What are programmable derivatives?
A brief introduction to the next stage in the evolution of programmable money.
Last updated
A brief introduction to the next stage in the evolution of programmable money.
Last updated
The Ethereum ecosystem coined the term programmable money to concisely capture the evolution that smart contracts brought to cryptocurrency infrastructure that vastly increased the capabilities of the Ethereum blockchain over earlier blockchains like the Bitcoin network. Programmable derivative is a term coined by Plaza Finance to describe a similar leap in cryptocurrency and blockchain architecture that enables better-tailored financial products without the need to trust a centralized authority for transaction execution or custody.
Programmable derivatives are tokenized representations of structured asset vaults directly embedded in a blockchain. Any tokenized asset (like ETH, BTC, SOL, tokenized US treasuries, tokenized gold, and more) can serve as the foundational vault asset of a programmable derivative. The total return of that vault asset can be split into an infinite number of structures i.e. a bond, an option, leverage, and more. Once structures are created, users can permissionlessly mint and redeem tokenized representations of those structures, called programmable derivatives, on the blockchain. Owners of programmable derivatives can use these assets in any number of applications like exchanges, vaults, and more. Programmable derivatives are always redeemable for some portion of the vault assets, therefore unique structures inherit the liquidity of the vault asset.
Many decentralized exchanges are working towards the ability to trade any asset permissionlessly via fully synthetic contracts (perpetual futures). These fully synthetic markets have two major downsides: lack of composability and limited liquidity, both solved by programmable derivatives.
While it is theoretically possible to create a perpetual future for any asset, the users' exposure and assets are trapped in the exchange. Users must completely entrust the exchange with holding their funds, and they cannot use those assets for other purposes, like borrowing, lending, and depositing for yield and airdrop farming. Programmable derivatives allow users to create any structure, and use the tokenized representation of that structure for any purpose, even hiding those assets away in cold storage if they desire, which is not possible with perpetual futures.
Another limitation of perpetual futures is that the liquidity of the synthetic contract for an asset, like ETH, is limited to the synthetic contract's liquidity on the exchange venue. ETH spot liquidity is far deeper than any decentralized exchange's ETH perpetual futures liquidity. With ETH-based programmable derivatives, the liquidity of the structure is only limited by the liquidity of spot ETH, since all tokenized structures on ETH are redeemable back for ETH. Programmable derivatives are fully asset-backed, and not synthetic.
Programmable derivatives unlock new possibilities not previously seen in decentralized finance. Examples include a fully decentralized ETH-backed bond that pays coupons in USDC, liquidation-proof leverage on BTC with an attractive convexity profile, and many more. There is an infinite array of structures that can be created on any number of assets, all without increasing network complexity and congestion, and without sacrificing liquidity for users.
Plaza Finance is a cross-ecosystem hub for programmable derivatives, focused on delivering better financial products for everyone. To stay up to date on Plaza Finance and programmable derivatives, follow @plaza_finance.
