DeFi Derivatives Series: (0) Why DeFi Derivatives?
Even as Crypto Summer continued with the theme of DeFi in 2020 and NFT in 2021, verse2 predicted the upcoming Crypto Winter. We concluded that crypto derivatives, especially DeFi derivatives, would be the next new keyword in the crypto market.
“Why Crypto Derivatives?”
This decision is not only because verse2 has a strong background in traditional finance, moreover derivatives. The growth of the crypto derivatives market has already been foreseen by many of the leading players in the crypto scene in terms of the demand for derivatives and the market size
- The Demand-side of Derivatives
Many institutions did not have crypto assets in their portfolio (or balance sheets). However, many of them have started to invest in crypto assets. It has increased the demand for hedging against volatility, maturity, as well as the price of the assets. Various tools and platforms have been developed for futures and options, using crypto assets as underlying assets, increasing the demand for crypto derivatives. - Size of the Crypto Derivatives Market
The size of the derivatives market in traditional finance is much bigger than the size of the spot market. It is still the same for the crypto markets, meaning the futures market is bigger than the spot market. Yet the difference is not as large as in traditional finance. Furthermore, the role of derivatives is not completely equal to what it is in the crypto market. We expect the different market size indicates the potential growth of the crypto derivatives market as more institutional investors will accelerate the growth rate.
These perspectives are accepted as why there would be rapid growth of the derivatives in the crypto market.
However, the crypto market scene has completely changed in 2022. In recovering from the economic shock caused by COVID-19, inflation worsened, and asset markets overheated. To alleviate the economic impact, the austerity policies led by the U.S. complicated the situation, causing the high-risk asset markets to collapse. Moreover, turmoil in commodity markets following the outbreak of the Russia-Ukraine War exacerbated the global macroeconomy and the financial market’s recession.
In addition, the failure of Terra caused distrust in the fundamentals of the DeFi ecosystem beyond the simple LUNA-UST price fall. The crypto market is going through the biggest bearish market it has ever experienced.
Despite the current market condition, verse2 has seen a great opportunity for DeFi derivatives during the crypto winter. Many investors suffered from Terra, but it created a consensus on hedging by derivatives, such as building a short position while the token price drops and making more profits.
On May 10th, the trading volume of the Binance futures market reached $156B, and FTX reached $28B. The trading volumes from two major central exchanges explained that hedging by derivatives is in need by investors. It can be a sustainable business model during the crypto winter.
“Why do we choose DeFi derivatives over crypto derivatives?”
DeFi takes 10% of the market in the crypto spot market relative to CeFi (Centralized Finance), while it is only 2% in the crypto futures market. The numbers show that the DeFi derivatives market has the potential to grow nearly five-fold. Also, DeFi derivatives can easily integrate with existing DeFi services in the ecosystem. It allows builders (service providers) to access besides traders because it is open source.
verse2 strongly believes that a unique DeFi derivatives protocol, never seen in traditional finance and CeFi, can be a market changer. New DeFi derivatives protocols are already introduced like perpetual futures do not expire, the power perpetual gives traders perpetual exposure to ETH² and options with various expiries. Such non-linear derivatives can be an appropriate tool to hedge impermanent loss by providing liquidity to Automated Market Makers. One can also develop a protocol that helps users access crypto-structured products for DeFi. It combines options, futures, and fixed income to improve a portfolio’s risk-return profile. On top of that, DeFi Option Vaults (DOVs) have been a phenomenon recently. We can imagine a structured product that satisfies users’ needs in terms of a structural profit model.
Verse2 conducted in-depth research about the leading protocols and innovative derivatives products, and we would like to share our thoughts in the DeFi Derivatives Series.
Please stay tuned.
The next topic of the DeFi Derivative Series:(1) DeFi Derivatives Ecosystem, will be about Futures.
This article is <DeFi Derivatives Series: (0) Why DeFi Derivatives?> provided by verse2. If you would like to read the entire series, please see the list below. We recommend you read the articles sequentially.
1. DeFi Derivatives Series: (0) Why DeFi Derivatives?
2. DeFi Derivatives Series: (1) DeFi Derivatives Ecosystem — Futures
3. DeFi Derivatives Series: (2) DeFi Derivatives Ecosystem — Options
