Decentralized finance (DeFi) has continued to prove its explosive growth due to numerous protocols, including lending, exchange and global payments that don’t require financial intermediaries. With many use cases, the newest contender taking the crypto sphere by storm is derivatives.
Derivatives are products like options and futures, where an arrangement has a value determined from the underlying asset, whether this is a stock, interest rate or cryptocurrency. The benefit to investors is that they gain exposure without ever holding the asset. Today many centralized exchanges deal with derivatives trading.
With DeFi, no broker is required, meaning settlement occurs automatically on the chain and fulfills the terms of a contract immediately. DeFi for derivatives trading also solves the larger problem at hand, being that users can’t trade centralized exchange derivatives from the blockchain at all.
The Deri protocol allows users to trade derivatives the DeFi way, providing options and futures to hedge, speculate and arbitrage, all on-chain. 0xAlpha, the co-founder and CEO of Deri Protocol, shares their goal of providing something “similar to BitMEX, with Uniswap style.”
With the Deri Protocol, trades are executed under an AMM paradigm, and positions are tokenized as nonfunfible tokens (NFTs), which can be used alongside other DeFi projects. The protocol aims to provide an on-chain mechanism to exchange risk exposures precisely and economically.
So far, the protocol has been deployed on Polygon (MATIC), Ethereum (ETH), Huobi ECO Chain (HECO) and the Binance Smart Chain (BSC). These integrations solidify their slogan, “Four Chains, One Ecosystem.”
DeFi for derivatives offers other benefits, such as extreme capital efficiency through the support of multiple base tokens to be deposited as margin to trade. For example, users will have several options for coins they can use as a margin, which is not something investors can easily do on a centralized exchange.
An introduction to perpetual derivatives
Currently, Deri offers two main products: perpetual futures and everlasting options. Perpetual futures and everlasting options are similar in that they both belong to the same funding fee-based perpetual derivative. These are kinds of derivatives in which the user must pay the funding fee to maintain the position, unlike regular futures, which come with expiration dates. Therefore, for as long as you pay the funding fee, your position is maintained.
The difference between perpetual futures and everlasting options is the payoff function that is linked to the derivative. For perpetual futures, it is a linear payoff. For example, if Bitcoin (BTC) were to go up, the derivative holder would make money, and if it were to go down, the holder would lose money.
In comparison, for everlasting options, the payoff function is non-linear. Using the same example for a call option, if Bitcoin goes up, holders make money, and they don’t lose anything if it goes down. To maintain this less risky position, a fee is typically charged to the user on a per-second basis.
Everlasting options implemented as a decentralized protocol are one of the pioneering DeFi primitives. That is, a new type of derivative that will give traders a never-before-seen long-term options exposure without the need for rolling positions. This work was based on a theoretical paper from Dave White and Sam Bankman-Fried and the Deri Protocol team’s extension.
The team at Deri helped make both theoretical and practical contributions. From a theoretical perspective, the Deri team proposed the continuous funding scenario, meaning the user pays the funding fee continuously rather than once or twice a day. The latter would not work on DeFi since transactions typically occur per block or per second.
A second major difference is the closed-form analytical formula. The initial proposed pricing framework was based on a summation of infinite series, which wasn’t practical for the Deri protocol. The alternative developed is much more simple mathematically, helping people understand everlasting options. Similarities can be drawn from the Black-Scholes model that helps investors understand regular pricing for options.
The CEO of Deri shares, “In six months, our goal is to make the Deri derivatives, perpetual futures and everlasting options, an important part of the DeFi infrastructure.” He continues, “finance is to deal with risk, and derivatives are the most important tool to do so.”
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