DeFi Dives: Intro to Tracer DAO
Disclaimer none of what I say here should be taken as investment advice, this is simply an examination of how the platform works. The goal of these articles is to simplify complex topics for both myself and the reader! I am learning about these myself and attempting to break things down in public. If anything has been misunderstood please feel free to reach out and I will amend where necessary
This week I wanted to take a look into Tracer DAO. Cool name eh. I was lucky enough to get to speak to Lucas of Tracer DAO & Mycelium for this one :). Sidebar, it was nice to speak to an actual human being for this one, rather than purely sitting in front of 100 open tabs for days on end, which I still did.
So what is Tracer DAO? Is it for people who are bad at drawing but want to claim photorealistic copies as their own? Not quite fren.
Tracer DAO is an ‘ecosystem of derivatives products’. It is being built as a place where you can build derivatives markets for anything. I mean anything.
Interestingly, Tracer has high ambitions to be a useful protocol past just speculation. By offering open-source and permissionless derivatives they envision a world where these products are available and used by households, rather than only accessible by sophisticated investors. They want to democratise derivatives. This can allow people to hedge things like the commuting cost, cost of energy, or exposure to certain assets (all of which feel especially relevant with rising energy costs, inflation, and threats of rising rates!!!).
Currently, it is most easily viewed as a perpetual pools protocol, (say that 10 times fast). Perp pools are their first product, with more on the way! People can use them to take a leveraged position to avoid the risk of liquidation with no margins.
That is the tagline, but what does it mean!?
Well typically, when leverage is offered to people you also have liquidation risk. Say you have $1000 in your wallet, on DYDX you could go 10x long BTC- so you are buying $10,000 worth of BTC with your $1000 as collateral.
If BTC goes up by 10%, great, you have doubled your money, but equally, if the price dips you can get ‘liquidated’ if you don’t add more collateral. This means your collateral, in this case, $1000, gets wiped out and you are left with nothing..rekt.
With some clever engineering from TracerDAO, perpetual pools eliminate this.
The way it works is- each side deposits collateral into a pool to take either a long or short position. This collateral could be anything in principle but to begin with, it is USDC. So each pool has two sides — long & short.
The pool will stipulate the equivalent leverage, so it could be 1x, 3x, 10x, etc.
You then mint a token that represents this position.
Now here is where it diverges from traditional leverage again. V1 of the pools used something called power leverage, V2 has moved to something called sigmoid leverage, it sounds intimidating but both represent a calculation that determines the amount one side ‘pays’ the other depending on price movements.
This matters because it “gives returns almost equivalent to “times” leverage for typical price movements, but dampens returns to extreme price movements so users can never lose 100% of their collateral”.
So this means when the price stays in a lower volatility range, you get almost the same upside as you would do with pure-play leverage, but when the price starts swinging more your upside is more limited. This protects the collateral in the pool and prevents liquidation.
This is the graph below that TracerDAO use in their documents to demonstrate 3x leverage. You can see the blue line tracks your returns with traditional ‘linear’ leverage, the red line is using perpetual pools.
The lines track together initially and then begin to diverge, this is the dampening effect. The difference between the two lines is what you would ‘miss’ out on if you had used traditional leverage. However, when using the pools you don’t get the liquidation risk.
The way I am thinking about it is: you all deposit collateral into a pool and you initially have a claim of X amount. When market conditions change your claim amount changes, this applies to everyone in the pool, but it all always adds up to 100%. The power leverage kind of supercharges your claims within a certain range, while dampening your upside if things go strongly your way (hey it can’t all be pure upside, no downside right?). At the end, you get to burn your token and take your claim out. So my understanding is your maximum benefit (from a returns, not hedging, perspective) comes when the asset prices aren’t too volatile.
Perpetual pools also offer some other benefits to users:
- you don’t have to manage margins/collateral
- there are no expiration dates
- no counterparty risk
- because the position is tokenised it becomes a composable part of the wider ecosystem (i.e you can use it on other protocols, like depositing it on Rari to use as collateral for borrowing
On the first point, one thing I’d like to expand on is the management of the position. The pools and token take care of this so you don’t have to.
This is known as rebalancing- which is how this value/claim transfer is managed. This is done hourly and managed by ‘keepers’. These are bots that rebalance the pools for a fee. This makes perp pools a lot more cost-effective than their closest real-world counterparts like leveraged ETFs where the trading and management fees add up quickly! I believe Tracer’s management fee is 1% PA. This also means there are periods, I believe it is 5 mins, where you can’t enter or exit a pool to prevent front-running.
V2 of their perp pools is also on the way and with that they have been able to reduce volatility decay, meaning you can hold these positions for even longer. The short explanation is volatility decay is where, by holding leverage, you end up with less than you would have without leverage because of a series of volatile moves that are amplified by leverage.
V2 is also bringing:
- No more minimum buys (V1 was a $1000 minimum)
- Permissionless deployment via the Perp Pools Factory (in the ethos of DeFi anyone can come and set up a pool)
- The ability to create custom indices- which track a basket of assets (see Perpetual Punks Token as what’s on the way as an example of what can be done!)
All of the above serve to democratise access to derivatives tools. There are a number of ways people and protocols might use Tracer DAO:
- Hedging for treasury management
- Hedging for energy prices
- Hedging for assets/investments i.e Real estate, Eth, BTC.
- Using unproductive assets (like governance tokens) as pool collateral
- Gaining price exposure to assets you otherwise couldn’t i.e Punks Token above!
- More things my smol brain cannot currently imagine.
The team building the initial product and setting up the DAO is Mycelium, an Aus-based dev studio.
The main risks I can see with setting up your own pools would be that the oracle data feeds are compromised or fed with poor information (however Tracer has partnered with ReputationDAO to try to tackle this issue). As always there is smart contract risk, like anything in this space!
Another nice benefit to note is that Tracer is deployed on Arbitrum (an Ethereum l2) so gas fees are much much cheaper! I was pleased to see this as it means the barrier to entry is much lower. People don’t have to have high 4 figures or 5 figures sums for it to make sense.
Other things worth mentioning: you have to bridge funds to Arbitrum to use the protocol so there will be a bridging risk, also when you want to withdraw funds from Arbitrum to Eth L1 there is a 7 day waiting period. However, you are free to move your assets on Abritrum freely, quickly, and cheaply :)
Oh and one last point I’d like to mention! As the name may suggest TracerDAO is in fact…a DAO…
Their DAO is run by holders of the Tracer Token, by holding tokens you get a vote and become a ‘Governor’. It is cool to see DAOs in the wild, much like Barnbridge, who I wrote about previously here.
It is a democratic voting system, which I have my reservations about in general, not specific to Tracer, but again the upside is- you got a token? You get a vote.
There are plenty of job opportunities to work with the DAO and the core team, hop into their Discord (link on website/Twitter) or check out some chances here.
I am interested to see the launch of V2 for Tracer. The protocol and the idea has kind of gone under the radar in the DeFi space. Especially when people are calling for more ‘real world’ applications. The team has quietly kept building. Being able to create your own indices and pools will be fun and has a lot of practical use cases!
Plus, my understanding is, Tracer is a developer layer too, they want people to come and build ON it as well as use it natively. The applications and usefulness of the protocol seems huge and currently untapped to me.
As usual, this isn’t an exhaustive examination of everything Tracer DAO, I feel I could write 20,000 words on the protocol and still not cover everything, but hopefully, this has whet your appetite as it has mine!
P.S. Some helpful documents for further reading: