What is a Structured Product in the context of DeFi?
A Question of (DeFi)nitions
Structured Products refer to a basket of different financial instruments packaged into a single product. In traditional finance, this meant using other financial instruments like equities, interest rates, forex, indices, commodities, spot, derivatives, perpetuals and options as combinable lego pieces in order to achieve unique, non-traditional pay-offs. Structured Products are the most advanced financial instrument in traditional finance simply because they are an amalgamation of all the previous instruments.
However, there are a few important caveats to DeFi Structured Products that may confuse the majority of DeFi users.
- They are still much simpler than Structured Products in TradFi.
- Given this simplicity, there is no agreed-upon definition of crypto Structured Products (yet). Crypto Structured Products are often conflated with DeFi Options Vaults (DOVs). Research will tell you that DOVs are considered by many to be the first “DeFi” Structured Products. This is technically incorrect, and we’ll break down why in this article.
Before that, let’s go over a DeFi primitive that may be partially responsible for this confusion.
DeFi Vaults are catch-all terms that refer to Smart Contracts where you deposit and lock different cryptocurrency inside in exchange for returns. They are by far the most popular primitive in DeFi and almost all DeFi protocols have some version of a Vault that they use.
Here’s how they work -
You deposit crypto into a Vault, which is then pooled together with the deposits from other users inside that Vault. These vaults then execute a number of complex DeFi strategies in exchange for a small performance fee. DeFi Vaults are essentially automated asset-managers. Unlike asset management in traditional finance that comes with requirements to use, anyone can use DeFi vaults. They are permissionless — which is a large factor that makes them so commonplace in DeFi. The strategies implemented by Vaults can literally be anything that earns yield in DeFi.
Yield Aggregator Protocols like Beefy Finance are built on top of this DeFi Vault primitive. Beefy Finance is like ride-sharing for DeFi Yield: it pools funds into vaults that execute different yield strategies across DeFi protocols. By pooling funds, the protocols save on gas fees which also make it easier for the end-user.
The image below is an overview of Beefy’s sUSD/DAI/USDC/USDT Vault strategy:
As a user — you could execute all of the steps above yourself.
Or you could look for a Vault that distills all of the steps above into just a couple of mouse-clicks. Vaults save you time, research and the need to fully understand technical complexity. It is this philosophy of vaultfiying complex investments that Ribbon Finance used to build its DeFi Option Vaults.
DeFi Options Vaults (DOVs)
Options Trading is complex. You need to decide on a Strike Price (an agreed-upon price for the asset you can buy or sell it for in the future) and an expiry date. This is much more complex than setting limit orders and stop losses for Perpetual Trades.
DeFi Options Vaults acknowledges this complexity, so they abstract all the complicated aspects of Options Trading into “Deposit Yield ➔ Earn APY”.
Using Ribbon Finance as an example, their DeFi Options Vaults (DOVs) choose a strike price for you.
What about the expiry dates?
Every Friday of every week. The Vault then chooses a new strike price every week.
To oversimplify a typical DeFi Option Vault Strategy — they basically vaultify weekly automated Options Selling Strategies. In the case of a Covered Call Vault:
- If the Options expire out of the money, the Premium is paid back to the Vault (good for the depositors)
- If the Options expire in the money, the Premium is removed from the Vault.
There are many other DOV protocols that purport to be DeFi Structured Products that only use Options as an underlying asset. Some of these protocols offer downside protection by offering vaults that use Straddle and Strangle Option Strategies (delta-neutral Options strategies that bet on the upside and downside) — but this doesn’t change their reliance on a single asset class for success.
In contrast, let’s examine what an actual Structured Product from traditional finance might look like.
TradFi Structured Product: CPPI
A Constant Proportion Portfolio Principle Insurance (CPPI) is an early example of a principal-protected Structured Product. Let’s dive in conceptually.
Here’s what a CPPI is composed of:
1 risky asset that can liquidate you + 1 Bond that acts as a stop loss.
Here’s how it works (simplified):
- You invest $100 into a CPPI, with the expectation that your investment appreciates. For simplicity’s sake:
- 70% of this is allocated to the risky asset, and 30% is allocated to the bond.
- $90 will be your liquidation point.
- Your investment depreciates.
- Right when price hits $91, the Structured Product sells the entire risky-asset position to buy the bond — essentially converting your entire CPPI position into a bond.
- The bond then appreciates back to $100 by the time your maturity date rolls around.
- Instead of getting liquidated, you’re back with your initial investment of $100.
In this example, notice how financial instrument type A is used as a hedge against financial instrument type B.
By definition, Structured Products are composed of different asset classes packaged into a single product. They aren’t pre-packaged delta-neutral strategies that hedge using singular asset classes in a single vault — like Straddle and Strangle DOVs.
Is there a DeFi solution out there that truly allows the mixing of different DeFi asset classes within a single product for unparalleled flexibility?
Instead of offering pre-packaged Vault solutions, Struct offers the option to use different building blocks to customize the parameters of your investment. These building blocks are called Struct Primitives.
The first Struct Primitives that are launching revolve around interest rate products. There are two general classes to these primitives:
- Pre-Built — Interest Rate Tranches for end-users that want an experience similar to DeFi Vault protocols (“set and forget”).
- Customizable — More adept users can con(struct) their own Interest Rate Product using an interface called the Factory. These customized products can also be used by other users.
Our first primitives cater to both the user that values simplicity — and the builder that values customization. For the latter, the Factory is a permissionless avenue that allows Struct users to build their own (true) Structured Products.
But Interest Rate Products are only the first ingredients to be introduced into Struct.
Future Struct Primitives (and partnerships) will allow other asset classes like Options into the mix when using the Factory. This will allow users to both (i) use and (ii) build their own Structured Products using a variety of different asset classes in a permissionless manner — starting with the Introduction of Interest Rate Struct Primitives.
We’re giving you one lego block — or Struct Primitive — to build with at a time. In time, these primitives will enable the construction of true Structured Products in DeFi with their characteristic high level of customization.
To conclude, let us ask the following question:
What is a real DeFi Structured Product?
A protocol that vaultifies different DeFi financial instruments to achieve unique, non-traditional pay-offs in DeFi. This vision is our guiding star for the protocol.
In the next article, we’ll go over our Interest Rate Primitives and why they’ll be the next settlement layer (or base layer) for Interest Rate Products in DeFi.