What are expirables?
With our beta launch approaching, we’d like to take the opportunity to better define the nature of the products offered on Contango and explain why they’re different from anything else currently found in DeFi.
What is Contango?
Contango is the first DeFi market to offer expirables, a new derivative that allows traders to buy or sell assets at a specific date and price in the future.
This is indeed what regular dated futures and forward contracts do (as opposed to perpetuals, which never expire). However, there are important differences between Contango’s expirables and the other standard instruments you can find in CeFi or TradFi.
First of all, Contango allows traders to take expirable positions without order books or liquidity pools. When a trader opens a position, the protocol borrows on the fixed-rate market, swaps on the spot market, then lends back on the fixed-rate market. By doing so it synthesizes an expirable position. See the details on how the protocol works here.
Contango automates a simple derivative trading strategy that could be replicated at any high street bank in TradFi: you could go to your bank and borrow some GBP, swap them for EUR, and lend them out, effectively synthesizing a EUR/GBP forward position.
So is this a future or a forward? Well, it’s a one-of-a-kind product that allows you to hedge or speculate at a future point in time, just like dated futures in CeFi.
Remember FTX (which, by the way, stands for “Futures Exchange”)?
Well, if you are looking for a DeFi alternative to trade dated futures on-chain you can now do so on Contango.
What is the difference between futures and forwards?
Both futures and forwards allow traders to lock in a specific price of an asset at a specific date in the future.
However, futures are standardized contracts, meaning they come with fixed maturity dates and uniform terms. They are very liquid instruments and they are traded on exchanges, where daily settlement occurs (meaning PnL is crystallized every day in the trader’s account). The counterparty risk is held by the exchange which ensures payment on the agreed-upon date, through a Clearing House. In TradFi, futures are available to retail investors and, as such, they are heavily regulated.
On the other hand, a forward contract is an arrangement that is made between two parties and settles just once at the end of the contract. The terms of the contract, such as the price and delivery date, are agreed upon by the two parties entering into the contract. Being non-standardized, forwards are not traded on exchanges. Also, they’re not regulated, and thus come with a degree of default risk since the counterparty is responsible for delivery. Being over-the-counter (OTC) deals, they’re not readily available to retail and they are not liquid instruments. (See more details on Investopedia)
As we like to say: all futures are a forward, but not all forwards are futures.
Where does Contango’s expirable stand?
Well, on Contango:
- Positions are synthesized by actions performed atomically on third-party protocols, following the famous interest rate parity model. According to this theory, the interest rate differential between two countries (read: currencies) is equal to the differential between the forward exchange rate and the spot exchange rate (source).
- Each position is unique, because the entry price changes depending on how much collateral the trader posts. Each position has an isolated margin. Everything happens on-chain in a non-custodial way: the trader’s assets are used directly on third party protocols to create an expirable position. When minting (read: opening) a unique expirable position, a trader indeed receives an NFT in her wallet.
- The pairs and maturities are the same as those offered on the underlying fixed-rate markets. For its v1, Contango will offer e.g. the ETHUSDC pair using both Yield’s and Notional’s maturities, which are not the same, and as such the respective contracts cannot be considered standardized.
- When removing equity, a trader can crystallize PnL without having to partially close a position.
- At expiry, the trader can: 1) bring the missing capital to cover for the full value of the position, and physical delivery occurs or 2) cash-settle her position in the quote currency. Positions are not settled daily (marked-to-market).
- The counterparty risk is not held by Contango or other traders, but by the underlying fixed-rate markets. Liquidations are indeed carried out by them.
Given the above, we decided to name the products offered on Contango as expirables, as this is broad enough to describe a derivative contract where you can long or short an asset at a specific expiry date and price.
By doing so, we don’t necessarily have to stick to futures or forwards, as this will limit the understanding of all the technicalities that distinguish Contango from other CeFi or DeFi products.
Our ultimate goal, as a DeFi project, is to provide absolute transparency on our products: more experienced traders are well aware of both forwards and dated futures, but we want to avoid confusion especially for retail users who might be familiarized only with the standardized futures offered by CeFi exchanges.
This is indeed the beauty of DeFi: new financial primitives pop up everyday. So we should document and market them as best as we can, to flatten the learning curve for anyone across the world.
About Contango
Contango is bringing expirables to DeFi. Buy or sell assets at a set price and date in the future without order books or liquidity pools. When a trader opens a position, the protocol borrows on the fixed-rate market, swaps on the spot market, then lends back on the fixed-rate market. Contango offers physical delivery and a minimal price impact for larger trades. Join us at contango.xyz.
