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TLDR below. This is not financial advice.
Today we will discuss platforms that offer a variety of derivative products. Our approach will go from off-chain to on-chain and outline the benefits and drawbacks of each platform.
In addition, we also analyse aspects related to token design. We will have a closer look at each of the tokens that make up the platform.
In this article, we focus on three main platforms: TFX ($FTT), Synthetix ($SNX) and Mirror ($MIR). All three protocols deal with derivatives. How are they different? How are they the same? How are they successful?
What are Derivatives?
Contract based on underlying asset
A derivative is a financial transaction contract between two or more parties based on a change in the future value of an underlying asset. That underlying asset can be a tangible asset, an index, or an interest rate. Derivatives themselves have no intrinsic value.
Assets: Gold, silver, precious metals, coffee, rice. Index: Stocks, bonds, interest rates.
That is, users transact based on a change in the value of another entity rather than directly owning that entity. Profit is generated based on the spread and price movement of the underlying asset.
Derivatives trades have been around since medieval times, between merchants. The first base assets used were olives and food.
In derivatives trading, there are four basic types of contracts:
Forwards Contract: An agreement to trade between two parties at a specified time in the future. The price is determined and agreed upon by both parties in the present.
Futures Contract: This is a standardised form of forwarding contract and listed for trading on official exchanges.
For example: In the US, there is the Commodities Futures Trading Commission (CFTC) and the Chicago Mercantile Exchange (CME).
Option: A contract in which one party has the right to require the other party to perform the obligation to buy or sell an amount of the underlying asset at a specified price on or before a certain date.
Swap: An agreement between two parties A and B in which they exchange the cash flow of party A’s financial instrument with the cash flow of party B’s financial instrument for a certain period of time.
Crypto derivatives are only a few years old. In the following sections, we will learn in detail about derivatives trading in crypto which will help us to make a profit in this type of crypto market.
©Collected By EconomicsDesign
What are Crypto Derivatives?
Short Answer: Crypto-based derivatives are dependent on change in value of crypto tokens
Simply put, you will trade with each other based on the price of tokens. You will not be directly owning and trading those crypto coins.
The biggest difference between traditional derivatives and crypto derivatives is that crypto’s underlying assets are not bonds, stocks or interest, but crypto tokens.
For example, you see that the BTC/USDT is aligned with your risk profile and you can find a way to make money there.
There are two methods for you to participate in profitable trading:
Method 1: Buy $BTC directly and trade it.
Method 2: Trade derivatives of $BTC. This comes in the form of a financial contract. At this time, you do not need to buy and own $BTC.
If you choose Method 2 to trade, you are trading derivatives.
Currently, in the crypto market, many exchanges and tools support crypto derivatives trading. Off-chain uses centralised mechanisms and on-chain uses decentralised mechanisms.
©Collected By EconomicsDesign
FTX Exchange (Centralised)
FTX is an exchange that specialises in providing derivative products related to cryptocurrencies such as Futures, Leveraged Tokens and OTC. FTX is founded by Alameda Research — one of the world’s largest market makers and liquidity providers.
FTX is a centralised exchange in the crypto space. The same goes for its derivatives. They are controlled and calculated by a central system.
Currently, FTX offers a wide variety of highly complex products. Obviously, there is an advantage with off-chain data processing, where everything becomes faster no matter how complex the derivative product.
With a typical perp contract, the funding rate is calculated every 4 hours to balance between two long and short positions. Going off-chain will be cheaper because they do not then perform any transactions on-chain. If they are done on-chain, every 4 hours FTX has to pay an amount to perform the calculation and balance 2 long/short positions to each participating wallet. The cost of this adds up quickly.
There are many protocols (such as dXdY) that combine off-chain and on-chain. Anything that takes a lot of resources will be done off-chain (like the order book, etc.).
Because it is a centralised exchange, FTX’s products are diverse, including future, perpetual, and leveraged tokenisation. These products are complex and resource-intensive, but for centralised exchanges, these are simple.
In comparison to the two protocols below, in terms of the synthetic asset market, FTX also offers tokenised securities to reach users in the crypto space.
Securities are staked off-chain and tokenised for trading. An interesting point is that these tokens still receive dividends like normal securities.
Synthetix Protocol (Decentralised)
Synthetix is an Ethereum-based protocol that allows users to issue and trade synthetic assets. These synthetic assets are tokens backed by $SNX collateral that mimic the performance of other assets including cryptocurrencies, commodities, etc.
These synthetic assets are collateralised by $SNX as they are locked in a smart contract allowing the issuance of the aggregate assets (called $Synth).
Synthetix’s asset exchange model allows users to make the switch between $Synths directly with the smart contract without slippage, avoiding third-party interference.
The highlight of Synthetix is the idea of allowing users to optimise their capital (currently $SNX), through the release of $Synths. Also, $Synths create liquidity for them by allowing trading of these $Synths on their DEX platform.
Instead of $TSLA, you trade $sTSLA. $sTSLA are called Synths.
This means that a holder can only hold one cryptocurrency waiting to increase in value. However, the trader can collateralise that cryptocurrency and get another amount of capital to optimise capital, reducing opportunity costs.
In the Synthetix ecosystem, $Synths are understood as synthetic assets.
For example, Bob has $2000 worth of $SNX. He wants to lock up this amount of tokens and issue 400 $sUSD and Bob sells or trades this $sUSD on Synthetix’s DEX platform. After a while, Bob wants to unlock his $SNX, now he just needs to burn $400 $sUSD (in the most ideal case).
$Synths here is $sUSD. You can understand it as a token whose price is equivalent to the price of the coin it is pegged to and its value is backed by $SNX.
Mirror Protocol (Decentralised)
Mirror is a DeFi protocol powered by smart contracts on Terra that allows the creation of synthetic assets called Mirrored Assets ($mAssets).
$mAssets will simulate the price behaviour of real-world assets and provide traders anywhere in the world with access without having to own or trade the real asset itself.
Currently, these real assets are only stocks of large companies such as $MSFT, $AMZN and $QQQ. In the future, assets could be gold, silver, etc.
Mirror Protocol allows users to create synthetic assets based on real assets, thereby making it easier for users to buy and sell ($mAssets).
Example: If a house costs $100,000 but the user only wants to buy $50,000 worth. Then, it can be purchased by splitting 100,000 tokens, each worth $1. The user only purchases 50,000 tokens.
To generate $mAssets, users must collateralise assets worth > 150% (if using stablecoin) or > 200% (if using $mAsset). For example: If you want to mint $100 worth of $mXAU, you must collateralise 150 $USDT or $mBTC worth $200.
For the above reason, you can see that $mAssets after minting from Mirror Protocol can be used as reverse collateral on Mirror Protocol, or traded on AMM Dexes.
With some of the above analysis, centralised exchanges have the ability to use complex calculations without worrying about costs to create many complex derivatives. However, with decentralised exchanges, they are limited in this ability, so they focus on a single niche and improve their products slowly.
FTX is one of the leading derivatives exchanges when it comes to creating unique (but also “dangerous”) products. Meanwhile, Mirror and Synthetix are more specialised in a particular market. Technological capabilities do not meet current needs.
In terms of synthetic products, all three exchanges are competing with each other. FTX simply collateralises real-life assets and tokenises them. Synthetix mortgages $SNX again for $Synths. Mirror is more diversified in collaterals to generate $mAssets.