Introduction: Synthetic Derivatives on the Blockchain
Editor's Note: This article comes fromEthereum enthusiasts (ID: ethfans)Editor's Note: This article comes from
Ethereum enthusiasts (ID: ethfans)
, Author: Allison Lu, Translator & Proofreader: Min Min & A Jian, reproduced by Odaily with authorization.
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A derivative refers to a contract that links returns to observations of a certain asset, the underlying asset. Typically, the object of observation is the price of the underlying asset, but it may also be a characteristic such as volatility or volume. Such derivatives transactions occur across all asset classes, such as credit agreements ($8 trillion in notional size), foreign exchange rates ($90,000) and interest rates ($437,000). The market is huge, partly because derivatives prices are flexible.
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What are synthetic derivatives
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-Derivatives originated as a simple agreement between two parties to hedge the prices of different commodities-
Consider Alice, a wheat producer, and Bob, a grain producer. Alice is currently planting 100 bushels of wheat that cannot be sold until the May 2020 harvest. She is worried that the price of wheat will drop by then, affecting her yield. Bob wants to buy 100 bushels of wheat to produce grain, and he is concerned that the price of wheat will increase next year. Alice and Bob want to lock in the price of wheat at $5, so they construct a derivative to seal the deal.
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-Illustration: "When we were young, COD meant cash on delivery"-
Of course, no wheat can grow on the blockchain. In fact, there is nothing on the blockchain other than the ability to mine or mint native cryptographic assets. Therefore, if physical derivatives are issued on the blockchain, physical settlement cannot be performed.
Alice and Bob can only agree to carry out synthetic settlement according to UMA's smart contract template. If the price of wheat rises, Alice needs to pay Bob in DAI; otherwise, Bob needs to pay Alice. How much Dai actually needs to be paid is determined by the net present value (NPV) of the assets held by each party. At the time of delivery, Alice does not need to actually prepare 100 bushels of wheat for Bob. Bob also does not need to prepare $500 in cash to pay Alice. They only need to put up a small margin to gain exposure to the wheat price, and only pay further money in money if the net present value of that trade changes; both parties gain leverage.
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-Gift to the effect: "How to calculate NPV, God"-
