DeFi Derivatives Dish Out Portfolio Protection

Each week, the Weiss Crypto Sunday Special brings you actionable video content on the hottest macro trends in crypto.

This week, host Chris Coney wants to help you learn how to protect the value of your assets.

See, the crypto market’s volatility is infamous. Investors who learn to work with the slings and arrows of the market can protect their investments. And, with the method discussed by Chris and his three expert guests, they could even find opportunities to profit.

At the moment, not too many investors are worried about future cloudy skies. After all, we’re in the middle of a multiyear bull market, with talking heads calling out projections for unbelievable highs.

But once the bull market is over, you’ll want to ensure you keep your portfolio protected. You can watch the video here or continue reading for the full transcript ...

Chris Coney:

Hi there, guys. Welcome to this week's edition of the Weiss Crypto Sunday Special with me, your host, Chris Coney. Today, we'll be discussing the various ways in which you can protect your crypto assets using DeFi derivatives. This is not protecting your assets from hacking or theft or anything like that. That's a conversation about security.

              What we're going to talk about today, is more about protecting the value of your assets using various derivatives. And maybe we'll talk about some centralized derivatives and then we'll talk about how you do that in a decentralized way with DeFi apps and so on.

              So today, we've actually got a full house today. I’ve got three analysts in the house. First off, we've got Alex Benfield. Alex, welcome back to the Sunday Special, mate.

Alex Benfield:

Hey, Chris. Thanks for having me back again.

Chris:

We've got the lovely Marija Matić back on the show.

Marija Matić:

Thank you for having me, Chris.

Chris:

And we've got the master, Juan Villaverde. Welcome back, mate.

Juan Villaverde:

Good to be here, sir.

Chris:

All righty then. I'm going to open this up. Back in the day, when I started my first business, I used to listen to … and I haven't listened to in a while, Jim Rohn, who's a motivational speaker.

              I remember specifically from one of his audio programs, he used to talk about ants, as in the insect. He would say that ants think about winter all summer long. And they think about summer all winter long. He’d say, "You can see this in the behavior." They never get faked out by what's actually happening with the weather.

              When it's sunny, you can actually see the ants frantically collecting and storing food because they know that winter is coming. Even though the sun is shining brightly in the sky, and they could be sunbathing instead. But they don't do that.

              Conversely, when it turns to winter, they don't despair. A, because they're prepared for it, and B, because they know summer's coming back soon. So with that in mind, I thought, "Let's start thinking like ants."

              Even though crypto prices are going pretty well right now, and the sun is shining bright, what could we be doing? When you start thinking about it, is what could we be doing to protect our assets for if and when the crypto winter befalls us?

              I started thinking about this when I came across this new project called, Bumper, which is basically an insurance fund where you insure your Ethereum (ETH, Tech/Adoption Grade “A”) first and foremost against downsize volatility. So, if you insure your Ethereum and it goes up, you get the price appreciation. If you insure your Ethereum and it goes down, you claim on the insurance and then get the value that you insured it for, just as if it was a car. And then, I went looking for some others and found Antimatter Finance and a few others.

              But let's start chronologically like I normally do. So I'm going to bring you guys in now. Before the DeFi revolution — like Juan's been a traditional trader and so he might have some more fundamental, universal principles on this — how did people traditionally hedge against downside volatility? Juan, you start that, and then we'll go from there.

Juan:

Traditionally, using futures, I think futures go all the way back to Babylon.

Chris:

Right.

Juan:

So thousands of years. Yeah. Yeah. The first mainstream way you hedge assets is through futures, which is basically when you fix the price of an asset. And somebody can fact check me on this, but options were either invented or became super popular in the early 20th century in the United States. So it's something that became a thing in the U.S. capital markets.

              Options are, like you said, Bumper Finance, Antimatter, options are interesting because they allow you to participate in the upside, but they cap the downside of your investments.

              Now, the flip side of that is there's always you have to pay in order to get that service, of course. It can be expensive if you're always buying insurance just in case something bad happens.

              But the good thing about options, and before I was into crypto was mostly an options trader. I would dabble in the futures. Actually, I would do options on futures, so I would dabble on futures markets as well. But I was mostly doing options on futures and options strategies. And so, I know them very well and I know how powerful they can be both from the long and the short side.

              You can create a lot of income as a seller of options, the seller of insurance. But you can also make a fundamental difference to your portfolio if you buy them for protection.

Chris:

So I'm thinking back to 2017, I'm talking to my friend, Simon, as we are nearing the talk, and he starts talk — he might've even done this. I don't know if he actually did it or not — but instead of hedging the downside, he was like, "Well, let's just say, someone has 100 Bitcoin (BTC, Tech/Adoption Grade “A-”), and they think it's the top. All you do is you take one 10th of that, so 10 Bitcoin, and put it on deposit with BitMEX. Take out a short position and leverage it 10 times." What that does is for every 1% tick down in price, you've got 10 Bitcoin, 10 times leverage, offsetting the devaluation of your 90 Bitcoin. Does that make sense? That's a very basic strategy.

Juan:

It does, but what that does is create what Arthur Hayes, the founder of BitMEX, calls synthetic. Actually, he doesn't call it that. I don't remember the name. He has a funny name for that. But it's synthetic dollars. You basically sold your Bitcoin if you do that.

              If I had 100 Bitcoin, and I sell 100 Bitcoin using 10 Bitcoin on BitMEX, so I lever up 10 times, my net Bitcoin position is zero.

Chris:

That's the key.

Juan:

What I have is synthetic dollars.

Chris:

That's the key.

Juan:

I still have Bitcoin, the asset, but it doesn't move in price.

Chris:

That's good.

Juan:

I have a ... Yeah. It's synthetic dollar.

Chris:

Yes. So it depends when you are accounting for your returns in USD or BTC.

Juan:

Correct.

Chris Coney:

Cool. Let's pass the ball. Alex or Marija: do you want to jump in? Have you got any comments on this? Traditionally, how you would hedge your downside risk?

Alex:

Marija, you can go ahead and take that if you want.

Chris:

If not, we'll move onto the next point. That's fine.

Marija:

No. I agree with Juan, options and futures are very useful. Both in the traditional and crypto worlds. But what's interesting is that the crypto world is now reinventing the wheel by making it potentialized, by making the other side and creating more participants in the system. So it's quite interesting.

              But besides Antimatter and things, there are other things that people do to hedge risks because it's not just about having certain assets. It's also about if you're using it in decentralized finance (DeFi), if you're loaning your assets, if you are prone to liquidations due to the price drop of your collateral, things like that.

There are many ways to hedge your risk outside of just holding the crypto or trading it in a traditional way. We can speak about this later. So Alex, if you want to jump in as well.

Chris:

Let me talk about Bumper for a minute, because this is timely and it's a current obsession, if you like. Juan took the wind out of my sails a little bit by saying, "Oh, yeah. They're not doing anything new. They've just taken options and made them super accessible as a product." Right? Which is basically, what they've done. Right?

Juan:

They've changed the contracts too, which is to Marija's point. What's interesting to me, coming from traditional markets, is these contracts are new. They did not exist before. Before crypto, there were no perpetual futures. It was just not a thing.

These are more like swaps, where you enter into a contract with someone and you pay them a fee like every hour or every day, and then you have this permanent protection.

              Again, I don't want to get ahead of myself because this is super interesting. These are tokens that can trade on exchanges. So on decentralized exchanges, so you could compose on them.

Chris:

What do you mean? What tokens that can trade on decentralized-

Juan:

I mean, I can buy a perpetual option, I can mint a perpetual option on-

Chris:

Yes, on Antimatter. You could do that.

Juan:

On Antimatter, and then I could trade that on Uniswap (UNI, Tech/Adoption Grade “B”).

Chris:

Correct.

Juan:

Because if this is an ERC20 token, I can now actually create contracts that use those. This stuff does not exist in traditional finance. It just doesn't. You can't do this.

Chris:

Well, to be sure ... Are you sure? Because isn't-

Juan:

100%. You don't have programmable money, so you can't create applications that use complex derivatives to do other applications.

Chris:

I mean, when they talk about financial weapons of mass destruction, and if you look at Demonocracy, it shows that massive, upside down pyramid of derivatives upon derivatives upon derivatives, which is the upside down Ponzi scheme that the system is based on.

              So isn't that similar in the sense that you've got derivatives of derivatives?

Juan:

The key difference is that each building block tends to be more secure in crypto. Because remember, the part of the traditional system that almost collapsed was the obscure, unregulated, non-listed —

Chris:

Opaque.

Juan:

... over the counter, opaque, dark bull money that was just trading these derivatives. And for the most part, they didn't know who the counter party was.

              So I have a contract with someone, let's say I have an option, a swap, and it turns out the counter party's bankrupt. So I think I'm hedged, but I'm not. This is what happened. The market just broke down. Market structure just broke down.

I think crypto is just fundamental because everything's over-collateralized. As long as the base layer is properly collateralized and that collateral is managed accordingly, you can build on top of this, and it will be relatively secure.

              To prove that, I mean, we've had 50% crashes in a day in crypto, and the market keeps going. So where's that systemic risk? It's just not there.

Chris:

Okay. This is-

Alex:

If I can jump in. I think the key difference, my opinion here, is that these crypto markets are significantly more transparent than anything you have in traditional finance.

Chris:

Yep.

Alex:

Right? You think you can literally tell who's holding the asset, who's controlling what contract, whatever. There's absolutely none of that in traditional finance, or at least you have to be an extremely sophisticated market to be able to track positions, right?

I mean these aren't reported. These aren't in databases that you can scan instantly, like Etherscan or something like that. So honestly the transparency is a real game changer. Right? It's a big differentiator.

Chris:

That's a good one. I remember, I'm thinking about this scene in the Big Short. I think it is in the Big Short.

Juan:

Great movie. Great movie.

Chris:

That's amazing. Who's the guy? Evan Almighty, who's the actor.

Alex:

Steve Carell.

Juan:

Steve Carell.

Chris:

Steve Carell, is it? So he's talking to ... The issue is some of these collateralized debt obligations and that's when it dawns on him that the system is just screwed up the yin yang, right?

