A breakdown of the advantages and disadvantages of the DEX derivatives market

Original title: "DeFi 丨 Layer 2 solution will be the catalyst for the explosion of derivatives DEX? "

Original source: Encryption Valley

Derivatives are financial instruments whose value Linked to its underlying assets. Derivatives can be used as a means to gain leveraged gains on underlying assets, or simply to hedge positions. In essence, they provide traders with greater options for adjusting the risk of related spot positions, whether it is increased leverage or hedging for downside risk.

These financial products are common in both traditional finance and cryptocurrency asset classes. Derivatives range from futures contracts, options, collateralized debt obligations, and perpetual swaps, a popular product in cryptocurrency trading. These financial products are offered by centralized exchanges and are usually supervised by regulators to ensure the safety of the trader’s funds and ensure that he understands the risks involved.

Cryptocurrency Derivatives Market

In its infancy, the cryptocurrency asset class only offered spot exposure to underlying cryptoassets such as Bitcoin, Litecoin and Ethereum. However, as the asset class began to mature around 2016-2017, exchanges such as BitMex introduced derivatives offering Bitcoin in the form of perpetual swaps and futures contracts through which traders could gain exposure to volatility. Asset's leveraged exposure.

Cryptocurrency derivatives are gaining popularity. This can be seen from the sharp rise in transaction volume in May 2020, reaching $602 million, which together accounted for 32% of the market, with the rest being spot volume, which reached $1.27 billion. In addition to perpetual swaps and futures, options offered on the Deribit exchange also saw a new record volume in May 2020, totaling $196 million.

Comparison of spot and derivatives monthly trading volume (November 18 to 20 May)

DeFi (decentralized finance) is encroaching on CeFi (centralized finance)

2020 has shown the power of DeFi to replace centralized financial services with permissionless smart contracts. The success of the order book model illustrates this point. In September 2020, Uniswap became the fourth largest cryptocurrency exchange by trading volume. One cannot swap volumes on a DEX (decentralized exchange) like Uniswap because transaction fees on the Ethereum blockchain make faking volumes infeasible.

Monthly trading volume ranking of Uniswap and centralized exchanges

 

Given that the rise of DEXs is cannibalizing the centralized exchange spot market, it is inferred that in the cryptocurrency asset class, options, futures and Financial instruments such as perpetual contracts can also be implemented with DeFi, and it makes sense to cannibalize the CeFi derivatives market. The rapid growth of the cryptocurrency derivatives market, driven by speculators seeking to profit from volatility, means that protocols designed to disrupt CeFi derivatives are likely to Acquired huge transaction volume for several years.

 

The benefits of decentralized finance

 

Harsh regulation

 

The UK Financial Conduct Authority (FCA) recently banned the sale of cryptocurrency derivatives to retail investors Mandatory on January 6, 2021. This decision is due to financial authorities’ belief that these products are too volatile and risky for retail investors to be consistently profitable.

 

In many cases, UK crypto traders, like US traders, will look for exchanges that do not require KYC , and use a VPN to reroute their internet activity from a UK/US IP address. If traders are willing to go this far in order to trade these products, there is a great demand for decentralized derivatives solutions.

 

If national and financial authorities continue to crack down on centralized exchanges offering derivatives, then permissionless, censorship-resistant Smart contract-driven decentralized derivatives will be the only viable option for residents of these jurisdictions.

 

Identity Information (KYC)

 

In order to trade derivatives on a centralized exchange, many require your identity information such as official identification (passport, driver's license) and a source of income to fund the account. As Nick Szabo said 'trusted third parties are security holes', which means that private information stored on these exchanges has the potential to be leaked, as demonstrated by the Binance KYC breach in 2019. Decentralized derivatives protocols require no KYC for traders to begin interacting with the protocol’s smart contracts.

 

Capturing Derivatives Trading Activity

 

Similar to how Uniswap allows liquidity providers to obtain transaction fees generated by transactions in liquidity pools, the decentralized derivatives protocol will allow users to obtain transaction fees generated by derivatives transactions.

 

There have been many models, such as the Perpetual Protocols governance token PERP, which will allow token holders to stake Inject PERP tokens to participate in protocol governance, and obtain 50% of the transaction fees generated by PERP's inflation and derivatives transactions.

 

Governance Incentive Model of Perpetual Protocol

 

Diversity of derivatives

 

The diversity of derivatives here is Refers to allowing traders to specify the contracts they want to trade. For example, if a trader wanted to create an ETHUSD perpetual contract, use WBTC as collateral, and also settle in WBTC instead of a USD-pegged stablecoin. The composability of DeFi will facilitate a wide range of possible derivative products that traders can use to execute trades of their choice.

 

The following is a practical example of the variety of derivatives. The Deribit centralized exchange offers call and put options on BTC and ETH that settle at a specified strike price on various days.

 

 Hegic is a decentralized options trading platform that allows trading Or specify a specific exercise price and holding period to provide users with additional products.

  

 

Some current shortcomings of decentralized finance

 

Transaction Delay

 

If in the chain For transactions on the Ethereum blockchain, the delay in waiting for the transaction to be packaged in the Ethereum blockchain can lead to slow transaction execution times. This is disastrous for traders, as execution time is of the utmost importance to take advantage of market volatility. Therefore, decentralized derivative protocols will need to implement L2 scaling schemes, such as optimistic rollup or zk rollup, where transaction execution time can be instantaneous.

 

Layer2 technology is undoubtedly making rapid progress, and Synthetix and Uniswap are actively integrating Optimism’s Optimistic rollup. However, it may be a while before these emerging protocols, which are primarily focused on derivatives, integrate the technology to meet trading needs.

 

Liquidity

 

Also One trading requirement is liquidity, especially for those trading at scale. When executing large trades, there is slippage, which means the difference between the expected execution price and the actual execution price. On centralized exchanges, market makers minimize slippage by ensuring that the exchange has sufficient liquidity to allow traders to execute low-slippage trades.

 

In DeFi, automated market makers have acquired enough liquidity to execute low-slippage trades, or In the case of stablecoin-to-stablecoin swaps, slippage is minimized using a novel AMM equation implemented by Curve. Uniswap and Curve's low-slippage trading, and partly responsible for their success in 2020, is driven by their incentive structure that allows liquidity providers to capture transaction fees.

 

In order for decentralized derivatives platforms to gain adoption, they must first Or maintain sufficient liquidity in off-chain order books to execute low-slippage transactions.

 

Conclusion

 

In Uniswap Once the success of automated market makers begins to eat away at spot markets on centralized exchanges, it is quite reasonable to infer that the same will happen to crypto derivatives markets. Increased regulation of centralized exchanges, coupled with third-party security breaches of privately identifiable information, will lead to decentralized derivatives once transaction delays and liquidity are resolved outflow of product agreements.

 

Original link

Welcome to join the official BlockBeats community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Official Twitter Account: https://twitter.com/BlockBeatsAsia