Capital Efficiency

Capital Inefficiency

Segmenting Protocols by Instrument type is a bad idea ~ kills capital efficiency

  • Effectively ensure a lack of composability amongst DeFi derivative protocols, in stark contrast with the rest of the DeFi ecosystem like money markets, AMMs, liquid staking protocols, etc. Means no cross-margining & therefore loss of capital-efficiency
  • Impossible to delta-hedge — segmented DeFi protocols means one protocol is oblivious of a trader’s positions with other protocols.
  • Market makers need to use multiple protocols or even Centralized alternatives to hedge their trades, thereby making it harder for them to add liquidity to the exchange.

DeFi derivatives have no/worse cross-margining

  • The most important feature of a derivatives exchange is its margining system & risk engine. These collectively dictate the capital efficiency of trading on the exchange.
  • Capital efficiency is crucial because a highly capital-efficient exchange will allow market makers to add deeper liquidity with lower capital requirements and traders to trade with more finer levels.
  • It’s hard & extremely inefficient to open delta-neutral or delta-one positions in the first place and impossible to have them work together to achieve reduced margin requirements in current protocols.

Lack of multi-collateral support

  • Most DeFi derivative protocols only support USDC as collateral. Though this is slowly changing with Perpetual protocol and GMX adding support for more assets. In comparison, FTX supports multiple assets to be supplied as collateral with each contributing differently to its margining system.
  • Allowing multiple assets to be used as collateral in a derivatives exchange is important primarily because it unlocks liquidity for trading without sacrificing direct exposure to the collateral asset. This feature can even enable other protocols to build delta-neutral basis-trading mechanisms like UXD Protocol on Mango Markets.
  • However addition of different collaterals often compounds and adds additional risk to the system but we rely on using proper weights, limit position sizes and risk tiers to handle lack of efficient spot markets and manipulations.

Lack of a scalable settlement layer for DeFi Options & DOVs(DeFi Option Vaults)

DeFi options in general have struggled to gain traction and currently lag behind as compared to Option volumes in TradFi. Even the CeFi options market as it currently exists is primarily monopolised by deribit.