In an article published in 1945, Friedrich Hayek pointed out a centrally planned economy would never beat the efficiency of a decentralized economy. Knowledge is unevenly dispersed among different members of society and a single agent only holds a small fraction of the total knowledge. As a result, decisions are best made by those with local knowledge rather than by a central authority.

What if individuals have their own opinions? What if people may get rewarded when their opinions are correct? Will the market gather more wisdom? Will it help us make a better decision?

Blockchain technology enables it and we see that even before the hype of DeFi, projects in the field of prediction markets such as Veil and Augur have attracted huge attention.

In this article, we will analyze pain points of the current prediction platforms, discuss the attempts that ambitious teams have been working on, and explore the future investment opportunities.

TL;DR

1. Crypto prediction market has managed to attract large numbers of betting products even though currently, it is only a small market with 0.08% total value locked in the DeFi field.

2. While the Scalability Trilemma exists in the broad blockchain industry, **there is also a dilemma between liquidity and compliance in the prediction market. *To achieve high liquidity, one most common way is to introduce more entertained scenarios. This leads to application scenarios like betting or gambling, which are unfortunately strictly regulated in different jurisdictions. *Liquidity remains still as an obstacle.

3. Our thoughts:

· The prediction market is still at its early stage and has the potential to capture the mass market for greater usage. We believe a financially-attractive decentralized protocol with a friendly user interface will be designed shortly.

· Automated tool providers are in urging need. As most players are focusing on improving protocols, UI/UX and value-added tools have been heavily ignored.

· Products dealing with insurance or hedging might be a killer use case in the prediction market. The market that insurance giants are hesitating to cover due to compliance and jurisdiction, is a ~250 billion US dollar market (total market cap of cryptos as at 19 Jan 2020).

Major pain points

All prediction platforms share a few problems in common: Small user base in the crypto world→low volume (even the biggest player Augur)→low liquidity→bad user experience→even smaller user base. Liquidity is hard to improve due to long resolution time, high learning cost, unattractive profit, and the trade-off between compliance and liquidity. These pain points impede the large-scale usage of the prediction market. Currently, it has less than 0.1% total value locked in the DeFi field (source: Defipulse).

First, compared to centralized platforms, which have almost instant resolution time (including derivatives exchanges and online betting), decentralized ones rely on crowd decision systems to find an honest result or a result that at least majority agree, and hence it is time-consuming. However, this pain point seems to have been gradually solved. For example, Augur’s V2.0 will cut resolution time from at least 7 days to around 24 hours.

Second, the learning cost is super high. Non-crypto users, who understand the technical theory behind the prediction market and how to bet on those platforms, prefer fiat currency. Let’s picture how complex and expensive for them: users need to learn how to convert fiat money into multiple cryptocurrencies to participate, which cost money (transaction fee), complex (download wallet, log in exchange, buy crypto, etc.) and not fun (due to some terribly-designed applications). This would definitely prevent new users from entering crypto applications. For crypto users, the learning cost might still be high as users need to learn how to create a valid market, how to use the tokens and all different mechanisms behind the oracles. The market creation is highly non-standardized and impedes its large scale. Fortunately, we do see some promising projects notice it and are trying to improve this feature such as Veil (failed sadly) and Guesser. They build on Augur and positioned themselves to provide better user interface and services.

Third, the financial incentive is not attractive considering the cost. We can see a low return model through the Augur’s example. Market creators need to stake ETH (or Dai in V2.0) to create a market and stake REP to designate a reporter, which will be returned with no bonus/interest if the market creator did everything correctly. The only return for them are fees on settlement volume, which is the creator fee in ETH, typically in the range of 0–5% determined by the market creator. On the other hand, a market creator has a lot of costs to bear: the opportunity cost of staking ETH and REP, a mandatory initial liquidity cost, and the learning cost we mentioned above. Overall, we think oracles with better-designed incentive mechanisms could help the prediction market attract more attention.

Finally, there is a dilemma between compliance and liquidity. Veil (owned by a Cayman Island company) which built on Augur and 0x provided instant settlement for traders before resolution by acting as the counterparty. This feature improved liquidity and user experience while drew the attention to authorities and eventually make itself sunset. Just as the Scalability Trilemma existing in the blockchain industry, in the prediction market, there is a dilemma between liquidity and compliance. The less decentralized the platform is, the higher risk it may face. Centralized platforms that allow real money play is strictly banned. ***In the crypto world, the regulation risk is getting high with centralized attempts such as off-chain resolution or act as counterparty to provide liquidity. ***On the other hand, projects try to provide more entertained scenarios to attract users for the ultimate goal of gaining liquidity. However, the current traction pool gathers most users who have been betting and gambling, which is strictly regulated in different jurisdictions. Even projects like Gnosis received a license from Gibraltar, is still prevented from touching a few related scenarios.

Project briefing

Let’s dive in:

1. Prediction Market Oracle/Protocol: Augur, Gnosis, Stox, Flux, and Bodhi. A lot is happening in this sector.

· Augur is the first decentralized prediction market built on Ethereum that allows users to create and trade outcomes of events in any category. It conducts a fully decentralized oracle from market creation to resolution and as a result, it inevitably leads to long resolution time. It is no surprise that its V2.0 will have to cut resolution time from at least 7 days to around 24 hours to improve user experience. The Augur team will integrate 0x to allow partially off-chain trading so that people can create, modify, and cancel orders faster and cost less. Maker will also be integrated to allow Dai as collateral token and trading token in an event.

· Gnosis will launch its prediction platform in 2020 soon. The project has big ambitions to establish a prediction ecosystem for greater use. It has multiple products pipeline such as a trading DEX-DutchX, an ERC-20 wallet-Gnosis SAFE and its multisig wallet. The major difference of its oracle compared with Augur is its centralized resolution- a default centralized Oracle for judging prediction results.

· Stox is a product of a CFD trading brokerage. The platform uses its own token STX as collateral token and wagering token. It uses a centralized oracle for resolution with a decentralized dispute mechanism. Unlike Augur and Gnosis, it mainly attracts centralized market creators such as invest.com to operate markets. However, having a consortium of centralized providers means that Stox is not technically censorship-resistant as those providers are easily shut down by authorities.

· Flux is an early-stage project and it will soon launch its Alpha version. It is built on NEAR protocol for scalable transactions and has data driven tiered oracle for an instant resolution which can be between 30 mins to 24 hours as the team claimed. Furthermore, their solution for solving liquidity problems besides having chosen a scalable blockchain is to have a standardized market making API for use by traditional and blockchain based centralized market makers.

· Bodhi aims to provide a prediction market platform for Chinese users.** In contrast to Augur, Bodhi uses third-party Oracle to automatically judge the prediction results. Different from Gnosis’ centralized Oracle solution, Bodhi enables BOT holders to take over the voting process and make the final decision of a prediction event in the event of Oracle failure. Similar to Stox, it also employs a single token model to pay fees, post collateral, and serves as the currency used for wagering.

2. User Interface/Service: Veil (failed) and Guesser

· Veil built on top of Augur and using 0x to speed up trading and settlement. Launched in January 2019, Veil announced the suspension of the company in July 2019. The Co-founder, Paul Fletcher-Hill attributes a difficult onboarding experience to its “failure”. The code, however, continued to be open-sourced and they have done a great job for improved user experience.

· Same as Veil, Guesser is an application built on top of Augur and they optimized user experience. They aim to build an open prediction platform for non-technical users. Apart from UI/UX improvements, they are providing bet indicators on events, advanced filters by subtopic, a probability chart and prediction list and a bunch of package tools for users.

3. Prediction Market for Insurance

· Although the most obvious use cases for prediction markets are gambling and betting, we believe both insurance and hedging have huge potential. For example, Companies heavily exposed to a particular type of natural disaster (i.e. earthquakes, hurricanes, or wildfires) could buy shares in the outcome “yes”. People can use prediction markets to hedge their positions to limit their downside.

· Decentralized insurance solution could cut 18% cost (i.e., human cost and operational expenses) in the traditional insurance market according to Nexus Mutual (Nexus Mutual is a decentralized insurance platform). In addition to the cost saved, decentralized insurance could enhance flexibility with customized insurance products available. Big traditional insurers are hesitating to provide crypto insurance due to compliance concerns and high volatility of crypto value. Therefore, we haven’t seen large amounts of complex products especially for hedging purposes yet. This gap is captured by projects such as Upshot and Opyn. Opyn introduces an insurance and hedging instrument that protects against both technical and financial risks that threaten users of DeFi.

· However, just as the prediction market, it is suffered from an unattracted profit and low liquidity. Take Upshot as an example, to obtain the premium, the counterparty must be fully-collateralized, which means collateralizing the equivalent amount of what policyholders’ insurance contract covering. The full-collateralization for a relatively low insurance premium means a low return, which is unattractive for counterparties and could lead to low liquidity.

Insights for the future

A prediction market is deployed whenever we want to know the market and to discover what people truly believe. Through the token economy, the best prediction gets rewarded and further incentivized to make better decisions.

Projects that provide valid solutions solving current market pain points deserve more attention. We believe there are three potential investment opportunities.

1. The prediction market is still at its early stage; yet has the potential to capture the mass market for greater usage. We believe financially attractive decentralized protocol with a friendly user interface would be designed in the near future. ***Currently, the prediction market has only 0.08% total value locked dominance in the whole DeFi field, while Maker accounts for ~50%. Augur as the first player is upgrading itself by cutting resolution time and improving user experience. Prediction market as one of the earliest and promising DeFi applications, there is still huge potential to be discovered. Also, the protocol layer might be less risky in terms of legal regulations as it does not interact with end users much. That’s why we are looking more at protocols in this field. But even with protocols, projects need to consider its business model with public chains and DApps, and most importantly, its monetary incentive for users. How to charge when others deploy your protocol? How to attract users to increase trading volume? How to incentivize users to stay?

2. The prediction market to attract crypto and traditional users will need robust UI/UX and useful automated tool providers. As most players are focusing on improving protocols itself, UI/UX and value-added tools are heavily ignored. Obviously, the market still needs more education, but current platforms do not make it easier for junior users to get started and the learning cost is high as well. The traditional potential customer base is huge. For the political prediction market, about US$277 million was traded on the 2016 U.S. presidential elections on Betfair. For illicit betting, a Wired article published in 2018 claims that the size of wagers in illicit sports betting alone ranges from US$80b to $150b annually. For insurance, an article of Coindesk in 2018 estimated the total amount of coverage is willing to provide to crypto custodians and exchanges at around US$6 billion. We think projects that focus on these details can be a large-scale user entrance. Efficiency, resolution time and liquidity still remain as major obstacles in the prediction market. We are expected to see more innovative methodologies to conquer the difficulties mentioned.

3. Regarding a more specific field, we see products dealing with insurance & hedging could be a killer DApp in the prediction market. ***Needless to say the huge market potential, decentralized insurance gonna bring flexibility and customization to contribute to the open economy. We believe there will be more complex financial instruments that appear as DeFi matures and prediction platforms can be a suitable environment where especially insurance & hedging products receive attraction.

References

1. Prediction markets by Circle Research

2. Content Review: Augur, Veil and Decentralised Prediction Markets by Anthony Faccenda

3. https://www.theblockcrypto.com/linked/47176/bitfinex-to-make-foray-into-prediction-markets

4. Crunchbase

5. The Ultimate Guide to Prediction Markets by Cultivate Labs

6. http://blog.oddhead.com/2006/10/30/implementing-hansons-market-maker/

7. All websites of projects mentioned above

8. Augur Protocol Overlays: Veil and Guesser. Prediction Markets Made Easy by MARTIN BANOV

9. https://zhuanlan.zhihu.com/p/37205364

10. Nexus Mutual white paper

11. Friedrich Hayek (September 1945). “The Use of Knowledge in Society” (PDF).

12. https://www.coindesk.com/crypto-prediction-market-and-derivatives-platform-veil-is-shutting-down

13. https://www.paddypowerbetfair.com/\~/media/Files/P/Paddy-Power-Betfair/documents/annual-report-2016.pdf

Background

bZx’s Flashloan attack event has sparked wide discussions across DeFi industry recently. This all began with a new DeFi primitive enabling uncollateralized loans: Flashloan, which allows you to get uncollateralized loans when your operations guarantee it will be repaid in 13–15 seconds (Almost free if you pay it back in the same one transaction ).

In this article, we share our thoughts on the flash loan-related facts, its impact and how this will change the whole DeFi world.

Flashloan

Flashloan was first implemented on Aave Protocol and it allows users to borrow from the reserves within a single transaction (i.e., within one block), as long as the user returns more liquidity that has been taken.

Aave is not the first one to bring this concept up. In 2018, Marble protocol introduced a flash lending concept which is exactly the same idea that enables borrow and payback within the same transaction.

Uniflash, a flash loan project developed recently by Cheng Wang (founder of sharding project @Alephium), is a Uniswap-like simple tool and shares all the fees to the lenders. Aave’s flash loan charges interest rate of 0.09% per loan.

DeFi lending protocols are in general built upon over-collateralization with a haircut rate of around 25% to 50%, which means that for every unit of collateral posted, only 50% to 75 % of the credit will be given. While providing the necessary safety of the system, over-collateralization introduces further inefficiency. We believe that a low collateralization rate will be the future of DeFi and find flash loans innovative. With flash loans, borrowers can take advantage of 100% undercollateralized loans with interest rates as low as 0.09% per flash loan, compared with a 30-day average borrow rate on dydx’s 125% collateralized ETH loans, which is ~ 0.45% annually (or ~0.0012% daily). (source: defirate.com as of Feb 24, 2020)

Note that flash loan cannot be freely deployed on every lending liquidity pool and it is functional only when the lending protocol supports this feature. For example, the Fulcrum team released the flash loan feature on the Ethereum Mainnet on Jan 11, 2020. Aave and dydx also support this feature.