              I think Juan just made a breakthrough in my thinking — that the trouble with CEOs and things like that is they contain toxic assets and people didn't know about it.

              When U.S. municipalities were investing in these things, they obviously got totally hoodwinked by Wall Street traders who knew how to sell. These municipalities just saw dollar signs and whatnot and just invested in these things but didn't know what a toxic asset was.

              So traditionally, you rely on agencies like Weiss Ratings to rate these things. But in crypto, you don't need that because it's fully collateralized. And those values are shifting in real time, so the solvency or insolvency of a particular, let's say collateralized debt obligation (CDO), is verifiable every 15 seconds. True or false?

Alex:

Yeah, right. I think that's back to the transparency issue. I'm still laughing at the fact that you quoted Steve Carell from Evan Almighty and not maybe like the Office, or the 40-Year-Old Virgin or-

Chris:

I'm sorry. That's the first thing that came to mind.

Juan:

True. I was thinking that too.

Chris:

I'm so sorry.

Alex:

No. Back to the transparency issue: Every block you can check somebody's holdings in cryptocurrency, right? Despite scanning the blockchain. But with traditional finance, you have to wait for weekly reports or something.

Chris:

Very true.

Alex:

I do think all this information is publicly available when it comes to traditional finance. It's just way harder to get your hands on and it's not live, in real time.

Juan:

It's not based on smart contracts.

Alex:

No.

Juan:

It's not based on rules that you cannot break, actually. If you're insolvent, you can call someone at the Federal Reserve to give you a credit. It's just so much more analog. It doesn't work that way. In crypto and DeFi, insolvent players get liquidated automatically, period.

Alex:

Right.

Juan:

That's it.

Alex:

Well, it's a trust vs. a trustless system. Right?

Juan:

Yeah.

Alex:

So there's no trust in crypto, but there's plenty of ways you can get around rules in traditional finance.

Chris:

I was reviewing some of the-

Marija: Can I-

Chris:

Go on. Marija, go for it.

Alex:

Marija, yeah.

Marija:

There are volatility risks related to long collateral in DeFi. So if you want to take out a loan, you can do it immediately in seconds. But the lending protocols usually require users to over-collateralize their loans upwards to, I don't know, 150% in order to secure the stablecoin [inaudible 00:13:46] loan.

              But because the collateral is very, very volatile, this opens users to a risk of liquidation, should the value of their collateral decrease.

              But there are hedges; smart contract automation platforms that can allow users to automatically replenish collateral, if the value decreases, to avoid liquidation.

Chris:

Good point.

Marija:

But on the flip side, users can rebalance their collateral as the value of the collateralized asset increases.

              But currently there are efforts — For example, debt to lending protocols are building credit risk protocols for users to borrow under-collateralized loans. Right now, crypto is over-collateralized primarily. But there are trends to go towards the credit risk protocols where you have a credit score based on your blockchain ID.

Chris:

Oh, right.

Marija:

Identity and behavior. And based on the behavior of your address, wallet and things like that.

              There are things that are moving in the direction of under-collateralized and more like traditional, but still it's very important that there are ways. And as Alex said, transparency and also automation are reducing risks of volatility.

Chris:

I think that's okay even if they're under-collateralized. It just sits on the spectrum of risk, doesn't it? They would just be higher risk. And if you want 100%, 150% collateralized assets, they'll be there. The whole suite of stuff will be there. You can just take your pick.

Juan:

That is true.

Chris Coney:

Now, Marija just said something about-

Marija:

When we're talking about collateral, I would say, like when you say, toxic collateral, I would consider toxic collateral to be, for example, what is placed into a MakerDAO (DAI, Unrated) contract.

Chris:

Oh, wow. Okay.

Marija:

MakerDAO, a stablecoin maker produces the DAI, stablecoin. So if it's collateralized, it's a source collateralized only with Ethereum, which is very high level value, very liquid, very important crypto.

              But then you've got multi-collateral with multiple different currencies. When it came to that part, it became, in my view, a little bit more risky because I don't want cheap coins in the collateral. That's why it's important to monitor all these very important building blocks in the money Lego system.

              As Juan said, this is all about composability. So it's really about putting toxic on top of toxic. It's more composability. How composable they are? Stablecoins are a very important part of this composability. And so, just realizing which are the key components of these DeFi blocks is very important, and to keep track of them and warn you if there is something not quite right.

Juan:

Now, on that note, what I would say is that even though there is risk for the individual to participate in these systems — because to Marija's point, these positions tend to be over-collateralized — when collateral falls under a certain threshold, you're going to get an auto liquidated. Basically, the contract has a mechanism to seize your collateral and repay your loans. DAI is one such example.

              But what I would say is, because the system is so good at managing individual risk via smart contracts, the system as whole tends to be more robust. There are no systemic issues that [we know of in DeFi.

              Now, DAI, is a very good example because, back in March 2020, there was this moment where DAI became under-collateralized for a while because Ethereum’s price fell too quickly. And so there was more DAI debt than there was collateral, and everybody was calling for the death of DAI.

