What are Structured Tokens? Introducing DEXSTs
In this article we would like to announce a novel primitive in DeFi, Structured Tokens, to introduce the first such token in the DeFi market, a capital-protected Token on ETH and to unpack what structured notes are in the traditional finance world and discuss the benefits that our tool can bring to the digital asset management space.
- Decentralized Structured Tokens (DEXSTs) are a new DeFi Primitive: they are hybrid tokens with adjustable risk-return profiles, better suited to express non-linear market views
- We introduced the first implementation as a Capital Protected Structured Token (CPST) on ETH which limits the downside while still giving participation to the upside of ETH
- Anyone can mint CPSTs (and we will soon build the front-end to design them as well)
- Even more people can simply buy them on a DEXes like Uniswap
- You can create DEXSTs which are suitable under any market conditions, and are particularly interesting for range-bound market environments
- CPSTs are antifragile, as they have the potential to perform best when markets are volatile
We are excited to announce our first Decentralized Structured Token (DEXST): a Capital Protected Token (CPST) on ETH.
Are you attracted to invest in ETH but the prospect of its volatility scares you?
Are you uncertain on the price impact of Eth2 but think that ETH has strong long term prospects?
Are you waiting to buy ETH at a dip but so far it only went up and you missed the boat?
You will love to hear more about our Capital Protected Structured Tokens on ETH, this token will give you a positive exposure to ETH but protects your capital on the downside.
Decentralized Structured Tokens (DEXST) are hybrid tokens that combine the features of multiple different DeFi projects: yields generating assets, derivatives, synthetics, options, etc. This enables DEXSTs’ creators to adjust the risk-return profile of investments, vastly expanding the number of possible payoffs. It also allows for richer ability to express market views.
Our protocol is here to leverage on the very composability of DeFi to provide the means to create strategies that help anyone to monetize on a certain market expectation.
Each strategy will have an expiration date at the end of which the payoff will be realized.
The textual definition of structured notes is particularly daunting for those who are not deep into finance or the asset management world. So let’s get on with it.
A structured note is a financial instrument which contains an interest-bearing obligation combined with a derivative component that adjusts the instrument’s risk-return profile.
The most simple structured note is made of a yield generating asset plus an option (derivative), that we call Capital Protected Structured Token (CPST).
A derivative is a financial instrument which performance is dependent on the underlying asset’s performance. An example of a derivative is a financial option offered by Opyn. Options are of particular interest for structured notes because they enable non-linear payoffs vastly expanding the possibilities offered by investing in them.
A financial option gives the holder the right but not the obligation to buy or sell the underlying asset at a predetermined strike price.
Options enable the possibility to take exposure to the volatility of an asset, to create yield from it and to naturally embed “good leverage” (leverage exposure that grows when the underlying increases and shrinks when the underlying goes down in price).
In general DEXSTs can help to achieve three primary objectives:
1.Investment returns with little or no principal at risk
2.Higher returns in a range-bound market with or without principal protection
3.Alternatives for generating higher yields in a low-return environment
They provide asymmetrical returns, meaning that returns will be higher or lower than those derived from a direct investment in a particular asset.
A clever Portfolio Manager can design DEXST to help their Investors to achieve greater diversification, to gain or hedge exposure to certain asset classes, or to align their portfolios with a particular market or economic view.
The Capital Protected Structured Token (CPST) on ETH is a novel tool that allows investors to participate in the upside of an underlying (i.e. ETH) while having a floor to the value of the token.
They are designed to protect against losses at maturity, while providing the opportunity to participate in the gains.
Where is the catch? Holders are effectively forgoing the utility value that they derive by directly owning the underlying token.
In order for it to function perfectly we need a few more primitives in DeFi (such as zero-coupon tokens, a developed decentralized option market, long expiry options market, etc.) and we intend to work with the likes of UMA (which is working on Zeroes) and Opyn (which is doing great work on Options) to improve the toolset and the design.
In the meantime, in the spirit of test in prod, we decided to launch with the imperfect tools we have: rather than a zero-coupon bond we will use a money-market-like token (Yearn vaults) to generate the fixed income properties and rather than long term options, we will use the short term Opyn options that are currently available for the returns.
The basic idea is very simple: if you want to floor (maintain at least) 100$ in 1 year and you have access to an asset yielding 25% per year, you just need to invest 80$ in that asset and hold to maturity.
With the remaining 20$ that are left you can buy at-the-money options on ETH with expiry 1 year.
If these options cost 0.2 ETH that means that you get 100% exposure to the upside potential of ETH, while if they cost 0.1 ETH you can get 200% exposure and if they cost 0.6 ETH you will only get 30% exposure.
At maturity the yielding assets will be worth 100$, the Options will be worth the price of the underlying minus the strike price, or zero, whichever is higher.
So for example if your ETH goes up by 10% and the participation is 200% then the note will go up by 20%, if ETH goes down by 20% instead, the option will be worthless but the note will be worth 100$.
Through the DEXTF platform anyone can mint CPSTs or design new ones, but the process is complex and we have yet to release a front end for it so we will launch the first batch of structured tokens on Uniswap, in order to make it convenient.
You will be able to buy them soon but please be careful of the below points:
- If you buy these at prices above 100$ the difference from the market price and 100$ is not going to be protected
- The protection is based on the yield expectations of yearn vaults which may be realized at a lower rate (or higher). We will work with UMA to integrate their zero-coupons which instead will make this certain (bar a smart contract failure)
- If you buy the CPST on Uniswap (instead of creating them on the DEXTF platform) you will move its price and increase it above the 100$ floor (read point 1), you can consider this as a market-making cost that repays the CPST creators for dealing with the complexity on your behalf
- There is significant smart contract risk (even if our code is audited)
- Uniswap market is not efficient for asymmetrical payoffs like options (we are working on our internal market based on 0x and we will experiment with Balancer as well)
- Short term Capital Protected notes are not efficient: since the cost of the option grows with the square root of time while the yield grows linearly with time, it’s more efficient to buy long term capital protected notes (we will work with Opyn to create them)
Structured Notes have been in existence for many years in traditional finance and they have developed a somewhat bad reputation. The reason is that in legacy finance, these notes are relatively illiquid products, highly opaque in terms of pricing, with complicated legal documents and fine print clauses which investors better had to be aware of. DEXTF rejects all the above features and adapts it to the fast-paced and democratic environment that characterizes DeFi and enables anyone to create, invest in and trade these notes/strategies. In fact, we will launch the DEXlink, a shareable link where crypto experts can build structured tokens for themselves and share their strategy which can be traded by anyone who shares that belief.
We understand that DeFi has been built for everyone to operate in and for that we hope to provide a chance for everyone to monetize their ideas while capping the downside to a negligible cost-opportunity.
Disclaimer: Please note that this is an experimental feature. Use at your own risk!