Tracer Perpetual Pools Launch
Agenda
- Introduction
- Perpetual Pools - Basic Overview
- A Simple Mechanism
- Power Leverage
- The Benefit of Leverage
- Developing Decentralised Financial Instruments
- Regulation
- Use Cases
- Effect on Prices
- Future of Perpetual Pools
Call Notes
Introduction
- Mycelium and RMIT discuss benefits and implications of Perpetual Pools with Ryan Garner and Lachlan Webb, the lead financial engineers of the project
Perpetual Pools - Basic Overview
- Perpetual pools - simple derivative protocol that is comprised of one pool with two sides
- Pool - hold collateral and given ‘x’ happens the collateral will move between the sides of the pool
- For example: long side and a short side tracking exposure to a price feed (ETH/USD)
- Given an increase in ETH/USD there will be a value transfer between either the long side to the short side; or vice versa
- In this case - collateral will be a stablecoin (USDC or DAI)
- Essentially, there is an arbitrary transfer agreement that moves collateral between pools
- The derivative itself is the share or the asset itself is ownership over one of these pools
- If you are going long - ownership of the long side of the pool
- If you are going short - ownership of the short side of the pool
- Two funds that have been divided into shares - transfer of funds back at forth at a certain percentage given some change in the underlying price feed
- Causes individual shares to move in a similar fashion - if they have similar fundings, which they should
A Simple Mechanism
- The attractiveness of perpetual pools is the simplicity of the mechanism
- This simplicity makes it possible for the general public to understand
- It is also useful in an academic sense - easy to simulate and reason about which is key for a product to obtain large financial traction
- It needs to be simple, straightforward and trusted
- The DeFi space is a bug industry with billions of dollars - the trust in decentralised applications is with the code and the smart contract agreement
- If the agreement is simple, it is easy to reason about and people are willing to accept the product
Power Leverage
- Mechanism is simple - the shorts rebalance the longs and the longs rebalance the shorts
- With power leverage the shorts don’t compensate the longs in a linear fashion
- In the limit case where there are many small and frequent transfers it’s the same as linear
- The issue - it is possible, when multiplying percentage gains and losses, to multiply to a number over a hundred
- If there is a 10% price movement on 10x leverage there will be a loss of 100%
- Early experiments into power leverage, and other close products to Perpetual Pools, ran into this sort of issue
- The solution - find a formula that performs identically for small price movements, but for extreme price movements it starts to limit it to the amount of funds available
- Linear for normal price movements
- Compress and reduce the leverage as needed for really large price movements to prevent bankruptcy
The Benefit of Leverage
- Leverage is beneficial when you have information and confidence that an event if going to happen
- Ability to magnify the benefits of a trade
- Normally, leverage a position by taking on debt - means you have to collateralise the debt
- The benefit of pools - builds leverage without debt simply by using a market mechanism
- Instead of one person putting assets at risk and finding a counterparty to take on the debt instrument - there is now a readily available market
- Essentially walk into market and it’s as simple as, “who has the other side”
- Instead of a debt contract, it is a swap of things already in the pool
- Exploits the mechanism of an existing liquid market
- Enter into a market where some people are long, some are short - do a swap contract and walk away with leverage
- Not only exploits an existing market, but creates that market by liquifying existing market knowledge that may have been previously untradeable
- In lending and borrowing markets - there are lots of people with specialised/localised knowledge that is valuable to trade
- However, they cannot access the debt markets and, consequently, cannot access any other market to trade
- Perpetual pool market - democratises opportunities that people did not previously have
Information Efficiency
- A lot of discussion around leverage - focused on magnifying gains
- Economist’s perspective - leverage is beneficial when you have information, which is the basic distinction between trading and gambling
- Leverage incentivises good information to enter the market making it more informationally efficient
- Good information now has a powerful reward
- If you have good information - you buy the where a pool product is of value to you
- Products like this (with leverage) make markets work better
- Less a story about individual gains and losses, volatility and price movements and more so about the implications of incentivising high quality information to enter markets
- Currently, there is an abundance of high level macro information - focus on brining macro information to markets
- However, local information is the driver of markets
- Observability bias - information that’s easy to find drives markets, but information that cannot be trustlessly communicated from the local to the broad is harder to find
- Whenever there is an ability to bring unique information to market - ability to create oracles