That's what prompted them to be multi-collateral. Whether or not that's a good solution is a different debate. The system survived. I think that's the key point here. I mean, it survived. It went through that massive liquidation event and DAI, after experiencing some volatility, remained somewhat stable.

Chris:

Do you mean with no external intervention?

Juan:

Well, you could argue that the debts came in and said, "Hey, let's initially ..." I don't know how many assets they accept now, but their knee-jerk reaction was to say, "Hey, let's back our stablecoin with more stablecoins. And let's suspend the rules for the stablecoins." In other words, you cannot get liquidated for a stablecoin loan.

              If I had a pause at USD Coin (USDC, Unrated) on DAI, and I create DAI and USDC for some reason fell below $1, the smart contract doesn't recognize that. It lets me keep that loan. So you could argue that's a bit of a quick batch solution, not really a sustainable solution. But it's not easy to back a stablecoin with assets that are as volatile as crypto.

Chris:

That's the problem, right? Yeah, exactly. That was thinking behind making DAI into a multi-collateral asset in the first place. While Ethereum remains the obvious choice — liquidity, market gap, all those things — it's the volatility. You'd still need 400% collateral to absolutely guarantee that it was always going to be solvent.

Juan:

Yeah, pretty much.

Marija:

Yeah, but still, I mean, crypto's very correlated. The prices of crypto are quite correlated with each other.

Juan:

Yeah, exactly.

Marija:

When the market goes up, almost all the crypto goes up, and vice versa. So, right now, multi-currency collateralization doesn't really protect it from black swan events.

Juan:

I didn't want to go there, but you're right.

Marija:

Yeah, but it's a very, very tough code, and battle-tested. As Juan says, we had some very serious events and it survived it, and there's some very, very diligent people who are participating, whether they're minting or this or that. So yeah, it's a very robust system and I'm quite satisfied with DAI.

Juan:

So let's segue into DeFi derivatives because I think this could be a solution for DAI. What if you throw things into that mix that are negatively correlated to price?

              In other words, assets, crypto assets that go up when the price of other crypto assets go down.

Chris:

Right.

Juan:

And actually, I was reading up on ... I think it was called Tracer DAO (TCR, Unrated), and they're working on these. It's a complex way of creating leveraged bull and bear tokens. They want to create leverage ERC20 tokens that have leverage, but cannot get liquidated.

              They go into how they create this synthetic leverage. But it's quite interesting because the bottom line is here's this ERC20 token that basically is a claim on a pool of assets. People pool assets together and you can take a bet long or short. Bottom line is this, you can buy an asset that will go up on leverage when the price of crypto crashes. And you can back Dai with those leveraged short ERC20 tokens.

              So this is the magic of composability. Now I can back a stablecoin in such a way I always have ... I can create some stability by creating a good mix of assets that are negatively correlated to one another.

Chris:

You've just described Antimatter.

Juan:

Antimatter's one such example. Yeah, you're right. The whole DAI pool could be hedged for all we know.

Chris:

Because it's-

Juan:

And it's just buying options on its own pool of assets.

Chris:

It's like Binance. Binance has those leveraged tokens like BTCUP and BTCDOWN.

Juan:

Yeah, but these are different though.

Chris:

I know, but these are-

Juan:

These are on chain.

Chris:

That was exactly my point. That was exactly my point.

Juan:

Right.

Chris:

And the opening, you're talking about, yes, all this stuff might not seem like anything new under the sun but, and this is the subtlety of describing DeFi, people are like, "Oh, yeah. I've heard all of this before." But not in a decentralized way, autonomous way that can be messed with.

              So Binance has BTCDOWN, and if you buy the asset and BTC goes down in price, the value of BTCDOWN goes up. Right?

Juan:

Right.

Chris:

It's just the way ... Which is good, because people are used to buying low and selling high. That helps.

Alex:

I was just having this conversation yesterday, actually. We're inevitably going to replicate the entire traditional financial system through DeFi, right?

Chris:

Mm-hmm (affirmative).

Alex:

So right now, we have options, derivatives, futures, plenty of different things that have already been replicated in decentralized fashion using smart contracts on DeFi protocols. But every aspect of the traditional financial system will end up being replicated over DeFi.

              And so, you're right now, talking about the benefits of how decentralization actually improves some of these things, but we're probably still in the infancy stages of DeFi right now. We're going to see everything under the sun that happens in traditional finance replicated again with blockchain.

              So you're talking a little bit about the worries of bad collateral or derivatives built on derivatives. We don't have that yet in DeFi, but something tells me we will eventually replicate some of these things. But risk will be mitigated via smart contracts and decentralization, and hopefully we're able to replicate those aspects of finance in a better way.

Chris:

Here's a question. I'm going to talk about Bumper again. How does it stay solvent? Because if it is a system that has no intervention from external parties, then a traditional insurance ... say it's your car insurance; I have a $60,000 Porsche. I take out an insurance policy that's worth $60,000 against that car, and it's $1,000 a year, right? Boom. That goes in the insurance pool. Right?

              The insurance company who's taking on that risk is hoping to God that at least 60 customers pay $1,000 a year into the pool and the Porsche crash ratio is only 60:1 or better because they're going to have to pay out $60,000 to replace that car. And if two out of 60 people crash their $60,000 Porsches, it's insolvent, right? That's that.

