#2 The Importance Of DATA Feeds To Crypto Synthetics
In this article let’s look at data feeds, oracles, and why they are so important to the crypto synthetic movement.
Let’s start back at our original example that was outlined in my first article about the most basic of synthetic assets: the paper receipt for a gold coin deposited in a gold vault. That slip of paper that represents one gold coin does not rely on any price feed for its redeemable value of ‘one gold coin’. With a gold coin as its value, that value is static. What you do with that slip of paper is where the real complexity arrives.
To make this example simple, let’s just go back in time before comex, before a global gold index and an agreed upon global price. Let’s look at how past data feeds were agreed upon in an isolated village setting.
In the example we used, the gold synthetic, the piece of paper, was used to speculate on wheat. We assumed the price of wheat would rise in respect to the price of gold, so you buy wheat with the paper gold, hold the wheat until the price goes up in gold, then sell the wheat for gold. Let’s say it does a 2x. Buy 100kg of wheat for one gold coin. After a month, sell 100kg of wheat for two gold coins represented in paper gold. How does the data feed work in that situation?
Well, basic supply and demand meant that at the start of the interaction one gold coin bought 100kg of wheat. That was the agreed upon price in the area based on the local economics and let’s say that first area had a lot of wheat. In the past(and today), geography played a huge role in the generally agreed upon price of wheat vs gold. You could take the risk of transporting that wheat upon yourself to an area with less wheat, and then you could sell the wheat for a 2x in gold. Very simple right? That basic mechanism is still the main price action today for most data feeds in the world. Tea is generally much cheaper in China than it is in places that don’t produce tea for example.
The data feed for market price in the past was known by word of mouth, and contracts could be set up before goods were moved from place to place. Or, a larger risk could be made by just moving goods and hoping that you could sell those goods for a higher market price when they arrived. Not the most efficient system, but one that has worked for thousands of years.
Now we enter the modern era with the internet and global, instantaneous price action. Global, agreed upon price of goods that is immediately known by everyone connected to the internet. The internet made price feeds instant but centralized, blockchain made them permanent and possible to decentralize, and decentralized finance makes them free from central control and manipulation. Enter platforms like Bao Finance and the general crypto synthetics movement, and the explosion of innovation can begin!
In the modern era, up until the present moment, global price feeds have been gated/walled/controlled by large financial institutions and government. Think of currency controls, stock price manipulation and regulation and the classic example of the price of precious medals. In our example from the past, the relative ‘price feed’ of the value of gold vs wheat was based on local conditions and relatively decentralized. Now, comex futures contracts, naked short selling, and other mechanisms not available to a regular investor move the price of precious medals in a very centralized, gated, controlled way. The gold data price feed is available to everyone globally, but the centralized nature of it makes it by design an unfair market. Large players with access to tools to manipulate the precious medals price feed have a huge advantage over regular retail investors and many traders have been charged and institutions fined over this practice.
How does decentralized finance(DEFI) change this? By opening the door to novel decentralized data feeds and investment mechanisms that are free from a central control, DEFI has the potential to build a transparent, efficient and innovative financial system that would make the traditional financial world obsolete. At the center of this, will be the data feeds.
(For the moment we will not go into the oracle problem and just into why data feeds are important to the Bao project and synthetics in general. Suffice it to say that the data feeds that will be talked about now are not created yet, but will be someday. Oracles will be a later article!)
Let’s go back to the moving wheat example above. In the modern world there are ways to hedge the risks inherent in moving goods, in this case wheat. Insurance for example. But, those options can be very centralized and expensive. In the case of moving wheat, only a few large insurance companies would take on that risk and even if something did happen in transport and the wheat was damaged, getting a payout from an insurance company can be no easy task. Even being able to get insurance would depend on geography, local laws and many other factors dependent on centralized regulation.
Enter defi and use of decentralized data feeds. Remember our definition of synthetics as well:
“Collateralize something of value in a contract, extract that value, and use a data feed to speculate on something else.”
Can you imagine all the options for the various parties in the moving wheat example for individual entities to hedge their risk? Insurance would be an easy one. Use a crypto synthetics platform to collateralize the full value of the shipment of wheat in gold equivalent and design a payout system based on an agreed data feed (amount delivered, quality, time etc.) all on the blockchain with automatic payouts when criteria(from data feed) is met, totally independent of geography or central regulation.* But, this is just a copy of the existing system and rather boring.
What else could be added to the data feed?
This is the key. The weather, the price of gold, average shipping times, the cost of fuel, average crop yield, wheat futures, bread/pasta sales, shipping rates, and to infinity. The farmer could hedge their bets by buying a synth that pays out if the weather is bad and their wheat crop is ruined. The shipper could buy a synth that rises in value if the cost of fuel goes up to hedge shipping costs. The buyer of the wheat could buy a synth based on the price of gold to hedge against price fluctuations. The Baker could buy a synth based on the price of wheat that would pay out if the price of wheat went up. And thousands upon thousands more, plus combinations of all of them! Imagine a shipper’s synth index that would rise and fall based on the shipper’s needs(fuel, labor, vehicle costs etc), a baker’s synth and on and on. All created on the blockchain, with trustless payouts, powered by decentralized data feeds.
And now that we can imagine it, what is needed to bring this into existence? First, is a trustworthy synth maker (What we are building at Bao) as a safe place to collateralize assets, mint synthetics and redeem them. The second is what this article is about: a large number of quality, trustworthy, accurate, timely, and decentralized data feeds that are accessible to the blockchain in a trustless way. And how would we get them? Decentralized oracles. But more about that next time!
*These examples are wildly complicated and speculative and the details of these examples have obviously not been fully understood yet. But solutions are being created and tested. (Look at Kleros for the problem of dispute resolution for example.) We are in very, very early days here and I am trying to give examples of what could be done. Sort of like designing commercial airliners in 1906. :)
