Analysis of Solana’s Decentralized Derivatives Landscape

Derivatives aren’t new to crypto. Since the centralized exchange industry began to penetrate the lucrative derivatives market long ago in 2014, CeFi derivatives have matured significantly.

Many centralized counterparts are tapping into the crypto derivatives market, with TradFi banks like Goldman Sachs, JP Morgan, Nomura offering crypto derivatives contracts to institutional clients.

The utility of derivatives surpasses the interests of investors and traders. Derivatives play a major role in hedging against inflation and deflation and achieving global diversification, resulting in an efficient, mature market.

We’re consistently seeing derivatives trading volume spike when major events occur. With derivatives exchanges hitting daily record highs in trading volumes amid the Luna fallout fiasco. There is also a consistent trend of crypto trading volume, derivatives included, reacting to FOMC events.

Currently, derivatives trading volume far exceeds spot trading volume amongst top CEXes. Most retail traders still prefer to trade derivatives on centralized platforms. Building a successful derivatives DEX is not a cake walk, especially when facing centralized competitors who already have a robust and liquid trading environment. DEXs have to match the speed, fees, and liquidity of these centralized exchanges. While also combating issues like scaling limitations of blockchains.

As opposed to traditional markets infrastructure, which facilitates a more well-rounded mechanism around price discovery, trade execution and capital efficiency. Crypto markets offer infrastructure that is capable of managing credit risk in new ways, including technology that allows 24/7 trading and real-time view of portfolio valuations.

In comparison to DeFi, the traditional derivatives market still has a much larger notional size. When DeFi comes into play, it aims to change the traditional ways to enable all market participants, no matter the size of their trades, can benefit.

Investors are beginning to understand the impact open sourced financial primitives can have on the financial market. Venture cash continues to push into the Solana derivatives market as we observe a plethora of decentralized derivatives protocols emerging after waves of hackathons.

Options takes up 2.56% of all DeFi sectors on Solana, accumulating a total of $3.41B TVL. The crypto market was and is still dominated by BTC and ETH, however SOL is starting to warm up to the options game with the largest derivatives trading platform Deribit beginning to offer SOL options.

Most derivatives protocols on Solana are widely expanding, offering other types of derivatives or more sophisticated financial instruments. From DOVs, to tranching, to exotic options, the derivatives landscape on Solana is scaling up rapidly.

Currently, Friktion continues to dominate amongst major derivatives protocols on Solana. Friktion differs fundamentally from other systematic option strategies in its execution infrastructure and strike-selection process. Friktion utilizes an on-chain, gradual Dutch auction process. The protocol determines the best strike range and timing with the help of an algorithm.

Friktion’s key performance indicators continue to increase throughout 2022. While its unique user growth has slowed down in Q2, it still shows a general uptrend. At first glance, TVL in terms of USD fell significantly in Q2, however in native SOL terms, TVL actually increased. This is due to the dramatic drop in SOL’s price.

Again, TVL by tokens measured in USD terms show a decline. This is due to the crash that led into the bear market, resulting in a majority of tokens experiencing significant price drop. Besides prominent tokens like BTC, SOL, and USDC, there is a notable inflow of mSOL and SCNSOL.

Trading a large number of options within a short period of time requires deep and concentrated liquidity. It can lead to loss of profits if price slippage and trade impact are not controlled. Traditionally, RFQs (Request for Quotes) have been used to solve this problem. A user sends out trade details and timing to many market makers, and they send back prices during a designated time window. Friktion acquired Channel RFQ in February this year. With the integration of the team and liquidity platform, the protocol is able to support larger option strategies. One of Friktion’s main competitors in this area is Zeta FLEX.

Zeta FLEX is a permissionless options creation and auction protocol which allows anybody to create a limitless variety of tokenizable options with flexible strikes, durations, exercise formats and underlyings.

Both Zeta FLEX and Friktion’s Channel RFQ utilize auction protocols that help DOVs do on-chain auctions for their weekly option sales. Friktion’s SOL volume saw a decline, this allowed Zeta FLEX to catch up.

The remaining non-DOV volume on Zeta is steady. Notable inflows from TVL by tokens include mSOL and ETH. Unsurprisingly, SOL takes up a big chunk of the TVL by tokens. As Zeta continues to grow, it could strengthen itself to become the dominant DEX for SOL options.

01 exchange is an orderbook DEX supporting derivatives like perpetual futures and power perpetuals. What Opyn did to SQUEETH, 01 did to SQUOL. It has remained in the forefront of the derivatives sector by introducing new DeFi primitives like the most recent zAMM (ZeroOne Automated Market Maker).

Unlike other protocols which have a relatively dispersed TVL by tokens, 01’s TVL by tokens is almost entirely occupied by USDC and SOL. This could be due to its flagship product SQUOL that attracts users to trade on its platform.

There are so many other derivatives protocols on Solana worth digging into. In fact, we’ve done deep dives on many of them. But unfortunately, there isn’t enough data available to add them into this report to facilitate a deeper analysis of Solana’s derivatives landscape.

All things considered, the potential for decentralized derivatives on Solana is gaining traction as market participants begin to recognize the full extent of the opportunity. As these protocols compete to develop the newest innovation, it’s worth noting that over- engineered, complex products usually struggle to gain traction. Most retail traders aren’t familiar with derivatives trading yet, so there is still a long way to go in onboarding more users into the space. However, I believe that DeFi derivatives volume will continue to increase relative to centralized exchanges, with a similar trajectory to DeFi spot volume.

Not financial advice though.

-SixOhFour

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