Derivatives

Derivatives are something that everyone has heard about at least once in their lifetime. Its use originates long before the invention of crypto, in fact, the first organized markets for the exchange of derivatives dates back to 1600-1700 with more primitive forms of futures contracts.

Specifically, a derivative is a financial product whose value depends on the value of its underlying asset, which can be an index, a raw material, an interest rate, a currency, etc.

The diffusion of these instruments began in the 1970s when, due to the strong fluctuations in oil prices, there was a great need to hedge against this market risk.

In 2006, one of the biggest world crises in history broke out in the United States and its effect was felt for about 6 years, from 2007 to 2013. We are talking about the great recession triggered by the subprime mortgage crisis related to the real estate market.

Poor management and regulation of financial institutions led to huge speculation in the derivatives market, the Collateralized Debt Obligation (CDO), which were nothing but toxic securities.

The underlying of these derivatives were made up of ABS (Asset-Backed Security), which in turn were made up of hundreds, thousands of defaulting loans, the subprime mortgages; one spark was enough to burst the immense real estate bubble.

We are almost at the end of 2008, October 31st precisely, the date of the publication of what for some will become the Bible of today: Bitcoin‘s whitepaper, or as some call it, Satoshi Nakamoto‘s manifesto.

Someone thought well about how to overcome the problem of an entire system governed by central authorities, whose sole purpose was to make money out of everything, thinking only of their personal interest rather than public welfare.

This brings us to the present day. Those who have been familiar with the idea of derivatives linked to the decentralized financial market, which is still a niche sector, will immediately notice the great difference behind the concept itself.

In order to understand it in-depth, we are going to analyze two different use cases that have led to this evolution of thought.

The first is Synthetix, a decentralized protocol developed on the Ethereum blockchain used to create and issue synthetic assets. Compared to the other two, this is the one that comes closest to the traditional concept of derivatives, obviously adapted to the blockchain context.

Within the platform, it is possible to decide to invest on different assets, such as fiat currencies, indices, stocks and even crypto according to the positive or negative perspective that the user has on that market.

To create a synthetic asset, called Synth, it is sufficient to buy a certain amount of SNX, the native token of the platform that stands for Synthetix Network Token.

The value of the different SNX tokens is equivalent to and influenced by the underlying asset whose value is derived from the performance it has in the real world; this way real assets are transferred to the blockchain world.

The second project is Augur, a decentralized peer-to-peer platform created to facilitate the prediction of results related to different events of any kind.

Each user participating in the platform can initiate a vote on what will be the future outcome of a certain event through the creation of a “marketplace”.

The “marketplace” is, therefore, the representation of possible outcomes and its value derives from how many and with what total sum users buy shares of the above-mentioned event.

Since every vote can have a random fund, small or large, precisely since it is left to the complete discretion of the user, the prediction related to any type of event will never be accurate but rather, most of the time it will have a high probability of failure.

As can be observed, the two uses are very different and with opposite purposes, but there is one thing they have in common: they are not and will never be fully managed by a central authority, but they will always be controlled by all participants in the network with equivalent decision-making powers.