Derivatives in DEFI Explained (Synthetix, UMA, Hegic, Opyn, Perpetual, dYdX, BarnBridge)

So what are derivatives? Why are they important? And what are some of the most popular derivatives protocols in defi? You’ll find answers to these questions in this video.

So what are derivatives why are they important and what are some of the most popular derivatives protocols in d5 you’ll find answers to these questions in this video before we begin if you want to learn more about decentralized finance and the technology behind it make sure you subscribe to my channel hit the bell icon and enable all notifications you can also

Consider joining us on patreon and learning even more about defy derivatives are one of the key elements of any mature financial system as the name suggests derivatives derive their value from something this something is usually the price of another underlying financial asset such as a stock a bond a commodity an interest rate a currency or a cryptocurrency

Some of the most commonly used derivatives are forwards futures options and swaps there are two main use cases for derivatives hedging and speculation hedging allows for managing financial risks to understand hedging a bit better let’s revisit one of the commonly used examples imagine a farmer that primarily focuses on growing wheat the wheat price can fluctuate

Throughout the year depending on the current supply and demand as the farmer plants wheat they are committed to it for the entire growing season which presents them with a big risk in case the price of wheat is low when the harvest time comes to accommodate this risk the farmer will sell short wheat futures contracts for the amount that they predict to harvest

As the time of harvest approaches the farmer will close their position and incur a profit or a loss depending on the price of wheat if the price of wheat is lower than initially anticipated the short position makes a profit that offsets the loss from selling the actual wheat if the price of wheat is higher the short position will be at a loss but the profit

From selling the wheat offsets that loss what is important to understand is that no matter what happens to the wheat price the farmer will end up with a predictable income to stay in the agricultural world yield farmers in decentralized finance can also use hedging to offset a potential loss that can occur if the price of one of the tokens used for yield

Farming loses its value in relation to another token this can happen for example while providing liquidity to an automated market maker like uni swap and it’s known as impermanent loss besides our agricultural examples derivatives allow other crypto companies to hedge their exposure to different cryptocurrencies and run more predictable businesses the other

Popular use case for derivatives is speculation in a lot of financial instruments including derivatives speculation can represent a significant amount of traded volume this is because derivatives offer an easy exposure to particular assets that may be hard to access otherwise for example trading oil futures instead of actual barrels of oil they can also provide

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Easy access to leverage a trader can purchase a call or a put option by providing only enough funds to cover the option premium and gain exposure to a significant amount of the underlying assets speculators are important market participants as they provide liquidity to the market and allow people who actually need to buy a particular derivative to hatch the

Risk to easily enter and exit the market derivatives have a long and interesting history from clay tokens representing commodities traded by the sumerians through the use of fur letters to buy and sell agricultural commodities in medieval europe to the establishment of the chicago board of trade in 1848 one of the world’s oldest futures and options exchanges

When it comes to more modern times derivatives have been one of the major forces that drive the whole financial industry forward since the 1970s the total market size of all derivatives is estimated to be as high as one quadrillion dollars which completely dwarfs any other market including the stock or bond markets and of course the tiny cryptocurrency market

That has just recently touched the one trillion dollar mark every growing market naturally develops its own derivatives market that can end up being an order of magnitude bigger than its underlying market this is also why a lot of people in the decentralized finance space are extremely bullish on the potential of decentralized derivatives that in contrast to

Traditional finance can be created by anyone in a completely permissionless and open way this in turn increases the rate of innovation that has been stagnating in traditional finance already for a while now as we know a bit more about derivatives let’s jump into some of the most important derivatives protocols in d5 synthetics is usually the first protocol that

Comes to our minds when talking about derivatives in d5 synthetics allows for creating synthetic assets that track the price of their underlying assets the protocol currently supports synthetic fiat currencies cryptocurrencies and commodities that can be traded on trading platforms such as quenta d hedge or paraswerb synthetics model is based on a deadpool in

Order to issue a particular synthetic asset a user has to provide collateral in the form of the snx token the protocol is highly over collateralized currently at 500 percent this means that for each 500 of snx locked in the system only 100 dollars worth of synthetic assets can be issued this is mainly to absorb any sharp price changes in synthetic assets and

The collateralization ratio will be most likely lowered in the future synthetics is also one of the first defy projects leading the effort of moving to layer 2 in order to lower the gas fees and make the protocol more scalable there is currently around 1.8 billion dollars locked in the synthetics protocol the biggest number across all d5 derivatives protocols