              Now, let's take it over to crypto. Let's say back in 2017, Bitcoin is at $20,000 all-time high. Let's say Bumper existed back then, and I had an insurance policy out on my Bitcoin. The difference here is that everybody crashed at the same time. All the $60,000 Porsches simultaneously got written off, which means all the Bitcoin holders had a loss of value. It crashed.

              So in that instance, not everybody, because not everyone would have insurance, but a ton of people would then claim insurance on their crashed Bitcoin, right?

Juan:

It gets to the issue of collateral though. I mean, this is an issue of individual collateral. I haven't looked at Bumper, specifically, but I'm guessing it's over-collateralized. Meaning if I sell someone insurance to buy one Bitcoin at $40,000, they'll want me to have the $40,000.

Chris:

Yes. So the “never mind, I'm the insurance buyer” [is on one side]. On the other side is someone who has USDC and puts it in the pool for a yield.

Juan:

Yeah, for a yield. This is a way to create yield. And in fact, I'm thinking of doing this. Once these perpetual options become popular, I'm thinking of doing them with some of my crypto assets, especially when prices go up. Because chances are, when prices go way, way up — which I'm expecting will happen as we head towards the end of the year — these insurance premiums, or rather, the amount people who are willing to pay to buy Bitcoin say at $100,000, $150,000 whatever, is going to be so high that Bitcoin holders will be incentivized to sell these contracts. They’ll say, "Hey, in exchange for this fee, I'd be willing to let go of my Bitcoin at say $250,000 in exchange for this fee every hour."

              And so, this is just a way of creating income based on the assets you hold and the prices you would sell at anyway. Not saying that I would sell at $250,000 or whatever; it’s just an example. If you see the market getting overheated, chances are ... Because why would people buy this insurance? Remember, you can buy these options without having the asset to insure. This is not just insurance, this is also a way to speculate. I could just buy this contract from someone because I want to place a leveraged bet.

              Which is why Antimatter compares themselves to a way of buying leveraged tokens, because I can buy these options from Bitcoin at $250,000 call options. Right now, maybe today, and chances are I'm only going to be required to pay a very small amount for these contracts.

              And if Bitcoin were to go up-

Chris:

Well, the closer it gets to that price.

Juan:

The closer it gets to that price, the price of that contract will go up. That's a way of placing a leveraged bet that Bitcoin will go higher. My downside is limited. This is the beauty of options. My downside is limited. I can only lose what I paid for that contract. I cannot lose more.

Chris:

Just like if I don't claim the insurance on my Porsche. If I don't crash it, then I just lose the $1,000. Well, I don't lose it, I've spent it.

Juan:

Exactly. But imagine buying insurance on someone else's Porsche. This is what we're talking about.

Chris:

In case they crash it ...

Juan:

In case they crash it.

Chris:

Alex, I'm looking at you Alex.

Juan:

Think about the incentives that creates.

Alex:

Show me these $60,000 Porsches and I will buy one right now.

Chris:

It's an old one, a Porsche Cayman.

Anyway, note that I was suggesting Alex is the one most likely to crash the Porsche, suggesting that Alex is most likely the one to own a Porsche. There you go.

Alex:

That's probably true.

Marija:

I think insurance protocols that are insuring against the volatility of stablecoins are also very interesting. Since stablecoins are, I mean, supposed to be stable. But in case of some event, for example, if you find out that maybe Tezos (XTZ, Tech/Adoption Grade “B”) is not collateralized enough to cash in the bank or, I don't know, USDC suffers some regulatory issue or DAI has some larger movement of the price due to the movement of the collateral, and you hold the DAI or USDC or some other stablecoin, and you hold a large amount, you may want to insure yourself until certain date, until you are planning to hold that stablecoin in your hands.

              So for example, you can go to the potentialized pools, potentialized protocols where individuals are giving their money, putting their money in the pool, and selling the insurance. They're fully selling the insurance for a certain fee to someone who wants to get insured.

              Again, for example, a price drop of 5%. So, if the price of a [U.S.-doller pegged] stablecoin — which is supposed to be $1 most of the time — goes below 95 cents, then I want the insurance to cover the rest if it goes before a certain date.

Chris:

Interesting.

Marija:

So, I think these stablecoin insurances are much easier and easier also for the usual resale investor to understand that this is also part of DeFi.

              So, on top of providing the creativity to potentialize the changes with automated market making models, on top of lending your money on other or some other lending protocol, there are tons of other options that you can do different things. You can also provide the insurance, again for example, the dropping price of the stablecoin until certain dates, things like that.

              I think with stablecoins, it's much easier to understand for a regular people than with the volatile coins.

Chris:

That's a good one. That is a good one because whenever I explain stablecoins to people, and say, "Oh, they're always backed by $1 in a bank account somewhere." But the next question is, "Well that's still a risk though. What if Circle, the backer of USDC, suddenly gets regulatory rug pull and USDC loses its regulatory approval or is found to not have the collateral, then the USDC would then lose its peg." Right?