The attacks

There are two successful attacks up to now. The attacks happened simultaneously across multiple protocols: Compound, dYdX, Uniswap. And we find some interesting facts:

· Return on Capital (17% for the first and 54% for the second) is pretty high considering only within several seconds.

· In the second attack, the attack’s profit takes 88% of the total loss compared to the first one’s 50%.

· bZx is the only one suffering from these two attacks. The first attack left a bankruptcy position and the second one left an undercollateralized loan.

Note our conclusions were calculated based on our assumptions. It is for analysis purposes only and shall not be treated as the truth.

There are three aspects worth being looked into and are elaborated below respectively.

Firstly, collateralized loan provider (i,e, Compound) was not a victim in the first attack, while it was in the second attack(i,e, bZx). It is because the Compound’s collateral was ETH, while bZx’s was sUSD, the one being pumped.

Secondly, the ways of pumping and dumping worth to be compared. A successful attack is “buy low, pump to the high and dump high”. Attack 1&2 “buy low” through collateralized loan-borrowed WBTC and Synthetix system-mint sUSD at a fair price; they “pump high” through bZx margin trade and direct Dex swap, both taking advantage of Dex’s low liquidity; they “dump high” through Dex swap and collateralized loan-borrowed ETH and left the position open to liquidation, respectively.

Lastly, attack 1 took away ~1,171ETH out of bZx’s total lost ~2,320ETH with ~1,149ETH residual profit for the Dex’s market makers, representing a 50% profit to loss ratio. Attack 2 managed to get ~2,378ETH out of the total lost ~2,696ETH, representing an 88% profit to loss ratio. Note the first attack had 6,800ETH in use while the second is 4,418ETH. The second attack is more successful in regards to higher capital efficiency.

Future

DeFi lending is normally overcollateralized as the anonymity of blockchains, which brings low capital efficiency. There are some attempts to lessen the LTV ratio (Loan to Value) such as credit scoring tool. Basically, the logic here is to lower the counterparty risk (~the possibility that the principal and interest will not be paid back) as much as possible. Flashloan as an example makes it possible and remains only system risk.

The attacks have raised many discussions. People questioned DeFi infrastructure such as oracles. However, even perfect oracles cannot avoid this kind of market manipulation attack. It exists already in the traditional financial market and it will continue to exist because the price can always be manipulated by whales. We think the flash loan is a good start. It brings leverage impact to DeFi that every 15 seconds the collaterals can be borrowed out once. In other words, the velocity of money is 1 for ~15 seconds, while the velocity of US M2 money was around 1.4 for a quarter (Source: https://fred.stlouisfed.org/series/M2V).

The idea of flash loans has the potential to be evolved further and areas below might be restructured.

· A costless decentralized futures exchange. Fees for margin trading can be much lower as the borrowed money must be paid back. A low-risk premium is possible. Centralized futures exchanges may face more competition when safer and costless decentralized derivatives exchange finally appear.

· To C financial product. Flashloan is not designed for everyone but for people who understand solidity. However, it is not impossible to make it available to the end-users. For example, aggregation platforms and user-friendly tools such as Zerion may deploy flash loan and allow users to do a one-click collateral swap and refinancing. Furthermore, high-frequency arbitrage trading strategies could be developed by professionals and create a market to sell the strategies on Set protocol.

· Insurance. Nexus Mutual paid out two claims worth~$31k after the attacks, which proved the system works. Since the attack is not unusual in traditional financial history and DeFi is still in an early stage, we believe asset protection in the form of cryptocurrency insurance is creating a huge demand.

· DAO. DAOs become vulnerable as the voting tokens can be borrowed almost without cost. It creates a possibility to act badly intervening system’s security.

· DeFi or CeFi. bZx used their admin key to stream interest and exit liquidity with the $600K of wBTC left by the arbitrager as collateral after the attack. So, is it after all DeFi at all or a CeFi indeed? Admin key means that the team has still the possibility to take away all the money collateralized by users, while the ultimate goal of DeFi is to eliminate a central party.

Part 1: NFT has the potential to become the most scalable blockchain application

Whether it is for a game item or a piece of art, NFT can help achieve the leap from the physical to the digital world. From the works of digital artists to the highlights of professional athletes to the collectibles in video games, more and more attention is drawn to different applications of NFTs. For example, Christie’s began to auction NFT artworks; the NBA cooperated with Dapper Labs to launch Top Shot; Disney and even Taco Bell are launching peripheral collectibles in NFT. Nevertheless, the issuance of NFT is not limited to professionals with a large fan base. Nowadays, average users are gradually getting more access to mint various forms of data files into permissionless and programmable NFTs and distribute them on platforms to be discovered and freely traded.

The hype surrounding NFT has been hard to ignore

With NBA Top Shot launching public beta in August last year, under the influence of its franchise, NFT market quickly broke out. According to CoinGecko, as of June 10, 2021, the total market value of NFT has exceeded 17 billion dollars, which is about 1% of the market value of the entire crypto market. Before then, the market was almost negligible. According to Nonfungible.com, NFT market transactions in the first quarter of 2021 reached their all-time high, and in the first week of May, recorded a volume of 173 million dollars. Although the current NFT market is showing a slight decline, it remains a track that cannot be ignored by investors.

The following picture introduces several noteworthy transactions in the NFT market. The first two were created by graphic designer Beeple, which recorded the highest and fourth-highest sales in market history. The creator of the third piece, Stay Free, was Edward Snowden himself, who subsequently donated all proceeds from the auction to the Freedom of the Press Foundation. The fourth piece, NYAN CAT, is taken from a video that swept the Internet ten years ago and then derived into projects such as video games and cryptos, symbolizing the vitality of streaming media in the digital world.

NFT is fueling the digitalization trend triggered by COVID-19

Covid has forced traditional business models to shift from offline to online, and people are unprecedently engaging with the Internet. For example, art collections and auctions have always revolved around offline exhibitions, physical delivery, etc. The empowerment of blockchain may profoundly change the industry in the following ways: a) Traceability and transparency on the chain, authenticity verification, and resolution of trust issues；b) Non-physical delivery, which noticeably grew during the pandemic. For instance, sports cards can be directly and conveniently stored in digital wallets；c) Improvement on the liquidity of transactions on collectibles；d) Lower barriers of entry, making it easier for creators and their works to be discovered by investors.

As a bridging tool between the physical and digital world, NFT’s core lies in tokenizing the unique values of certain assets. Before then, there was only FT, which only represented undifferentiated value, and NFT further expanded the types and usages of digital assets on blockchain.

While the pandemic is driving traditional industries to become more online and digital, we believe that NFTs can empower these industries to become more efficient.

