Oct 14, 2022
STRUCT: Derivatives and the importance of Structured Products
Finance is, fundamentally, about the movement, allocation, and pricing of money and risk throughout the economy. And derivatives are a crucial component of the global financial system. Financial systems are made up of financial markets, and financial markets are all about managing risk. Derivatives are financial instruments that allow market participants to easily manage their risk at a granular level by limiting potential losses without significantly sacrificing potential returns. In this article, we will be focusing on Structured Products, which are pre-packaged investments that normally include assets linked to interest plus one or more derivatives.
The value of Structured Products stems from its ability to mold a risk-return profile that is in line with the needs of investors. It does this by combining the risk profile of different instruments or restructuring the instrument itself. The resulting product, and the investment it represents, other than being closely aligned to what investors want, whether it is to reduce overall risk, or increase the possibility of investments bringing a successful return.
The Market for Structured Products
The derivatives market in DeFi has seen rapid adoption throughout the past year — irrespective of the challenging conditions that the markets are experiencing. Structured Products are, in fact, a natural evolution for the space in the current environment, as these sophisticated products are tailored to varying investors’ risk tolerance. They achieve this through the combination of derivatives such as interest-rate products and options. They now represent a $7T market in traditional finance.
Structured Products have recently started gaining traction in DeFi, with Options Vaults forming the bulk of the total value locked in the $700M DeFi options market at the start of 2022. The size of this market tells us that most DeFi investors require derivatives to be packaged into something that is catered to their risk tolerance, and is easy and seamless for them to use. We see this trend continuing, with the market for Structured Products growing as the derivatives markets grow.
The need for more Structured Products in DeFi
The value that Structured Products bring to DeFi are threefold:
- For investors, Structured Products package derivatives that are otherwise complex to utilize into easy-to-use investments
- The ecosystem as a whole benefits since it generates demand for underlying derivatives and assets. This in turn increasing liquidity and indirectly strengthens the ecosystem.
- Derivatives, on the other hand, help with both price discovery, and risk management. This enables traders to be more capital efficient.
Stakeholders now
There are two main stakeholders in the derivatives and Structured Products market.
Firstly, we have retail DeFi investors. These are users that know how to navigate different DeFi ecosystems and understand how to interact with different protocols. However, despite this knowledge, most of these users do not have the time or the expertise to use derivatives in their portfolios.
Secondly, we have sophisticated traders and investors that understand how to capture opportunities and hedge away their risks using complex instruments. These individuals usually act on the behalf of institutions and capture these opportunities at the intersection of CeFi and DeFi.
Both of these types of customers have needs that are simply not met by existing tools available. High barriers to entry, volume restrictions, a lack of custom products and the necessity to adhere to the parameters of protocols have created a need in the derivatives market to innovate — and open up derivatives to a far wider audience.
Where Struct comes in
Struct increases the volume and variety of products available to customers and provides stronger matching of products to customer profiles, all while keeping products simple to understand and navigate.
On this point; Struct sits right at the intersection of retail and institutional customers, enabling them to utilize the Struct platform to structure, source, and discover investment products and instruments tailored specifically to their needs.
Interest Rate Tranches
Struct enables retail DeFi Investors who are uncertain where to invest their capital, to achieve better/sustainable yield that matches their risk-return profile. Unlike others in the DeFi space, Struct is able to provide both settlement and composable layers for Structured Products. We achieve this by tranching/splitting the underlying yield position to offer fixed returns to risk-averse investors and offer variable returns for the risk-loving ones. This both widens the choice available to investors, and contributes to the size of the DeFi derivatives market.
For crypto-native institutions that face challenges to create competitive financial products, Struct offers a better way to invest. The settlement and composable layers provided by Structured Products are, for institutions, significant and powerful differentiators to Struct’s offering through tranching underlying positions. This enables the offering of both fixed and variable yield instruments.
To sum up, Struct’s short-term objective is to broaden the design space of financial products on DeFi by increasing the number of instruments available in the ecosystem, designing and implementing Structured Products, and creating the tools for the ecosystem to structure their own financial products. Our platform puts significantly more control into the hands of both retail and institutional customers in the derivatives market, making a complex system of financial offerings easier and faster to navigate. The same benefits apply to professional market participants, such as traders, banks, and investment firms, that want to offset or “hedge” risks to cater for unforeseen events such as high price volatility.