Marija:

Lose the peg. For example, in the case of DAI, it would probably be ... DAI cannot be regulated, but it can lose the peg due to the change in price of the collateral, and it can lose... I don't know, short term, up to 5% maybe. So yeah, in those cases it's quite interesting.

              But those that have systemic risks ... higher regulatory risks or that need to have cash in banks, have different risks. But still as you say, the unpegging is somewhat a risk especially if you need to hold a certain stable coin until a specific date.

Chris:

Yes. What I find interesting, which is different in the DeFi world vs. the traditional options insurance and so on, is in the case of Bumper again, a large part of the token supply has been allocated to protocol use. That boggles my mind, though, because everyone's going to be paying their insurance premiums in the Bump token, and then suppose the USDC stakers are going to be earning their yield in Bump tokens, right? Okay?

              But then at the same time, in the insurance pool, the protocol's got all these Bump tokens which you hope would have a high market cap and high liquidity. You want to make sure there's enough capital there to pay out the insurance policies that get claimed on.

              Which is weird, because I'm still thinking about traditional insurance, car insurance. Everyone pays their insurance premium in the dollar or the pound, and then the car is insured to a pound or dollar value. And then when it's claimed, it's pounds or dollars that are paid out. It's pretty straightforward to get your head around the fact that it's the same asset all the way through.

              In the case like Bumper and these decentralized options, you've got initially Ethereum as the asset you're insuring. You're paying the premium in another asset called Bump token. But then the insurance pool is being provided by people staking USDC. It's like, "Oh, my goodness me."

Juan:

Of course. Because what you're insuring here is the price of Ethereum dollars, presumably.

Chris:

Correct. Yes.

Juan:

Now, in my view, if you told me that, "Hey, I hear you can stake USDC to sell this insurance to people so that in the future they can sell their ETH to you," and you told me that I'm going to be receiving that in Bumper tokens. I'd be like, "Yeah, I'm not sure I'm so interested in that." I want yield on my dollars. I don't necessarily want a crypto token.

Chris:

Well, I know, but that's the same old yield funding thing, which is when you've got your premium, you can swap it into more USDC and compound it if you want to.

Juan:

Well, right. I mean, a mix would be fine. But if all I'm getting as a premium for selling this insurance is the Bumper token, then I'm not sure I'm so interested in that because then you're adding this X factor.

Chris:

Well, is it because you can't be bothered to go and swap out on Uniswap?

Juan:

It's simply because I don't know how much I'm going to get. Typically, the reason investors want yield is because they want some certainty with regards to their income. I mean it's not that they have no certainty. They know they'll make something, but can't reason into how much.

What if it says 10%? Right? I mean, it says 10%, but in Bumper tokens. Okay, if the price of Bumper token is down 90% over the next year, then I got 1%. I don't want that volatile rate. The whole reason  I'm parking my USDC and selling a contract is because I want stable yield.

Chris:

Yes. It relies on you taking your Bump tokens in every payment and then flipping them into USDC quickly, before the price moves.

Juan:

Which is why, just pay me USDC. I mean, this is how certain crypto derivatives work already. The most common derivative there is right now, both on chain and off chain, in other words decentralized and centralized, is the perpetual swap.

              There are two kinds of perpetual swap: Some settle in crypto. In other words, you have a Bitcoin. You can trade Bitcoin against the dollar, but the contract settles in BTC. So when the seller needs to pay the buyer, the exchange takes place in Bitcoin.

Chris:

Right.

Juan:

These contracts, sellers typically get incentivized to short BTC because they get a premium payment every eight hours from the buyer. That’s how these work. So how do you incentivize someone to sell a crypto asset? You pay them to do so. The seller can choose to be either paid in Bitcoin or in dollars, depending on the contract. And so, you have both. You can pick and choose.

              But if you're forced to take ... And these are prime assets, right? It usually is the asset that's being traded.

              For example, if I'm engaging in a Bitcoin USD market, perpetual swap, I can either get paid in Bitcoin or in dollars. There is no third token. I would argue that if there's a third token involved, that's actually a bad thing.

              I have a good example for that. BitMEX, which only accepts Bitcoin, tried to do contracts that settle in Bitcoin, but trade Ethereum against the dollar. These contracts are not very popular. I know that because premiums on those contracts tend to be huge. Meaning there's no one doing arbitrage.

              And if there's no one doing arbitrage when premiums are significantly higher than the market average, that means market makers are not willing to come in and make these markets. The reason for that, I can only imagine, is that they don't want the added complexity of managing these positions.

Chris:

Right. It's too far removed.

Juan:

So when you add a third token, when you ... Because in the Porsche example, you're trading Porsche vs. the dollar. It's a Porsche USDC payer.

Chris:

Right.

Juan:

So you can either get paid in Porsche, or in dollars. But if you add a third token, I would argue that extra layer of complexity is something that puts people off.

Chris:

Well, you can't actually get paid in Porsches because the insurance company doesn't get the car for you and give you it.

Juan:

Right.

Chris:

It settles in U.S. dollars.

Juan:

Right. So the analogy breaks down at one point.

