Tracer Drop Episode #08: Tracer Perpetual Pools Launch

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 Recording Link: https://www.youtube.com/watch?v=pWVY84ttx6U

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