Part 2: We are experiencing the transition from creating NFT, using NFT, to socializing with NFT

Looking back at NFT’s market history, each bull market was led by its representative project. In the first bull market, Colored Coin (BitcoinX) caught people’s eyes. Colored Coins can mark a variety of unique assets, similar to putting a line on a dollar bill with the message “can be exchanged for 1 share of Tesla”. This attempt allowed more people to understand the possibilities of blockchain other than ledger transactions. By the second bull market, the outbreak of CryptoKitties caused serious congestion on Ethereum, marking NFT’s first entrance to the public view. At that time, CryptoKitties had nearly 20,000 users and recorded 40 million dollars worth of transactions. The most expensive kitten, “Dragon,” was sold for 600 ETH (equivalent to 170,000 US dollars at the time). In the third bull run that we had just gone through, NBA Top Shot was the leading project that attracted users outside of the crypto space, and it now has more than 1 million registered accounts[1] and total sales of more than 600 million U.S. dollars. From the past vicissitudes of bulls and bears, NFT has gone from 0 to 17 billion in market value, and its market focus shifted from the creation of NFT (Colored Bitcoin, crypto cat) to the usage of NFT (NBA Top Shot).

We believe that the next break-out point for NFTs will be social platforms.

Firstly, NFT-based social platforms provide an outlet for NFT owners to display and show off. Whether you are a speculator or an investor, there is a need for a platform that provides collection display and price discovery.** **In our current social environment, Proof of Passion provides a channel for people to exchange perspectives and share inspirations. These proofs can be a work of art, a pair of limited-edition sneakers, or a record; In 1961, Keith Richards reunited with Mick Jagger at a train station in Dartford, England. Keith recognized the Chess record that Jagger was carrying, and the two started talking on the station platform. A few years later, the two of them formed the Rolling Stones, and together became the most influential pair of music creators in our music history. Nowadays, people are accustomed to listening to music on streaming platforms and keeping their collections of artworks at home. The arrival of NFT makes it easier for them to handily present and share these valuable proofs of passion in a digital form.

Secondly, NFT’s incentives can further stimulate the originality of social media content, encouraging creators to provide more authentic and valuable content and ultimately enhance the value of the platform itself. We compare several commonly used social methods based on their essential elements. The elements are as follows:

Number of contacts

Speed and frequency of connections(velocity)

Unique and authentic content

Thirdly, social platforms provide content creators with free promotion and sharing channels, lower barriers for creators to display and establish more direct and transparent communication between creators and fans. For creators, they can publish project-related NFTs on social platforms to raise funds, and these “project tokens” will also appreciate along with the portfolio. On top of that, the tokens can be used as proof of passion for patrons and collectors to display on social platforms. Instagram and Twitter are the representatives of the current centralized social platforms. They encourage users to convey and share information using simple text and images while reaching sub-communities with the help of their precise algorithms to recommend content tailored towards their passion. As for NFT social, we believe that the opportunity lies in the platform that allows users to share and engage with proof of passion easily, provides accurate NFT content and price discovery, and properly designs community tokens.

Right now, the utility of NFT is only a piece of the puzzle, and we can only grasp the actual value of NFTs until we put every piece together. As of June 10, 10 of the top 15 NFT projects are on the Ethereum network based on total historical sales[2]. In terms of trading platforms, OpenSea has the highest historical total transaction volume of more than $500 million[3]. In terms of applications, there are only two projects with a total transaction volume of more than 100 million dollars: the star project NBA Top Shot on Flow, which ranks first in historical transaction volume, reached 600 million dollars; The other is CryptoPunks, which has a total transaction volume of more than $300 million. It can be concluded that the currently successful NFT projects mainly focus on two sectors: resources-intensive with solid IPs (real-world assets) and encrypted, unique collectibles (on-chain assets).

Part 3: Investment Opportunities in the NFT Field

As for now, the development of NFTs is still in its early stage, and major projects are concentrated around games and artworks. We dissect our focus into the following directions:

Infrastructure: token standards for NFT.

Platforms: NFT minting, NFT searching, NFT social networking, and highly valued IPs;

Applications: DeFi with NFT as an underlying asset, and new composability with NFT as a value representation form.

We have selected several key sub-tracks as follows.

Infrastructure opportunity: Token standards for NFT

The token standards are deployed on the public chain, which limit the scalability of the upper-layer NFT applications. ERC-721 is the most stringent NFT standard that each smart contract corresponds to only one NFT. It cannot define the FT part of the game, where could have 1000 pieces of fungible armor. ERC-1155 solves this problem by allowing smart contracts to represent a collection of NFTs and FTs, but the disadvantage is that it cannot track the information of a single asset in the collection.

The composability of NFT also largely depends on the underlying protocol: ERC-998 allows any NFT to own other NFTs or FTs such as multiple ERC-721 and ERC-20 tokens; Fractional[4] is a project that aims to split the ownership of the NFT and convert it into FT to improve liquidity; the RMRK project is trying to build a cross-chain NFT standard on Kusama.

There are also other attempts to explore NFT usage in specific scenarios, such as EIP-2615 is trying to extend NFT to support rental and mortgage functions; EIP-1523 is trying to build a standard interface for insurance policies, based on ERC 721; EIP-2981 is trying to enable universal support for royalty payments in all NFT marketplaces.

In summary, each protocol has its own advantages and disadvantages. Since ERC-721 appeared earlier, it has become the protocol with the lowest trial and error cost and is widely used. From the perspective of requirements, the underlying protocol needs to be open (developer-friendly and less restrictive), composability (interoperability), integrality, and so on.

Platform opportunity: NFT minting

As for now, tokenization and creating NFT are still limited to elite artists. We need to ensure the integrity of the dynamic metadata by tradeoff, whether to save it on-chain or off-chain.

Firstly, most of the NFT minting platforms are only open to a small number of artists, such as MakersPlace and SuperRare, and the authorizing criteria are not transparent. Because the platform itself needs traffic, it might be biased towards artists with an established audience. According to the recent analysis[5] of NFT researcher Kimberly Parker, 65% of NFT sales prices are less than $300. Considering that current gas fees are high, there is little profit to make, and only a few well-known artists such as Beeple were truly profited among all the authorized artists.

Secondly, there is a lack of complete database and ownership verification on current platforms. Creators only need to fill out a series of questionnaires[6] and check the originality of the piece to upload their works on chain.

Finally, most of the underlying assets for NFT are off-chain, and the extent to which NFT can fully represent these off-chain assets depends on its data storage method. For example, Aavegotchi can store all media and metadata completely on the chain; Mintbase[7] uses a combination of Ethereum and Arweave to mint NFT；SuperRare uses IPFS to store files metadata.

Application opportunity: NFT + DeFi

Currently, DeFi’s mainstream applications, such as lending and dex protocols, only support FT assets, and the combination with NFT is still meaningless. Early attempts of such included grab. finance’s cryptowine: users can swap for cryptowine NFT using the reward tickets from providing liquidity to the Grab/ETH pool on Uniswap. At the same time, the transaction fee goes into the prize pool, which would then be distributed to the cryptowine NFT holders. However, this is only an experimental implementation of NFT for DeFi.