By a wide margin uma is another protocol that enables the creation of synthetic assets the main difference here is that uma instead of highly over collateralizing the protocol relies on liquidators who are financially incentivized to find improperly collateralized positions and liquidate them uma’s model allows for creating priceless derivatives this is because

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The model doesn’t rely on price oracles at least not in the optimistic scenario this in turn allows for adding a very long tail of synthetic assets that otherwise wouldn’t have a reliable price feed hence it wouldn’t be possible to create them in synthetics there is currently over 63 million dollars of total value locked in uma’s smart contracts hedgic is a

Relatively new defy project that allows for trading options in a non-custodial and permissionless way users can buy put or call options on eth and wbtc they can also become liquidity providers and sell eath call and put options three months after the launch hedgic had almost 100 million dollars in total value locked in the protocol a total cumulative options

Trading volume of around 168 million dollars and generated over three and a half million dollars in fees interestingly hagic has been developed by a single anonymous developer which again shows the power of defy where in contrast to traditional finance even a single person or a small group of people can build a useful financial product another defy project that

Allows for trading options is open open launched in early 2020 started from offering ether downside and upside protection which allowed users to hatch against eth price movements flash crashes and volatility they’ve recently launched a v2 of the protocol that offers european cash settled options that auto exercise upon expiry there are two main option styles

European and american european options can only be exercised at the time of expiration whereas american options can be exercised at any time up to the expiration date in contrast to open hedgic uses american style options the open protocol auto exercises options that are in the money so options holders don’t need to take any action at or before the expiration

Date since its first release the protocol had over 100 million dollars in traded volume perpetual is yet another fairly new entrant into the decentralized derivative space as the name suggests perpetual allows for trading perpetual contracts a perpetual contract is a popular trading product in the cryptocurrency space used by well-known centralized platforms

Such as bitmex binance and bibit it’s a derivative financial contract with no expiration or settlement date hence it can be held and traded for an indefinite amount of time perpetual protocol at the moment allows for trading if btc wifey dot and snx trades are funded and settled in usdc a popular stablecoin in the defy space all traits on perpetual protocol

Are processed using the x die chain a layer to scanning solution this allows for incredibly low gas fees that are currently subsidized by the protocol this means that currently there are no gas fees while trading on perpetual protocol paying the gas fee is only required when depositing usdc onto the platform the protocol has been live for only just over a month


But it has already managed to achieve over 500 million dollars in volume and five hundred thousand dollars in trading fees dydx is a decentralized derivatives exchange that offers spot margin and more recently perpetual trading dydx architecture combines non-custodial on-chain settlement with an off-chain low-latency matching engine with order books besides that

The dydx team has been building a new product for perpetual contracts on layer 2 powered by starkware’s zika rollups that is due to launch in early 2021 the total cumulative trade volume across all products on dydx reached two and a half billion dollars in 2020 a 40x increase when compared to the previous year dydx has recently raised 10 million dollars in

A series b round led by three arrows capital and defiance capital barnbridge is a risk tokenizing protocol that allows for hedging yield sensitivity and price volatility this can be achieved by accessing deadpools of other d5 protocols and transforming single pools into multiple assets with different risk return characteristics barnbridge at the moment offers

Two products smart yield bonds interest rate volatility risk mitigation using debt based derivatives and smart alpha bonds market price exposure risk mitigation using tranche volatility derivatives there is currently over 350 million dollars of total value locked in the protocol barnbridge is also running a liquidity mining program that distributes its token

Bond to all users who stake stable coins uni swap bond usdclp tokens or bonds tokens on their platform as we mentioned earlier the derivatives market in traditional finance is huge and it will be interesting to see how big it will become in decentralized finance it’s also amazing to see more and more projects launching derivatives protocols and being able to

Create new and exciting financial products in a permissionless and decentralized way this video covers some of the most interesting derivatives protocols in defy let me know in the comments down below if you think that we missed any other good ones and one more important thing interacting with new defy protocols can be risky so before using any of the protocols

Mentioned in this video always do your own due diligence as most of these projects are still in their beta or even alpha versions i’ll put links to all mentioned protocols in the description box below so what do you think about derivatives in defy how big will they become in the future would you like to see a deep dive into one of the projects we mentioned in

This video comment down below and as always if you enjoyed this video smash the like button subscribe to my channel and check out cinematics on patreon to join our defy community thanks for watching

Transcribed from video
Derivatives in DEFI Explained (Synthetix, UMA, Hegic, Opyn, Perpetual, dYdX, BarnBridge) By Finematics