Chris:

Same with Bumper, actually, because if Ethereum gets the $10,000 and then I take out insurance, like Marija said, and insure it for $9,000, up to 90% of its value, and then the market takes a 60% dip, okay? Happy days. I'll exercise my option, and then it costs me 10% plus whatever the premium I've spent. But it's better than 60%. However, as far as I understand it, I'll get USDC back. I get $9,000 of USDC to pay for my Ethereum, but I get my Ethereum back.

              Which is why, at the beginning of this episode, Juan, you said, in my BitMEX example, yeah. You're effectively selling your Bitcoin at that point. Or in my case, I'm effectively selling my Ethereum. I'm agreeing to committing to sell my Ethereum at the time I take out an option. Because I never get it back unless I get the USDC and buy it back.

Juan:

Right. So I don't know if you want to go down this rabbit hole, but it is possible to settle the contract in Ethereum, for example, and what you get is $9,000 worth of ETH, at whatever the price of ETH is.

Chris:

Sure.

Juan:

You can do this too. So if ETH is $9,000, you get one ETH. If ETH is $2,500, you get two.

Chris:

Well, you could program that in, right? I suppose.

Juan:

You can program that in. So yeah, you can do that as well. So when you do the synthetic Bitcoin, what happens, which is quite interesting, is the amount of Bitcoin you have fluctuates so that you always have a fixed amount of dollars.

Chris:

Yes.

Juan:

This is ... Yeah.

Chris:

Yes. This is probably slightly mind boggling because Uniswap provides a lot of that backend for all these apps. And I think Bumper, talking about that as well. They'll integrate with other yield farms so that the interest rate you end from wherever, you end finance or whatever, they might be tapping the Bumper protocol for some yield, then passing it onto their users and stuff like that.

              So there's this web of interconnectivity which is all transparent as Alex said early on. It doesn't matter how complex it gets, the auditability and accountability will all still be there. Which is why that is a key distinction between rebuilding the existing financial system on these new rails, it's that transparency and accountability that is fine. Even if that's the only thing that changed, it would transform everything. Right?

Alex:

I think all three of you are significantly better traders when it comes to derivatives and futures, options, etc., than I am. But this example of taking out insurance on your Bitcoin, 90% insurance like Juan did in the beginning of this shoot ... I'm not experienced with options, but I'm not sure. You're talking about how, when you take that insurance premium, you're effectively selling your Bitcoin. Call me simple, but I don't know why you wouldn't just sell your Bitcoin. Take that, sell it for USDC or something. Park that USDC or somewhere you're going to generate yield and just already start making that yield.

So instead of paying an insurance premium, you're making a yield.

Juan:

Let me correct you there, my friend. If you're buying an option, like I say, if you're buying an option that's 10% below the spot price on Bitcoin, you participate in the upside, and you can only lose 10%. In exchange for that unlimited upside, can only lose 10%. In exchange for that, you're going to pay a premium. Okay?

Alex:

So essentially, you'd go down that options route if you thought there was still a little bit of upside-

Juan:

You just cut the downside. Yeah.

Alex:

But you wanted to protect against the downside, right?

Chris:

Exactly. Going back to my example if Ethereum hits $10,000. Then, if I made the decision to sell it for $10,000, then that's it. I have to make that call. I could be right or wrong. If I'm wrong and Ethereum doubles again, I've sold at $10,000 and I could've sold at $20,000.

              By taking out the option, I pay the insurance premium, then Ethereum doubles. I just don't exercise the option. I just sell the Ethereum at $20,000. If it falls, I claim on the insurance and get it at $9,000. So it's kind of win/win.

Alex:

It's-

Juan:

Yeah, it's the best way to hedge, is through options.

Alex:

Yeah. I usually solve this problem myself by dollar cost averaging and not selling everything all at once. But you know that meme, where it's the parabolic curve, right?

Chris:

Yep.

Alex:

You have the dumb guy on the left side, you have the smart guy in the middle and you have the guy in the hood on the right side. I think I'm the left guy. I'm not the smart guy.

Juan:

You're not the guy in the hood?

Alex:

We're both doing the same thing. We're both getting the same results, but you guys are thinking way further ahead than I am.

Chris:

It's the IQ bell curve thingy, isn't it? Super dumb and super smart guy basically do the same thing. It's the middle guys that are always losing.

Alex:

Right.

Juan:

I love that meme. I love that meme. I use a lot of instruments though and I don't like to think I'm that stupid, but hey.

Alex:

You just don't want to be the guy in the middle right? As long as you're not the guy in the middle, you're fine.

Chris:

So, I just want to close this one out with another comment from Marija.

So Marija, when I was looking into all this, I thought, "Well, what else is out there." I end up on CoinMarketCap.com and they actually have this category for options. There are 10, right now, 10 option-based tokens. One of which is the Antimatter token. Just a quick comment. Don't mean to put you on the spot, so you say whatever you want to say. But have you studied any of these from an investible point of view?


Marija:

Not for advice, but yes, I was looking at them, especially Connector was very, very popular. I don't know. I think we are still very early. I actually want to see them and how they perform in the world — the volumes and amounts that are going to be locked in those protocols, and all the systemic risks and game tier risks that may arise. It's quite early. I think it will be very important in the future together with the insurance protocols. They’re still not there yet, but certainly from investment point of view, I think it can be very interesting.

