Derivates 101
In a world of complex financial products, it pays to understand derivatives.
If you follow crypto, you have definitely heard about crypto derivatives.
But what are derivatives and how do they work in DeFi?
Hereβs DeFi Derivatives 101:
In a world of complex financial products, it pays to understand derivatives.
If you follow crypto, you have definitely heard about crypto derivatives.
But what are derivatives and how do they work in DeFi?
Hereβs DeFi Derivatives 101:
Warren Buffet said: "Derivatives are financial weapons of mass destruction."
So we better understand what derivates are, especially in the DeFi context.π‘
This Thread will get you up to speed:
So we better understand what derivates are, especially in the DeFi context.π‘
This Thread will get you up to speed:
Essentially,
derivatives are contracts
with set conditions
that relate to underlying assets.
Conditions might be:
a specific price and a specific delivery date in the future
derivatives are contracts
with set conditions
that relate to underlying assets.
Conditions might be:
a specific price and a specific delivery date in the future
Types of Derivative:
β’ Future Contracts:
Agreement to buy/sell an asset for a certain price at a certain time in the future
β’ Options Contracts:
Like futures, but with the option to exercise the agreement
β’ Swaps:
Agreement to exchange cash flow in the future
β’ Future Contracts:
Agreement to buy/sell an asset for a certain price at a certain time in the future
β’ Options Contracts:
Like futures, but with the option to exercise the agreement
β’ Swaps:
Agreement to exchange cash flow in the future
Here is an example of a commodities derivative contract:
Consider the example of Alice,
a dairy farmer who sells milk for β¬1/L to her local supermarket.
Milk production costs Alice β¬0.50/L,
as her cows consume 1kg wheat/L of milk they produce.
Consider the example of Alice,
a dairy farmer who sells milk for β¬1/L to her local supermarket.
Milk production costs Alice β¬0.50/L,
as her cows consume 1kg wheat/L of milk they produce.
Wheat currently costs β¬0.50/kilo (ignoring other input costs)
So, Alice enjoys a healthy 50% margin today.
However, she fears that, due to unstable weather conditions,
the price of wheat will double next six months.
So, Alice enjoys a healthy 50% margin today.
However, she fears that, due to unstable weather conditions,
the price of wheat will double next six months.
To hedge her exposure to such a devastating increase in wheat prices.
she enters a contract with her supplier which, for a price paid today,
gives her the option to buy up to 1,000 kg of wheat
at the price of β¬0.75/kg six months from now.
she enters a contract with her supplier which, for a price paid today,
gives her the option to buy up to 1,000 kg of wheat
at the price of β¬0.75/kg six months from now.
The contract is a options derivative:
β’ It derives its value from the price of wheat.
β’ If wheat trades at or above β¬0.75/kg at the contract's expiry, Alice will exercise her option to buy
β’ Otherwise, she will let the contract expire & buy at the market price
β’ It derives its value from the price of wheat.
β’ If wheat trades at or above β¬0.75/kg at the contract's expiry, Alice will exercise her option to buy
β’ Otherwise, she will let the contract expire & buy at the market price
Risks of derivatives include:
Liquidation Risk:
inability of a contract party to meet its obligations when they are due
especially in combination with leverage.
See the derivatives time bomb where many open derivative positions unwinding simultaneously, leading to volatility
Liquidation Risk:
inability of a contract party to meet its obligations when they are due
especially in combination with leverage.
See the derivatives time bomb where many open derivative positions unwinding simultaneously, leading to volatility
Counterparty risk:
probability that the other party of the derivative contract
may not fulfill its part of the deal & may default on the contractual obligations.
This especially risky in the case of physically settled contracts.
probability that the other party of the derivative contract
may not fulfill its part of the deal & may default on the contractual obligations.
This especially risky in the case of physically settled contracts.
Derivatives in DeFi:
Crypto derivatives are
- decentralized derivative contracts
- that make use of smart contracts
- & are deployed on blockchains.
--> DeFi is redefining derivatives.
Crypto derivatives are
- decentralized derivative contracts
- that make use of smart contracts
- & are deployed on blockchains.
--> DeFi is redefining derivatives.
Types of decentralized derivatives:
1/DEX-traded βtraditionalβ derivative contracts:
β’ like futures, options, & swaps
β’ Those are equivalent to TradFi derivatives just on blockchains
1/DEX-traded βtraditionalβ derivative contracts:
β’ like futures, options, & swaps
β’ Those are equivalent to TradFi derivatives just on blockchains
2/Synthetic assets:
β’ smart contract-based derivative tokens
β’ Representing other assets (so called underlyings) through tokens
β’ Creating a blockchain record of the relationship
between the underlying asset & the synthetic token.
β’ smart contract-based derivative tokens
β’ Representing other assets (so called underlyings) through tokens
β’ Creating a blockchain record of the relationship
between the underlying asset & the synthetic token.
This relationship is programmatically enforceable and verifiable
Hence, synthetic tokens derive their value from their underlying assets.
The represented assets can be on-chain or off-chain
Hence, synthetic tokens derive their value from their underlying assets.
The represented assets can be on-chain or off-chain
Synthetic assets can be created by anyone and for anything e.g.
β’ Real and financial assets, for example, gold, stocks, and indexes
β’ Digital currencies
β’ Trading strategies etc.
β’ Real and financial assets, for example, gold, stocks, and indexes
β’ Digital currencies
β’ Trading strategies etc.
Why do we even need wrapped tokens?
For token usage across blockchains
-> using Bitcoin in Ethereum, in the form of wBTC.
For intra-blockchain compatibility
-> so that DeFi smart contracts can treat Ether, in the form of wETH, as an ERC20 token
For token usage across blockchains
-> using Bitcoin in Ethereum, in the form of wBTC.
For intra-blockchain compatibility
-> so that DeFi smart contracts can treat Ether, in the form of wETH, as an ERC20 token
What derivatives dApps currently exist on #Cardano?
currently there are no Derivatives available at Cardano,
In the Future, @CardanoMaladex
might offer derivatives after the Cardano Vasil HFC has been rolled out.
Is there any other upcoming project? Add in the comments:)
currently there are no Derivatives available at Cardano,
In the Future, @CardanoMaladex
might offer derivatives after the Cardano Vasil HFC has been rolled out.
Is there any other upcoming project? Add in the comments:)
So what about me:
Do I trade derivative crypto products?
Also if I understood the basic structure & logic of derivative products
for me, they remain complex
& not always well understood structured financial products.
Not the ideal entry point for novice investors, imO.
Do I trade derivative crypto products?
Also if I understood the basic structure & logic of derivative products
for me, they remain complex
& not always well understood structured financial products.
Not the ideal entry point for novice investors, imO.
Why do I then write about them, you might ask.
Because only if I start understand all the fancy financial BS Bingo out there
I can make educated decisions if it is something I wanna look deeper into and learn more about
It gives me perspective and a choice.
Because only if I start understand all the fancy financial BS Bingo out there
I can make educated decisions if it is something I wanna look deeper into and learn more about
It gives me perspective and a choice.
That's a wrap!
I hope this was useful.
If you enjoyed this thread please:
1. Follow me @DiMoneymindset for more of these
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I hope this was useful.
If you enjoyed this thread please:
1. Follow me @DiMoneymindset for more of these
2. RT the tweet below to share this thread with your audience
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