There are also projects that try to use NFT as the underlying asset to enrich the DeFi ecosystem and expand asset categories. However, due to poor liquidity, NFT poses a challenge to the actual application. Whale issued FT tokens based on its massive collection of “valuable” NFTs, yet the pricing system of its NFT vaults is still shaky. NonFungible runs a monthly audit on Whale’s staking pool based on the recent transaction records of similar NFTs[8], and the results show that there is substantial price feed latency to be fixed. Currently, Whale’s staking pool valuation is under US$50 million.[9]. However, once we figure out the solution to the liquidity and pricing issues of NFTs, it will not only establish a new DeFi ecosystem (similar to MakerDAO, Compound, and Uniswap) but also create a capital market for traditionally illiquid assets such as artworks and collectibles.

There are some other attempts from current DeFi projects. For example, Aavegotchi NFT expands the use of NFT to gaming by bringing aTokens (Aave interest-bearing tokens) into its gameplay; Zapper treats NFTs as an additional incentive for users’ activities on its platform. But there are no further applications for those NFTs except for sale posting on OpenSea. Some projects are illustrating the demand for NFT usage, such as yinsure.finance turning unique insurance policies into NFTs[10], which are then free to flow in the secondary market; Uniswap V3 also made LP Token into NFTs[11], differentiating the value of liquidity and making advanced trading strategies possible.

In short, we aim to focus on certain opportunities where NFTs are necessary rather than reluctantly imposed, either expanding the underlying assets of the current market or enhancing the compatibility of Defi as a whole.

Some other opportunities for NFT: games and culture

People hold artworks in their wallets, but apart from collecting and displaying them, they have no actual use of these assets, and video games can provide the interactivity that artworks lack. According to Forte’s statistics, since 2012, the annual revenue of the gaming industry has been exceeded the sum of the film and music industries. After all, how NFTs can propel video games is still a cliché. In the past, most projects we saw were NFT-powered game items or casino games entirely based on blockchain, but we also saw another opportunity embedding in the markets. According to Statista, viewership of the 2020 League of Legends World Finals peaked at 46 million[12]. It would be sweet to think about the possibility of owning an NFT that records esports highlights or even game items that professional players used during major tournaments; Moreover, the characteristics of esports audiences and those of crypto users overlap greatly: they are very young and easy to overcome the technological barriers of blockchain, making the cost of education low.

Most of the current high-value trades in the NFT space are still limited to art, backed by big IPs and well-known creators, and the beneficiaries are limited to small circles surrounding European and American aesthetics. This imbalance can be traced back to our real world (comparing Western and Eastern shows, NBA and CBA, Bundesliga and Chinese Super League), as well as the current DeFi layout in the crypto community and the ideology of regional funds. As for now, many of the top-performing blockchain projects are run by European and American teams. We look forward to witnessing more Asian entrepreneurs become the major contributors in digitalizing and decentralizing our world. Meanwhile, Asian blockchain ventures like A&T are eager to gain more recognition from global investors and entrepreneurs. With sufficient funding and a broadening market, we are culturally confident to present our aesthetics and value to the world through NFTs.

[1] https://www.coindesk.com/dapper-labs-nba-top-shot-has-crossed-the-million-user-mark

[2] https://cryptoslam.io/

[3] https://dappradar.com/nft/marketplaces

[4] https://medium.com/@fractional_art/what-is-fractional-dd4f86e6458a

[5] https://thatkimparker.medium.com/most-artists-are-not-making-money-off-nfts-and-here-are-some-graphs-to-prove-it-c65718d4a1b8

[6] https://docs.google.com/forms/d/e/1FAIpQLScTZhB9On31juoFzMD3hg0gGNf3hgjVyBz1xwCHsOBSydvPw/viewform

[7] https://docs.mintbase.io/creating/data-storagev

[8] https://nonfungible.com/static/january-2021-whale-vault-audit.pdf

[9] https://whale.me/

[10] https://medium.com/iearn/yinsure-finance-a-new-insurance-primitive-77d5d4217896

[11] https://uniswap.org/blog/uniswap-v3/

[12] https://www.statista.com/statistics/518126/league-of-legends-championship-viewers/#:\~:text=The%20timeline%20presents%20the%20number,almost%2046%20million%20concurrent%20viewers

Foreword:

Late June, we published a research about the current NFT track and the investment opportunities in which we are focusing on. Since then, NFT is in the ascendant, and we have seen more industry leaders dabbling in NFTs. We hope to share our methodology in mapping out the current industry value chain through the following article.

On June 21, Alipay released two limited-edition “Dunhuang Feitian, Nine Color Deer” payment code NFT skins on the AntChain Fan application, and the 16,000 of them were instantly sold-out.

On June 24, Reddit, also known as the “Internet front page”, issued its first three NFTs from CryptoSnoo collection for a seven-day auction. Owners of these NFTs can link them to their Reddit accounts as their avatars and display special animations whenever they engage in the community. All three of the CryptoSnoos were sold over 100 ETH; and the ‘Original Block’ recorded the highest sale of 175 ETH, which was equivalent to more than 367 thousand USD.

On June 25th, Marvel announced its collaboration with VeVe Digital Collectibles APP to launch peripheral digital collections in NFTs. Marvel fans will be able to purchase and interact with official Marvel NFT digital collectibles, 3D statues, and digital comic books through mixed reality on VeVe’s platform.

On July 1, CNN launched two NFTs that allow to collect historical moments on CNN news, namely 1980: Ted Turner launches CNN, which marked the birth of the world’s first 24-hour television news network CNN and 1991: ‘The skies have been illuminated’, which is an exclusive report by CNN reporter Bernard Shaw on the outbreak of Iraq War”.

On July 6, blockchain game and NFT developer Animoca Brands announced that it has received funding from Bluepool Capital, the family office of Jack Ma and Joseph Tsai.

In the past month, although the market has remained sluggish, the exploration of NFT has continued outside the crypto space. The reason, of course, is that the value of NFT is gradually recognized in that it provides a way to mark the ownership of native digital assets (that is, assets that exist in the digital world or originate in the digital world), and this ownership can exist outside of centralized services. Further, NFTs expand the range of assets that can be represented on the blockchain. At the same time, the expanded asset classes are closely related to the masses and are easier to spread, which makes the logic and business model behind NFTs easier to understand and accept.

We believe that the NFT track still has huge potential, and the NFT puzzle has just begun to be pieced together. Following is the NFT value chain that we have mapped out in the order of token flow:

1. The Infrastructure Layer

Layer 1, Sidechains/Layer 2, Developer Tool, Token Standard, Storage, and Wallet. They capture value through gas fee generated from NFT minting,: the more NFTs minted, the more value captured.

2. The Protocol Layer:

NFT Minting Protocols & Primary Marketplaces (most projects contain both to capture value). They capture value through primary transactions of NFTs rather than secondary transactions since most secondary transactions are concentrated on few platforms such as OpenSea. This leads to projects like Mintable to introduce gasless minting to attract users to mint and trade on the same platform.

Liquidity Protocol (provide price discovery system). Instead of providing NFT minting tools, they construct different mechanisms for price discovery. Liquidity protocols would likely capture value in the same way as DEXs and oracles that generate liquidity for fundamental financial services.

DeFi+NFT Protocol. These protocols generate NFTs to boost DeFi activities within. They capture value from minting activities.