              But as Juan said, having and receiving depends on which coin you are receiving. I have to see if people really want to receive those tokens as collateral. And these are all behavioral economics and game theories that we need to track a little bit more in order to go deep into.

              Also, with the insurance tokens and projects … They're very nice ones, but liquidity isn’t there yet. And also, you have to track all the possibilities and how it's going to behave under stress testing. As we've seen with MakerDAO when it was stress tested due to market conditions. We are going to see with these projects as well. So maybe if you're thinking about investing, yes, you're early. But picking the winner, I think it's a bit too early to say. There are different things-

Alex:

Being early is not always great, right?


Marija:

Not always. It can have comprehensive advantages, which is very important in crypto, but it's not always great. But consistently gets battle tested first, which may harden its first like it did with Aave (AAVE, Tech/Adoption Grade “B”). We will see for now.

              We also have, in terms of kind of regulating volatility, these index tokens token where you disperse risk by buying an index, a basket of different projects, for example, related to DeFi or equities, we have the Solana (SOL, Tech/Adoption Grade “C-”) ecosystem or now the Polygon (MATIC, Tech/Adoption Grade “B-”) ecosystem. Because if you don't know what to invest in — exactly there are so many DeFi projects, so many Polygon projects, — you can simply invest in an index, which has a basket of the most promising projects.

              And there are people who are always caring about which tokens are in the basket. These are also for price risks in some ways, because the topic of this video is volatility, price volatility and how to hedge. There are so many topics around it, but yeah-

Chris:

So, you think it's –


Marija:

I think it's a very large part of the subject.

Chris:

You didn't say-

Juan:

Sometimes-

Chris:

... want to clarify something. So, do you need to see a working product before you would make an assessment?

Marija:

As an analyst, sometimes you’re assessing free sells and different stages of the projects. Even just white papers. It's just ... it depends. I have higher risk tolerance than regular investors and I would invest on less information, but not ... I wouldn't risk too much.

Chris:

Gotcha.

Marija:

So yeah, it depends on the purpose and the person.

Alex:

Sometimes being too early is not any different than being wrong. One thing I would clarify when it comes to investing in these types of DeFi protocols — different applications of DeFi, insurance, whatever — is the way I would approach investing in these is to check out what institutions are buying. These are people that participate in traditional finance. They understand it better than most people, and they're going to know what to look for and what makes a good product.

              So I don't think they're really getting too deep into those DeFi protocols yet. I could be wrong. But I would just monitor their portfolios. That's how I would look at the winners of this space. Whoever's going to get the money from institutions that are already participating in that type of financial product, they're most likely going to be one of the winners from this new DeFi boom.

Juan:

Or, for me, it's using the product. If there's no working product, I'm not interested. If they have a good product, a recent example is dYdX (DYDX, Unrated). I'm not surprised they're doing so well. The token launch was recent. I think it was last month. Yeah, it was last month. They're doing great.

              I think based on CoinMarketCap, I think they're the second largest derivatives. They have identified as derivatives token. I'm not surprised because they have a great product, and they always have. They were one of the early movers. I think they were the first ones to have an off-chain order book combined with on-chain settlement. I always thought, "Hey, this is a great idea. No one else is really doing." I mean they are now, but not back then. It's just a great product. It's a great product.

              This is, for me has always been, "Hey, if these people had a token ..." And a bunch of us were actually telling them years ago, "You guys should have a token." Because people would buy it, because it's good. Just throw some governance features into it and people will buy it. And so, now, they're exploding in popularity because it's again, good product.

              Sometimes it's about using ... It's just looking at what they're doing. What Antimatter's doing, I agree with Marija. I would like to see liquidity. I'd like to see how it integrates with the rest of DeFi. I'd like to see if there's demand for these. Because sometimes, they're so complex.

              The two I looked at recently are Tracer DAO and Antimatter. Antimatter is perpetual options. Tracer DAO is these synthetic leveraged tokens. My sense would be to not be so bullish on Tracer DAO because I'm not clear. It's not clear to me that people will understand these products enough that they become popular. I think it was just so complex that most people would just get lost. Great opportunity for people doing arbitrage though. It's a great product for arbitragers.

              But perpetual options, I think are simpler. It's just insurance, so I think it could catch on. And if it does, these projects and these tokens, the underlying tokens, will do very well.

Chris:

Cool.

Juan:

It's just getting involved in the products. Use it. See if it can make sense of it. If it's good, and you think, "Hey, there's something valuable here," then you can place a bet. Say, "Hey, I think this is going to go higher."

Chris:

Gotcha. All right. Well, I think we'll wrap it up there. Thanks to all three of you for being on this week's edition of the Weiss Crypto Sunday Special.

Juan:

Thank you, Chris.

Alex:

Thanks for having us again.

Marija:

Thanks, Chris.

Chris:

All right. That's going to do it for this week's edition of the Weiss Crypto Sunday Special. Keep your eye on your inbox for next week's episode. Until then, it's me, Chris Coney, saying, "Bye for now." (Silence).

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