Up Big? Afraid Crypto is Going to Crash? Here's a First Look At the Decentralized Insurance & Options Market

in LeoFinance4 years ago

Incredibly, the crypto markets have recovered nicely from Black Thursday. We haven't seen those same highs that we saw back during the very curious (upon retrospect) crypto mini-bull that occurred right after the Wuhan Lockdown. If the traditional markets face another decline, bitcoin will most assuredly go down with them (at least temporarily). But for now, we are back above $7,000 per BTC again and that is freaking impressive in my book. You would think that people would have run away screaming after an asset plunged almost 60% in a day (at its lowest point). But they didn't!

So here we are. If you're a smart cookie (like one guy I know in Hong Kong who aggressively bought the lows with both fists full of cash!), you might be wondering how exactly can you protect these (comparatively) massive short-term gains. The answer is, of course,

DeFi!

The great thing about this rapidly emerging DeFi industry is that new experiments emerge almost everyday in this ecosystem. For instance, yesterday I found out about this great tool called Zerion. It's almost like an on-chain portfolio management software. But it also has hooks into a lot of other various essential DeFi tools. The tooling allows you to simply manage your unipools, easily access swap platforms, lend out your assets on Aave or Compound for steady returns, or even borrow tokens if you need to! It's definitely worth checking out if you've started a little DeFi portfolio and want to start getting it under control.

If there's one thing I've learned about interacting and collaborating with developers in the past two years, it's that crisis brings out the best in them! I hate to say this, but it might be a good strategy to come in on Monday morning and just scream "Fire!" as loud as possible to get those folks moving with the proper speed. 😜

But getting back to protecting those recent massive gains...

An important tool in any financial system is insurance. In the "real world" most likely your biggest investment is the house you live in. Most cultures (curiously this does not include China, even despite the massive values of their skyrise apartments) would not dream of owning a house without insurance that would pay for them to rebuild their homes should, God forbid, they be burned down. Each month, at least in America, we pay huge premiums, sometimes even a sixth of our mortgage payments, to insure our most treasured asset.

The same perspective can also apply to stocks. If you have a massive position in one security, whether it be the S&P 500 index or just Alibaba Group Holdings (BABA), to protect the value of that asset you can buy what's called a put. The idea is that, if you experience a sudden loss of value in that asset, say if a pandemic crops up out of nowhere or something and keeps everyone inside for half a year, then you can "put" that security into the portfolio of the counterparty that sold you the put option at the price you agreed upon before that loss in value occurred. The price previously agreed upon is called the "strike price" and you don't really need to use it, unless the value of your asset drops below it. Thus, a put option is exactly like the insurance that you buy on your house just in case something bad happens.

In the DeFi world, there are two projects that are trying to bring this functionality on chain. The first is Nexus Mutual, which focuses on insurance for smart contract failure. In most cases, that means you're insured for hacks against you. But in some cases, as with happened to the poor Maker Vault owners who had their entire assets liquidated on Black Thursday, sometimes you're just fucked. The decentralized governance of the Nexus Mutual ecosystem determined that those losses were NOT due to smart contract failure and therefore would not be refundable. And they're right. The losses occurred due to the congestion of the Ethereum system, not due to an exploit of the smart contract code. Under the terms that Nexus Mutual provides insurance, they were not liable for those losses. Hey, that's how insurance works in the real world, too!

Opyn is a recent entrant to this market. This startup has developed a 3-token model to allow people to freely trade their insurance exposure, an important differentiator with fellow crypto-insurance provider Nexus Mutual. We at FinNexus developed the following chart to try and better understand the Opyn token model when we first heard about it:

So if opyn had been available when widely used at the time of Black Thursday, the Maker Vault owners could have just "bought protection" on the Opyn website to hedge against a precipitous drop in the price of Ethereum. Although they would not be able to access their own ETH in the Vault, they could have sold their puts to other owners of ETH who could have then benefited from that protection. The increase in value of their "protective put" options would have offset a substantial chunk of their losses from losing their ETH in the Maker debacle where $8.32 million worth of ETH was liquidated for 0 DAI. Oops!

I think we can all easily see why their should be some more BUIDL-ing in this market. DeFi needs derivatives to provide protection to the bankless "early adopters." We should not punish them for supporting this worthy cause, but rather build products to protect them!

The Opyn.co mechanism works as a two-sided market place. On one side, interest rates are proposed to “insurers” to participate in an ETH/DAI collateralized pool, from which insurers mint oTokens to insure insurance buyers. On the other side, insurance seekers pay a premium in stablecoins (USDC & DAI) to receive oTokens, which function as options that users can exercise if they like.

Take a look at their interface here:

Screen Shot 2020-04-23 at 8.55.25 PM.png

As you can see they are currently only offering insurance on Compound deposits and 4 different flavors of ETH puts, all with very near-term expirations. I honestly don't get the Compound insurance. If you're going to insure your deposits so that your effective yield is 0%, why even make the deposit to Compound in the first place? Their second product, although it is barebones at the moment, is a lot more intriguing. It will certainly be interesting to see this particular niche of the DeFi market start seeing some competition. You know what Michael Porter says...

"Competition on dimensions other than price - on product features, support services, delivery time, or brand image, for instance - is less likely to erode profitability because it improves customer value and can support higher prices."

I have a feeling there will be more competitive forces working in this space very soon. 😉

While crypto-asset options and volatility are complex topics where liquidity often becomes an issue, by simplifying and decentralizing the insurance mechanism and using stablecoins, Opyn and other protocols that emerge like it hope to provide to the DeFi community useful tools for financial products to effectively manage risk in the emerging digital asset industry.


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Things are #posh, sir!


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