3. The Application Layer

It mainly focuses on applications derived from the tokens generated from the Protocol Layer. One example is OpenSea, the NFTs traded on such secondary marketplaces stem from different minting protocols from the Protocol Layer. The value capturing model on this layer mainly base on the realization of traffic and demand in areas such as social and curation.

Protocol Layer — NFT Minting protocol & Primary Marketplace — Multi-Asset

This category represents the multi-asset marketplaces in which various types of assets can be traded in NFTs. They directly connect creators and users. On one hand, the platform needs to improve user experience, and increase user stickiness and participation; On the other hand, platforms need to provide creators with an easy-to-use and cheaper minting experience to continue attracting diverse content providers who are not familiar with crypto-native concepts.

Protocol Layer — NFT Minting protocol & Primary Marketplace — Art/Collection

This category represents art/collection-based minting protocols and primary marketplace. Art projects value IP resources and artistic taste strongly, while collection projects value Belongingness and easter eggs. Among them, most of the art projects have a high threshold for creators. It requires creators with a certain artistic background or enough fans on social platforms to gain access to the platform, which actually contradicts the ideology of decentralized and equal access advocated by the crypto space.

Protocol Layer — NFT Minting protocol & Primary Marketplace — Game

This category of applications enumerates the current cases where blockchain game developers use NFT to empower in-game economics. In the past, the strategy of blockchain games to attract players was heavily focused the P2E (Play-to-earn) mode, using the unique and tradable characteristics of NFTs to create appealing game economy; However, the game design and the playability of most games were lacking. Due to the P2E/gold mining-intensive nature of these games, gameplays are oftentimes boring and repetitive, which makes them hard to attract videos game players outside the crypto space, let alone the regular day traders and yield farmers who are purely interested in profit-making within. After gradual development in recent years, developers have slowly realized that a successful blockchain game requires a solid gameplay, coupled with the blessing of P2E to fully unlock its full potential.

Protocol Layer — NFT Minting protocol & Primary Marketplace — Metaverse

This type of application represents how Metaverse applications are using NFT-backed digital assets in a virtual immersive experience. Compared with early applications such as NFT art and collectibles, the current metaverse applications in the space still has considerable room to grow. Some of the current issues that need to be resolved are as follows:

1. Hardware barriers are relatively high, and optimizations are far from perfect. Most of the real-time graphics rendering requires user’s device to reach a certain configuration to be able to run smoothly. In the future, project developments still need to make a trade-off between graphic performance and smooth play experience.

2. Compared with other blockchain sectors, Metaverse currently lacks the gameplay and economic incentives that fit its own advantages. At present, most of the content in the blockchain metaverse is still built around NFT collections. Collectors display their collections in every corner of the metaverse, as if they are running a 3D version of OpenSea. Looking back at popular metaverse projects off-chain like the Roblox and Minecraft, users are given tools to create experiences that aren’t limited galleries or casinos; We believe that it is important for metaverse projects to diversify the ways that users can create and interact with an open-world that is backed by blockchain values.

3. The player population is largely made of crypto participants, and has a hard time reaching people outside of this circle. It requires powerful IP, smooth user experience, and innovative NFT metaverse gameplay combined for a project to emerge as killers apps of the future.

Protocol Layer — NFT Minting protocol & Primary Marketplace — Fan Economy

Under the traditional fan economy, neither fans nor idols are the biggest beneficiaries of this ecology. Instead, the centralized social platform serves as a medium for creators and fans to establish connections and obtain most of the income by inserting advertisements and algorithm recommendations between creators and users. Moreover, the interaction between idols and fans is often monotonous and one-way. The advantage of NFT lies in connecting fans and idols more efficiently and encouraging two-way interactions between them. Social NFT platforms surrounding fan economy need to set up appropriate economic incentives and mechanisms for both fans and creators to facilitate everyday users to become idols and encourage more originality.

Application Layer — NFT-Fi — Liquidity Protocol

These protocols represent NFTs as underlying assets and provide pricing systems for NFTs. There are currently three solutions: one is buyer pricing, such as TopBidder’s radical market auction; the second is seller pricing, such as NiftEx/NFT20/NFTX where sellers stake NFTs to generate ERC-20 tokens, then provide initial liquidity to generate pricing; the third is third-party pricing, for example, Upshot generates pricing suggestions based on collective data from random users. These liquidity protocols are necessary financial infrastructures to provide NFT value discovery for upper-level and complex applications.

Application Layer — NFT-Fi — DeFi+NFT

This category represents protocols that use NFT as an asset representation tool. NFT can be seen as the evolution of FTs, from only representing indifferent assets to defining unique values. This category will produce “DeFi” NFTs, such as Uniswap LP token and yinsure’s insurance policies. Compared to NFTs from art and collectibles minting protocols, the difference lies in how they are created, which would be through DeFi activities.

Application Layer — NFT-Fi — Collateralized Loan

This category represents protocols that recognize NFTs as underlying assets in collateralized loans. As for now, due to the lack of NFT liquidity and pricing systems, collateralized lending can only be realized in the form of P2P. However, referring to how Defi has iterated in the past years, from ETHLend to Aave, P2Pool might be the next stop.

Application Layer — NFT-Fi — Asset Management Tool

This category shows asset management applications at the upper level of our NFT value chain. They have the same functions as Zapper or Debank in DeFi space.

Application Layer — Vertical Application — Secondary Marketplaces

These secondary marketplaces allow users browse and trade NFTs minted and auctioned from different primary marketplaces. They are the major liquidity contributor in secondary market of NFTs.

Application Layer — Vertical Application — Data Provider

There has not yet been a comprehensive data provider in the NFT field. The existing data is either not comprehensive enough in NFT coverage, or incomplete in data dimensions. In addition, there is also a lack of a full-featured search engine, which might be an important traffic entry in the future.

Application Layer — Vertical Application — Curator DAO

These curators or DAOs are generally composed of senior NFT participants, who can better explore the potential value and emerging directions of NFTs. In addition, for NFT creators, a major trigger is the inability to obtain initial traffic for their works. Therefore, curators are born. While helping NFT creators to self-market, they can also optimize the efficiency of the NFT market and discover more potential value.

Application Layer — Vertical Application — Social Network

In our latest article, we introduced our expectations on NFT social platform that could become a potential direction for NFT to break out and popularize among the public. Unlike NFT artworks, which has a certain threshold, those social platforms can provide users experience that is very similar in traditional apps. Therefore, we believe that social platforms are an important medium for NFT to expand its reach.

Conclusion

The reason why we have conducted frequent research on the NFT ecosystem recently is that, we have seen the potential of NFT from the increase in transactions, the increase in users, and in the exploration of NFT by various industries outside the crypto space.

In the future, everything except currency can be tokenized, and NFT can be regarded as an open API interface. Users can unleash their creativity using this API and create more meaningful applications.

Visit Defrag.fi to mint now and become the initial participant!

