Look for benefits along the risk curve of a structured product

Kyle Liu, Investment Manager, Bing Ventures

*Reading guide: Over time, the crypto industry is developing its own structured products. Most of these products appear in the Decentralized Finance space, which means that investors utilize smart contracts to conduct investment strategies on their behalf without connecting to any centralized exchange. *

Decentralized Finance structured products are a new type of financial instrument based on Blockchain and Crypto Assets, similar to structured products in the traditional financial space. These products can be a combination of multiple crypto assets and derivatives with predefined maturity dates, different yield curves and return curves, such as capital protection products, yield enhancement products, and leveraged products. In the Defi space, structured products are mainly dominated by Options products. Unlike traditional structured products, the underlying asset of Defi structured products is Crypto Assets. This makes Defi structured products more flexible and innovative, but also exposed to higher risks and uncertainties.

Source: Bing Ventures

Decentralized Finance structured product trends

Decentralized Finance structured products provide investors with a simplified way to invest in crypto assets. The emergence of such products is due to the increasing complexity of the number of projects and benefits in the cryptoasset market, which necessitates the introduction of a more simplified way of investing. Decentralized Finance structured products are designed based on existing financial products and strategies, and innovated and improved with the help of technologies such as Blockchain and Smart Contracts. These products are typically based on DOV and PPV models.

DOV Mode

The first cryptographically structured products were in so-called Decentralized FinanceOptions libraries (DOVs). DOV (Decentralized Option Vaults) is an on-chain Options library where users can buy and sell Options. Users must lock Tokens in the vault to prevent their counterparty from deciding to exercise options to ensure that the vault is always fully funded. The initial strategy that DOV runs is a simple call put option strategy, but investors are still exposed to the risk of a decline in the value of ETH itself. The development direction of the DOV protocol is to provide more advanced financial Derivatives, and eventually develop into a complete solution for private banking products.

PPV Mode

Principal Protected Vaults can be understood as a principal-protected investment vehicle, similar to structured products in traditional financial markets. The way it works is based on Smart Contract, which provides users with a low-risk investment opportunity while guaranteeing the safety of their investment principal. The basic structure of Principal Protected Vaults consists of three parts: collateral, asset lock-up, and margin. Users can purchase this investment vehicle by depositing Crypto Assets or other digital assets as collateral. These Crypto Assets or digital assets will be locked in a Smart Contract until the contract expires. In the process of asset locking, users can obtain certain returns, and Margin is used to protect the safety of the investment principal.

Products with the theme of “Principal Protected Vaults” are attracting attention. Principal-Protection Vaults are an extension of the DOV problem and promise to be the next innovation point, providing risk-averse investors with some ways to generate low risk and high returns. Although these products protect investors’ principal to a certain extent, there are still certain risks, especially the Exchange Rate risk for Stable Coins. In addition, the revenue of these products is mainly derived from governance Token rewards, and increasing the rewards of governance Tokens may help increase yields, but this yield is limited.

Source: DefLlama

The future evolution of structured products

As the crypto asset market grows, so does the number and types of Decentralized Finance structured products. These products are designed to provide investors with a more streamlined way to invest and attract more people to invest in crypto assets. DOV and PPV are currently the most common Decentralized Finance structured products, which are based on existing financial products and strategies and improved using technologies such as Blockchain and Smart Contracts. Although there are some problems with DOV, with the development of the market and the advancement of technology, the future of Decentralized Finance structured products will be more diversified and innovative. We believe that Defi structured products will evolve in the following directions:

More Popular

With the continuous expansion of the Decentralized Finance market and the growth of the number of users, Decentralized Finance structured products will receive more and more attention and recognition from investors. In the future, such products will become more popular and become one of the important tools for investors to conduct asset allocation and Risk Management. In the future, such products will cover more categories, more fields, and provide different types of services for different types of investors. For example, in the lending space, there may be more types and forms of lending protocols in the future, and in the trading space, there may be more types and forms of trading strategies.

With the intensification of market competition, Decentralized Finance structured products will become more specialized, such as liquidity staking, synthetic assets, etc. In the future, such products will require a higher level of technology and expertise to meet investors’ needs for risk control and yield optimization. For example, in the field of quantitative trading, more trading strategies based on machine learning and artificial intelligence technologies may emerge in the future.

Tranched Lending

Tranched Lending is an important form of Defi structured products. This is an investment vehicle that cuts a debt investment opportunity into different parts, each with its own risk/reward ratio. Investors can choose from different investment segments to capture different risks and returns. For example, in Tranched Lending, investors can earn a more stable return by investing in a higher tier of debt, while also earning a higher return by investing in a lower tier of debt. This form of product is very popular in traditional financial markets.

However, the demand for the higher-tier debt segment in the Defi market is not very large at the moment, which makes the return on the lower-tier debt segment relatively low. However, it also provides an opportunity for institutional investors to enter the Defi market. With the continuous development of technology and the continuous maturity of the market, Defi structured products will become an important means for institutional investors to enter the Defi market.

Sustainable Revenue Generation Opportunity

Yield generation opportunities in the Defi ecosystem are gradually becoming more sustainable. Obtaining stable returns by providing financial insurance or providing capital to borrowers has become an important form of Defi structured products. In the future, Defi structured products will focus more on providing valuable products and services to better meet the needs of users and achieve the sustainable development of the Defi ecosystem.

Capital preservation is very important in Decentralized Finance structured products. There is a growing demand for products that can be traded and invested in a decentralization environment. More and more Defi structured products provide users with a safe, efficient, and transparent way to invest by leveraging external Decentralized Finance protocols to provide underlying income and create Derivatives structures using an on-chain/off-chain hybrid approach.

Source: STFX

With the rapid development of the Decentralized Finance industry, we believe that excellent Decentralized Finance structured products in the future need to have the following characteristics to adapt to the evolution direction of the industry:

• Decentralized Finance structured products should have a more attractive rate of return. Structured product designers need to have a deep understanding of the Decentralized Finance industry and use disciplined investment strategies to effectively capture industry trends and obtain better ROI.
• Decentralized Finance structured products should be able to provide a rich and diverse asset allocation. Future Decentralized Finance structured products should cover assets in major sectors of the industry and be able to adjust asset allocation in a timely manner according to market changes to ensure diversity and flexibility of asset portfolios. In addition, consider adding some non-standardized asset types to broaden the range of market participants.
• Decentralized Finance structured products should be able to offer a relatively low level of risk. Structured products should use scientific risk control methods to drop the risk level of the entire product portfolio to ensure product stability.
• Decentralized Finance structured products should be able to meet different customer needs. Future Decentralized Finance structured products should offer different investment thresholds and different income levels to meet the needs of institutional and professional investors. At the same time, product flexibility and customizability are also one of the important features of excellent Decentralized Finance structured products in the future.
• Future Decentralized Finance structured products need to be better integrated into the traditional financial system. Strengthening the risk control of Decentralized Finance products, such as strengthening compliance review, establishing risk control systems, and strengthening fund security management, can effectively improve the stability of Decentralized Finance products and better serve institutions and professional investors.