- Example: housing index for your suburb
- Live in an information economy - most important resources are human capital (between the ears) and the information and economic activity generates
- The more markets that can trade local information the better off the economy will be
Developing Decentralised Financial Instruments
- Fundamentally easier to develop financial instruments for a decentralised world
- Perpetual pools versus perpetual swaps
- Perpetual swaps have many mechanisms - acquiring debt, counterparty risk, liquidation, bankruptcy and insurance funds
- Also have various measures put in place to ensure the mechanism works as intended
- Creates more barriers to entry - prevents niche markets from emerging
- Creating a decentralised mechanism destroys or lessens these barriers - allows greater information to be present within financial markets
- Leverage is a representation of conviction
- The point of Tracer - have permissionless deployment for financial contracts so that anyone can deploy a market on any information they wish to hedge/trade on
- Allows information to come to the market forthright without barriers
- Experimentation in a centralised environment (i.e. not blockchain) requires trusting the organisation
- In terms of engaging with a novel financial products - placing trust in an organisation is costly
- In a decentralised world - need only to trust the code
- Easier to gain traction in a decentralised environment
- The main difficulty with developing novel financial products would be gas costs - the cost of transacting on Ethereum/any other blockchain
- DeFi is the future of finance - space for novel and innovative ideas and mechanisms to be built
- The main benefit - can be solidified into code which ensures that the mechanism works
- Tracer’s goal - experiment and introduce new and novel ideas and have a proof of concept that they can work in solidity
Regulation
- Current regulation system - moulded to fit the existing financial system
- Hard for regulators to accept DeFi as a solution to a missing market problem - in their mind there are no missing markets
- Initial hostility - perceived as a new form of gambling etc.
- Method to overcome this would be to provide regulators with a variety of use cases which do not currently exist
- Mechanism for getting exposure to the housing market, labour market etc.
- Final end goal - ability to build purpose build products, mechanisms and portfolios where people control their own financial futures without the need for institutions
Use Cases
- Capital markets - new form of EFT that is more efficient
- Issue - most regulators would not like/accept this idea
- The best obvious use case is not capital markets but labour markets
- The largest unhedged risk most people take is there job - out of tens of thousands of possible careers you pick one (wildly not diversified)
- Built complex social welfare institutions to offload that risk onto society
- Possibility to hedge against other careers - buy a share of other careers
- On a global scale - you could trade this information and make decisions by looking at the prices of certain types of labour
- Ability to make better decisions with better information to offset risk - all the makings of a good financial product
- Already exists with capital markets - labour markets are conversely horrible
- For intangible assets the main value is for an oracle price feed to dictate a new market
- Perpetual pools, specifically when compared to other market mechanisms, will be the best for handling any instance where there is natural demand to speculate and profit from price movements
- There is no interest as there is no borrowing - no additional costs
- When compared to a standard EFT, or any traditional leverage - makes leverage potentially obsolete in cases where there is natural demand for price movements in either direction
- Another use case is the possibility to create more novel and complex transfer agreements
- Create a transfer agreement between two pools or possibly more
- For capital market efficiency - have three sides of a single pool, one short, one long and one side predicting sideways volatility
Effect on Prices
- Perpetual pools make information flow faster, and therefore, impacts prices faster meaning markets reach equilibrium faster
- If there are two markets trading the same financial product - one with lots of debt leverage and the other with swap leverage; swap leverage with faster true price discovery is the preferable option
- Speed of price discovery is the equivalent of market efficiency
- Pool mechanism - trading is faster than every other market which is a powerful competitive advantage
- Better faster markets allow for better faster pricing systems - this establishes the cost of capital allowing used for the allocation of resources
- This two-way information flow contributes to driving overall economic activity and growth
Future of Perpetual Pools
- Possible to speculate about specific use cases
- Mindset, however, is more similar to opening the door to infinite possibilities
- Specifically, once the permissionless market deployment is activated, there will be the ability to create simple and efficient markets
- With a global community and money on the line the results will be surprising and beyond even what the initial developers were able to achieve