TL;DR

• Defrag is the only practicable Peer to Pool solution for NFTs so far by introducing a put option ingeniously. Just as what happens to ETHLend in DeFi history, Peer to Pool model will dominate in NFTs again, solving the fragmentation resulting from Peer to Peer models such as Opensea and NFTfi.

• 2 main challenges: 1) Liquidity risk on liquidation. NFTs collaterals with high utility are favored as they also have high liquidity, with tokens airdropping or other staking/holding benefits. 2) Price manipulation. Defrag sets a dedicated liquidity pool for each NFT collection with different borrow and liquidation threshold factors based on volatility.

• Compared with current DeFi TVL and a total market cap of FT assets, the lending TVL on NFT should be at least $ 900 million and Defrag’s optimistic reasonable market cap should be $ 144 million, 10x upside for initial participants.

A Peer to Pool liquidity protocol for NFTs

Defrag builds a pool liquidity model for NFTs by introducing a put option ingeniously. The basic mechanism is: Borrowers collateralize NFTs and buy put options at a premium to get a loan immediately, while liquidity providers underwrite these options, enjoy the premium, and govern the whole system with $FRAG in the future.

Peer to Pool > Peer to Peer

There are 2 types of liquidity models for Lending: “Peer to Pool” (Compound, Aave, etc.) or “Peer to Peer” (ETHLend, etc.). The second one was already weeded out because Peer to Pool allows immediate liquidity for all kinds of assets, solving the fragmentation resulting from different terms such as duration and rates.

Right now, NFT lending is still in its early stage. Only NFTfi has meaningful loan stats, with a total loan value of $ 46 million¹. But it is a Peer to Peer loan product similar to ETHLend. Its dashboard is hard to understand and handle for massive users, who need to set a lot of parameters and terms to get a loan or lend.

Here is an example scenario² to glimpse how the system is running:

Mitigate liquidity and manipulation risk

Just as with other DeFi protocols, the main challenge is liquidation. The premium fee is insignificant when the pool is filled up with liquidated NFTs. To compensate the protocol and incentivize liquidity providers, the key is to transfer liquidity risk.

The team is fully aware of that and prudently chooses the kick-off partner NFT project. To transfer liquidity risk, NFTs with high utility are considered preferentially such as 1) airdropping tokens to its NFT holders (eg, Adventure Gold); 2) staking NFTs for utility (some Launch Pads, eg, Infinite Launch); 3) staking NFTs for other liquid assets (most play to earn games, eg, Axie Infinity).

The other risk is when borrowers manipulate floor price to get unreasonable loan sizes, the pool easily gets exhausted. To mitigate this, every NFT collection will have a separate pool just as Uniswap or Compound. Defrag will set different borrow and liquidation thresholds based on the volatility of each NFT collection. Over time, Defrag will create standards for NFT projects with similar mechanisms to easily tap into.

$ 900 million³ TVL achievable

Just as FT, NFT is a new underlying asset type with the massive need for utility and liquidity, which will bring in by DeFi. Compared with the current DeFi TVL and a total market cap of FT assets, DeFi TVL on NFT is estimated conservatively at least $ 1.8 billion. Considering not all FTs have DeFi built on such as BTC, the DeFi TVL on NFT should be underestimated.

Currently, the two largest categories in DeFi are Lending and Dex, nearly accounting for 50% each. If it happens the same in NFT, NFT lending could achieve a TVL of $ 900 million.

Incentives for initial participants: ~10x⁴ upside

According to the roadmap, Defrag will launch $FRAG tokens in Q1 2022, which will accrue to the owners of Metamaticians. The governance and voting will be upgraded to use the $FRAG token. Currently, Metamaticians is in a fair mint with ~$ 15 million valuation (6400 mintable NFTs with 0.618 ETH each), while the optimistic reasonable valuation should be $ 144 million based on the assumption below.

Notes: All data captured on Dec 30, 2021

1. NFTfi stats: Total Loan Value $46 million including 10427 ETH and 7.8 million DAI, with per ETH = $3700.

2. Example scenario.

3. The total TVL is $244 billion on FT assets; the total market cap is $2,319 billion on FT assets; the market cap of top 100 NFTs is $16.7 billion, the guardian.

4. TVL; Market Cap (Current Price x Circulating Supply)

Published on Sept 2

Takeaways:

• dYdX’s token issuance accelerating the replacement of centralized derivatives, showing a pumping Dex / Cex Ratio of derivatives. I see at least 20x potential of trading volume, as derivatives should act as the same of Dex / Cex Ratio of spots.

• Perpetuals are the most popular decentralized derivatives just as in centralized space, with US$47B accumulative trading volume today, 92 times¹ the figure of Options volume, the latter of which is more for high-skilled gamblers to hedge the risk.

• I simplify 2 types of liquidity models for derivatives: “Peer to Pool” (Perpetual Protocol, Synthetix, etc.) or “Peer to Peer” (dYdX, etc.). The first one allows freely derivatives listing, lower liquidity requirements; The latter one has less platform risk, higher leverage tolerance, and various order types (Fortunately, Uniswap V3 actually makes limit order and more order types possible.)

• I love vAMM design! vAMM is only for price generation, while it separated the liquidity pool out to mitigate the impermanent loss for stakers. Unlike AMM design (say, Uniswap), one-token staking makes positions hedged and cut a lot of profit loss for stakers. While Uniswap stakers bear all the profit loss for their positions because they are traders as well for the pair staking.

• I see perpetual projects using **“Peer to Pool” **design such as Perpetual Protocol are the improved versions of Synthetix in the way of better UIUX and higher capital efficiency, etc.

• I projected FDV for dYdX would be ~US$11,451 Million by initiating *FDV / APR *ratio. Given dYdX’s total supply of 1,000,000,000, per dYdX token price should be ~$11.45. Interestingly, the estimated figure is not too far from reality: the estimated FDV of Perpetual Protocol is US$2,801 Million, while the market figure is ~US$3,010 Million, as of Sept 1, 2021.

Macro factors are pushing: (Pass this part if you already know that DEXs are the future!)

1. Stricter regulation on centralized derivatives. Binance recently shuts down derivatives trading offerings in Hong Kong, Germany, Italy, and the Netherlands. BitMEX, which was once the largest derivatives exchange, recently was required to pay $100 million penalty to settle the charges with CFTC and FinCEN. Traders in more regions are beginning to turn to decentralized derivatives.

2. Centralized exchanges are too powerful and less innovative. Due to the custody of user assets and the sole possession of transaction data, we see a lot of “emergencies” such as suspend withdrawals, freezes, downtime, etc. Even worse, centralized exchanges may treat trading data abusively. Robinhood has previously accused that its main business model is to sell customer orders to high-frequency traders, so it benefits from leaking customer information. Centralized platforms have been difficult to gain users’ trust.

3. Layer 2 is making things work. In August, dYdX’s trading volume is 55 times² the figure in March with the fact that Layer 2 perpetuals went live in April. Perpetual Protocol will soon launch its V2, Curie on Arbitrum, so as Futureswap’s V3. Decentralized exchanges are poised to replace centralized exchanges.

