Decentralized Derivatives

VeradiVerdict - Issue #55

Pantera recently led a $5m round into Vega, a decentralized protocol for financial derivatives that allows for safe and non-custodial margin trading. Read how it works and why it’s compelling:

  • Vega is a decentralized protocol for creating and trading financial derivatives on the blockchain. It automates tons of “middleman” steps in such markets, such as settlement, collateral, risk management, and fee pricing to create a seamless experience for traders and market makers alike.

  • Vega’s protocol has three main defining qualities:

    • The protocol has built in incentives that reward price makers and market makers for providing the liquidity to power various financial markets. These incentives adapt to draw market makers to financial products that need their support.

    • The protocol uses cryptocurrency-based collateral, but can plug into a variety of blockchains and take collateral in the form of Bitcoin, ERC20 tokens, stablecoins, and more. This offers users a high degree of customizability.

    • It’s exceedingly easy to make markets on Vega’s network, as they automate much of the financial infrastructure necessary for that market to persist. Markets are approved through a proof-of-stake (PoS) protocol from Vega’s participants.

  • Vega offers powerful market making and trading engines that automate intermediate processes. Making a market is as easy as setting the parameters for the market and submitting it for review, and trading is as easy as plugging an existing infrastructure or interface into an API or submitting an order through the dapp created by Vega, which is then automatically executed by Vega’s protocol.

  • Ultimately, Vega represents a major step forward in diversifying decentralized finance and breadthening the kinds of financial products available for trade using blockchain infrastructures.

The DeFi Ecosystem

Decentralized finance (DeFi) is one of the hottest applications of cryptocurrency and blockchain technologies––taking traditional financial concepts like securities, bonds, money markets, and more, and putting them on the blockchain puts significantly more power in the hands of those who participate in these markets, not just the middlemen who manage them.

Though DeFi is a very nascent field, there’s an incredible amount of rising interest in trading on the blockchain and extending the financial capabilities of cryptocurrency.

Introducing Vega

Vega is a protocol for creating and trading financial derivatives on the blockchain. Vega removes the middlemen often present in derivative markets and automates the entire market-making and trading through smart contracts, consensus, and other applications of blockchain. It enables anyone to create a decentralized derivative market and facilitate fully automated margin trades.

Vega supports literally any kind of financial product, not just those based on cryptocurrencies. It can even support tokenized securities. The idea is to set up a generalized marketplace for assets with a critical time horizon, like futures, options, etc.

If DeFi is so popular, why is Vega different?

Vega is one of the first automated derivative protocols for cryptocurrency, so it’s a huge development for the broader financial investing market in the context of blockchain. On top of that general application, Vega has three key differentiating factors.

First, built-in liquidity incentives. The protocol has liquidity tools baked into its architecture to support market makers and traders for literally any financial derivative. It automates the liquidity pricing process individually for each market, by ingesting the volume and prices of trades and real-time liquidity prices in order to calculate an accurate price. The prices are also algorithmically set to draw liquidity to markets with the greatest need, and to ensure that all markets are operating at the greatest efficiency possible. It then uses the revenue generated from the liquidity price to reward market makers and infrastructure operators––this incentivizes market makers to continue creating and managing markets on Vega’s protocol, increasing the total volume and diversity of transactions occurring on the network. This cycle of positive reinforcement draws more and more attention to Vega’s product and also the broader sphere of decentralized derivatives––rewarding market makers incentivizes them to make more markets.

Second, a breadth of collateral options. Vega’s derivatives are all collateralized by cryptocurrency, but Vega’s decentralised infrastructure supports a variety of cryptocurrencies to be used as collateral. Vega connects to most major blockchains and supports collateral in the form of digital assets like Bitcoin, ERC20 tokens, various stablecoins, and more. This is critical because it gives users the power to choose their preferred medium for collateral, rather than having an arbitrary middleman define the underlying infrastructure of the trades. Vega’s high degree of customization with respect to collateral truly makes the cryptocurrency derivatives markets as personalizable and adaptable as possible. The network also calculates the minimum collateral necessary to maintain open positions in near-real-time, which optimizes the cost of margins and maximizes leverage. Vega’s interface also allows traders to see their collateral balance at any time, simplifying the process and putting more control in the hands of traders and market makers.

Third, the simplicity of making markets. The entire ethos of Vega is making it exceedingly simple to create markets in an otherwise complicated (decentralized, P2P) system. Vega will eventually offer a library of product features and cash primitives from which market makers can easily architect cash flows and settlement infrastructures for various options, futures, and more. Vega has pre-built risk models that automate margin and leverage calculations; participants in these markets simply must feed in parameters like underlying assets and dates.

How does market making actually work on Vega?

After users enter in the necessary parameters for their desired financial product and market on Vega, the market then enters a review process by participants on Vega’s network. Market makers must also submit a financial bond to the Vega network to ensure that the market maker complies with Vega’s processes. Vega uses a proof-of-stake (PoS) protocol to vote on markets––essentially, the weight of any given participant’s vote is proportional to their stake, or the value of assets, in the network. Once a market passes the review period, Vega automatically launches it.

As the market evolves, market makers must continuously provide book order volume that’s proportional to their market making commitment. They are also responsible for providing and maintaining liquidity in the market. In exchange, they receive a portion of the trading frees from when any trader decides to take the price of a financial product. Trading fees are dynamically calculated by Vega to ensure that market makers are supporting the markets with the greatest need. The dynamic updating of various parameters can be highly computational, which is why a platform like Vega is so critical; it provides near-real-time updates about the state of any given market, which is super useful for users who face time-complexity challenges when interacting with the layer 0 blockchain or alternatives like Ethereum virtual machine.

How does trading work on Vega?

Vega uses the same genius of its decentralized protocols to create a fair, efficient trading environment. Users can place orders for any of the markets listed on Vega’s protocol; once they’ve been placed, the network uses a consensus protocol to rank them in terms of time priority. The protocol then deterministically executes the trade on all nodes of the network to ensure that the same matching, risk management, and settlement occurs for all orders and participants in the protocol; in this regard, Vega’s tech is particularly robust, with complete entire matching engine, risk engine, collateral engine, settlement engine, and governance engine. The entire network is thoroughly architected to provide the highest degrees of automation and create truly fair and decentralized markets. When price takers issue a trade, they also pay the trading fees which then go back to participants in the network like node operators, price makers, and the market makers that provide liquidity for the protocol.

Vega’s also working to increase the modalities of trading it supports, including requests for quote, auctions, limit order books, good-til-time, and more.

Vega also has various APIs that users can plug into to automate trading with their own infrastructure and interfaces; it will also have a dapp that provides a UI to help users visualize positions and various financial products for which they can take trades.

An early stage prototype of Vega’s trading UI.

Final Thoughts

Vega provides a robust and customizable decentralized protocol for creating financial derivatives on the blockchain and trading them. Though relatively early in development, Vega’s market making and automatic trading capabilities hold great promise for decentralized finance; it gives users the necessary power to create their own markets and define their own parameters, while providing enough second-layer scaffolding to simplify the DeFi experience and automate as much as possible. This extends far beyond simply blockchain and cryptocurrency, but serves as a decentralized model for how financial products can be equitably and efficiently created and traded online.

Ultimately, Vega represents a major step forward in the sphere of decentralized finance; high degrees of control over financial products and derivatives greatly diversify the applications of technologies like blockchain and consensus in the financial sector. 


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Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. The firm invests in equity, pre-sales/IEO rounds, and cryptocurrencies on the secondary markets. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.

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