Following the economic collapse of 2008, there were calls for increased transparency in the financial markets and ways to transact without relying on a third party custodian for your assets. Enter: cryptocurrencies. But with all the growth in this sector a new set of challenges has arisen, particularly around how to bring together fragmented pools of liquidity that are distributed across thousands of token exchanges and digital networks.
Neutral is a new smart contract system designed to solve several of these key issues. It’s a piece of software sitting on a digital ledger that allows for the creation of aggregate digital currency instruments. This software-based approach to the creation and management of crypto baskets drives price discovery on the network itself without relying on “trusted” third-party sources of information. By reducing reliance on these, it allows pricing to become more transparent. The result of these processes allow for users to benefit from an aggregate financial instrument for transactional purposes that is decentralized in nature.
The core team is comprised of experienced investors, quantitative traders, trading system developers and is advised by Nobel Prize economists and financial industry experts. Sequoia led the recent round of equity investment together with FBG Capital and Bixin.
On Exchange-Traded-Funds (ETFs)
The Neutral Project aims to usher a new wave of financial instruments, a series of flagship offerings that functionally exhibit properties like an ETF, but utilize blockchain technology to gain exposures to crypto assets in a more efficient and transparent manner.
An ETF — or an exchange traded fund — is simply that. ETFs can be purchased on a variety of exchanges globally, representing an aggregate basket of assets. Traditional ETFs continue to be the fastest growing product to obtain market share, with more than $5 trillion in assets today. The popularity of these instruments gained traction after the US recession, with good reason. ETFs offer a more simplistic structure from the standpoint of the end-consumer in the secondary market — the upfront cost is a management fee and cash flow payments from the underlying assets are typically reinvested. The fund structure also provides transparency into holdings and are significantly more tax efficient than mutual funds, through an elegant system that is the creation/redemption process. Because ETFs are so diverse they are also a core component into the creation of portfolios, especially seen in a top-down investment management perspective and have inspired the creation of many other exchange-traded products. The success of ETFs has been met with strong empirical evidence, offering many benefits for end consumers ranging from tactical investment bets to efficient sector allocations. Increased trading activity on secondary exchanges allow ETFs to be more liquid and price efficient than its underlying constituents, enabling investors easily take on exposures to broader markets.
A simple analogy of how an aggregate product can increase trading volume and liquidity is in relation to how Amazon aggregates a market. For example, the shoe market is quite fragmented, and not easy for a consumer to purchase shoes. Different sellers may even offer the same shoe, but often varying prices. Often times in retail, we see mom-and-pop shops finding it difficult to get visibility and an overall disconnect when it comes to connecting buyers and sellers. Customer experience becomes elevated due to the increased ease of finding, comparing, and purchasing the end product when aggregation comes into play. With a platform facilitating this exchange, shops get better visibility to drive more volume and individuals like you or me have more purchasing power. The result is an ecosystem that is mutually beneficial to both buyers and suppliers of a product.
Neutral is modelled as a smart contract system. Smart contracts are a class of software that live on networks (such as Ethereum) and are executed and validated autonomously by a collection of computers that make up the network. Cryptography secures and surrounds these systems, and gives us a mathematical basis to verify their integrity. This allows their code to execute based on a set of inputs and produce a set outputs without relying on a centralized party. This is important because the code itself, its input, and its output can be validated by many parties who are unable to alter it to their benefit. Given the open nature of these systems, it is possible to audit and monitor the entire program and its connected components. In the context of the Neutral ecosystem this gives users, auditors, and regulators deep insight into its construction and operation. Many are able to verify the integrity of the entire process. Ultimately, once a Neutral token is deployed on these smart contract networks it will function completely autonomously. The math and algorithms that govern its operation will operate independently of a centralized entity, and provide continuous services to both users and other software on the network.
The Neutral Project has the explicit goal of creating lower volatility aggregate instruments — that is, a basket of digital currencies or digital tokens that together form a new token which is representative of the basket. In this context a token is a transferable sub-unit of account on a digital ledger. The intent is to lower consumer risk through diversification, and to create a completely trustless and transparent mechanism accomplishing this.
Avoiding adverse manipulation by third parties is an important starting point for building a trustless system. The initial collection of components in a Neutral basket are ERC20 compatible tokens on the Ethereum network. The initial selection will be done through a rigorous and transparent process where we assess the relative quality of these tokens. Several important considerations include, security, code quality, liquidity profile, and token ownership distribution. Ultimately, a Neutral token will transition to a more thorough decentralized governance structure which will allow stakeholders in the instrument to determine its composition.
The Neutral token will be created through the collateralization of its components. The collateralization process establishes market prices for all of the components in relation to the Neutral token. This market price is used when calculating future redemption or creation pricing. The quantity of Neutral generated per collateralization is large enough to disincentive small players from collateralizing. Only participants who have significant economic capability will be able to engage in this process.
Just as the Neutral is created by participants, it can be deconstructed by holders. An entity that controls a Neutral token can also redeem it. This would destroy the Neutral token and replace it with the underlying collateral.
Balancing is an important consideration for aggregate instruments, and a Neutral token accomplishes this algorithmically, and without third party interference due to the natural interaction of participants in the ecosystem. The interaction between Creation and Redemption mechanics creates an auto-balancing mechanism whereby the underlying becomes equally weighted. Arbitrage opportunities for participants show up between underlying components vs the aggregate Neutral instrument as the market price fluctuates.
A critical flaw in many blockchain-based financial instruments and services is that they rely on third party sources of information (Oracles) on which to make decisions. This means that the input into a service can be used to alter the function of the system to the detriment of the users. The Neutral pricing mechanism offers a real alternative that should increase the accountability of the entire system — processes together result in pricing information being injected into the primary market by the participants themselves. Once this information exists on the network additional smart contract software and services can utilize it for better and more transparent pricing.
The Neutral software is a new way to aggregate digital currencies to create lower volatility and reduced risk tokens. Its novel design further extends the capabilities of these networks by providing trustless pricing and swapping mechanisms that significantly increases accountability and auditing, reducing the chance of third party fraud through false oracular statements.
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