Two inside signals are showing:

Among all the derivative products in this space, perpetual contracts are currently the most popular ones with the largest trading volume. They are developed on the basis of delivery futures with no expiry date. Therefore, it is characterized by a funding rate mechanism, which is to prevent the price from deviating from the spot price and avoid becoming a pure gambling tool.

Dex / Cex Ratio

In 2021Q1, the transaction volume of centralized perpetual contracts exceeds US$14 trillion³. While in the same period, decentralized perpetual contracts generated US$7 billion**⁴ **volume, which counts for 0.05% of centralized transaction volume. At the moment, decentralized perpetuals account for 0.5%**⁵ **of the monthly transaction volume of centralized ones, 10x the figure in Q1.

In the spot market, this figure is 10%⁶. That means decentralized derivatives trading volume would still go up at least 20x, even given no growth on centralized derivatives.

Data Source: CoinGecko, as of August 31, 2021. Note: Cex data includes Binance Futures, Huobi Futures, OKEx Futures, FTX derivatives, Bybit Futures.

Token Launch Effect

I believe that the issuance of platform tokens by the leading projects will have a very large pulling effect on the entire sector. The following figure shows the impact on the centralized exchange before and after the issuance of the derivatives leader dYdX and the spot leader Uniswap. It can be seen that after the issuance of UNI, spot Dex / Cex Ratio jumped to 20% and it is never getting back to the level before August 2020 (rumors of token launch came out after the last round of fundraising).

Data Source: The Block. Note: I ignore the Sept figure for incomplete data.

Dive in, who are the best ones?

I here only discuss: Perpetuals with linear P&L, Options with convex P&L, and Synthetics with irregular P&L.

Perpetuals with US$47B accumulated volume proved themselves are most welcomed, 92 times the figure of Options. The latter one is suitable and attractive for professionals to hedge. However, there are several projects that are trying to bring it mainstream. Shield Official is testing simple perpetual/everlasting option products for general users.

Synthetics are interesting. But sadly, they are all not as easy as perpetuals to understand and trade, while some of them provide diversified innovative yielding products. For example, one of the most popular products on UMA is Yield Dollar with ~US$36M assets locked⁷, which is similar to a zero-coupon bond (fixed interest rate/yield).

**“Peer to Pool” **or “Peer to Peer” ?

• **“Peer to Pool” **means the traders’ counterparties are pools, or the stakers, normally. For example, if you are staking PERP on Perpetual Protocol V1, you are actually the counterparty of those traders. You are taking this risk because you are rewarded to do so (rewards come from trading fees and inflation). They even create a Virtual AMM to cut out price fluctuation for stakers to decrease impermanent loss. The purpose is to make stakers stake to expand liquidity. That’s important: imagine only one trader in this system, if he bet right, who should pay him? Now, we are clear why Perpetual Protocol can only allow you to have 10x maximum leverage, and why it sets an emergency shutdown function. Risk control is important for those derivatives platforms to prevent net negative positions.

• “Peer to Peer” means the traders’ counterparties are other traders, or the market makers, normally. For example, dYdX has an order book, which is a sign for matchmaking. That is, different from Perpetual Protocol, ideally, dYdX has zero involvement in trading against anyone. Hence I do see dYdX has a high tolerance for 25x maximum leverage.

I believe both are needed in the near future. **“Peer to Pool” **shows the capacity for long-tail assets that have low liquidity. It can even allow freely list token derivatives in the future, which may be adopted in Perpetual’s Curie version. Meanwhile, **“Peer to Peer” **provides a similar Cex experience, such as various types of orders, compared with Perpetual Protocol V1 only has market orders. But I do see solutions from Uniswap V3’s design, which makes limit order and more order types possible.

The evolution of derivatives

I see **“Peer to Pool” **Perpetuals as an improved version of Synthetix. There are 3 reasons: a) why bother to use a more complex system when you can easily get crypto exposure from Perpetuals; b) currently, near 90%⁹ of synths on Synthetix are cryptos synthetic tokens, which means the need for real-world assets is not mature. Additionally, perpetuals are capable for real-world assets derivatives as well; c) Margin is well adopted and it shows higher capital efficiency than collateralization, comparing 200% liquidation ratio of Synthetix with 2.5% liquidation ratio of Perpetual Protocol.

Going to the Moon?

I analyzed the metrics of current spot dexes and initiated a useful multiple for further valuation projection: “FDV / APR” (Fully Diluted Valuation / Annual Projected Revenue).

Multiplying FDV / APR median of spot dexes by derivatives APR accordingly, I estimate FDV for dYdX would be ~US$11,451 Million, and FDV for Perpetual Protocol would be ~US$2,801 Million.

Given dYdX total supply of 1,000,000,000, per token price should be ~$11.45.

Interestingly, the estimated figure is not too far from reality: FDV of Perpetual Protocol is ~US$3,010 Million, as of Sept 1, 2021.

Data Source: The Block, CoinGecko

Data Source: The Block, CoinGecko

Appendix: 2 types of derivatives comparables

References:

(all the data captured as of August 31, 2021)

(1) Accumulative Vol:

Perpetuals US$46.8B [dYdX: US$17.5B from dYdX metabase metrics; Perpetual Protocol: US$25.1B from Dune Analytics @yenwen / Perpetual Protocol; Futureswap: US$4.2B from futureswap.com.]

Synthetics US$9.4B [Synthetix: US$9.4B from stats.synthetix.io; UMA: no transaction data, TVL is US$144M from projects.umaproject; Mirror Finance: ~US$13.9M from the most traded assets on mirror.finance;]

Options US$507M [Hegic: US$492M from hegic.co; Opyn: US$15M from Dune Analytics @loren / Opyn v2.]

(2) Our calculation is based on data from CoinGecko.

(3) https://image.tokeninsight.com/levelPdf/TI_Research_Report_-_2021_Q1_Crypto_Perpetual_Trading.pdf

(4) Our calculation includes the volume of dYdX, Perpetual Protocol, and Futureswap sourcing from CoinGecko and Dune Analytics.

(5) Our calculation includes the volume of dYdX, Perpetual Protocol, and Binance Futures, Huobi Futures, OKEx Futures, FTX derivatives, Bybit Futures. Data source from CoinGecko.

(6) I ignore the Sept figure for incomplete data. https://www.theblockcrypto.com/data/decentralized-finance/dex-non-custodial/dex-to-cex-spot-trade-volume

(7) https://projects.umaproject.org/

(8) Fundraising Amount:

Perpetuals US$97.4M [dYdX: US$87M; Perpetual Protocol: US$1.8M; Futureswap: US$1.6M; MCDEx: US$7M; from multi-sources including Crunchbase.]

Synthetics US$55.7M [Synthetix: US$46.1M; UMA: 4.6M if estimate IDO raised $2M; Duet Protocol: US$3M;]

Options US$26.1M [Hegic: ~US$12M on ICBO; Opyn: US$9.1M; Primitive: US$3M; Shield: US$2M; from multi-sources, including Crunchbase.]

(9) https://stats.synthetix.io/

Others:

https://research.paradigm.xyz/Yield.pdf