swallow part of the centralized derivatives market
In the traditional financial system, most derivatives markets are already very large and liquid, especially those related to important commodities (such as gold, oil, corn) and stocks (such as the Dow Jones Index).
However, derivatives based on DeFi have some inherent advantages, which will encourage part of the traditional derivatives market to shift to decentralized derivatives.
-The decentralized derivatives market is inherently easier to enter. Anyone with an internet connection and an Ethereum wallet can use them-no matter where they are or their social status. This is in sharp contrast to the traditional financial sector, which mainly serves those who live in rich and powerful countries.
-Creating a customized derivative on DeFi is easy, cheap, and anyone can complete it.
In the traditional financial system, the process of creating a new derivative and bringing it to the market is very complicated, and the cost involved is close to millions of dollars. Because of this, most derivatives are created by big banks, which may make it more unfair and less efficient than DeFi. Taking Opium Protocol as an example, by combining the on-chain derivatives formula with a price oracle combination, it takes only a few minutes to create a derivatives contract from scratch. We have already seen this effect, and currently four independent external companies are working to build their derivatives on Opium Protocol and quickly bring them to the market at almost zero cost.
Based on the above, market dynamics will lead to an organic shift from the derivatives market to DeFi, which will increase transaction volume.
5. Institutional players will start participating in DeFi
In the past few years, we have seen increased interest in cryptocurrencies among institutional participants. But this is not the end of their participation. These large professionals will also begin to participate in this Internet-native financial system, which will bring more liquidity, transaction volume and competitiveness to the field. These players may not participate in profit farming to avoid facing catastrophic tail risks, but will participate in arbitration to provide liquidity for the most stable and secure strategy.
No matter how they will participate, they will demand tools for risk management. They will need advanced derivatives to hedge risks. They will need financial primitives with limited ups and downs potential. This is the beauty of this.
Professional derivatives as a new market for DeFi
One thing to be clear: The DeFi field has amazing upside potential. Whether it is relative to the entire crypto market or especially relative to the traditional derivatives market, the total value of DeFi is minimal. New users entering the field will bring liquidity and promote the exponential growth of the DeFi derivatives market.
But where can investors find Alpha? In the total growth of encryption and DeFi, which market will grow faster? We believe that the increasing participation of institutional investors in the DeFi currency market and fixed income instruments will create a strong demand for professional derivatives suitable for institutional investors and professional traders. This new area within DeFi will usher in the greatest relative growth.
Opium Protocol as a professional derivatives platform
- Opium Protocol is unique because it is designed to be combined with DeFi markets and professional markets. At present, most of the derivatives protocols in DeFi introduce theoretically unlimited risks by using on-chain liquidity pools, or the introduction of AMM, which is actually a step backward for traditional finance. At Opium, we believe in a robust and simple on-chain (layer 1) financial infrastructure, which can further utilize off-chain (layer 2).
- Opium Protocol provides a powerful financial primitive at layer 1. More complex functions (such as order books, advanced derivatives, market-making strategies, arbitrage, combined orders, dynamic pricing, automatic hedge fund strategies) are implemented in the second layer. This makes the agreement universal and robust, allowing the creation of decentralized derivatives with risks more similar to traditional financial products, which is what professional market participants need.
3. Opium was established in 2017. Before DeFi appeared, Opium had already begun to work on the infrastructure construction of decentralized derivatives. The team behind Opium has professional experience in the traditional financial field and has a deep understanding of financial primitives, risk management and DeFi. The Opium protocol has been launched on the Ethereum mainnet and has been audited by SmartDec. So far, we have launched three work products based on the Opium exchange and assisted four external independent institutions to use the Opium protocol to bring their derivatives to the market .
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