Ribbon Finance: Structured Products For DeFi | Deep Dive
Review Date: May 20, 2021 |
INTRODUCTION
Ribbon Finance is a protocol building structured products in DeFi. Structured products are an investing mechanism in which the returns are directly linked with the underlying asset that it represents. In layman’s terms this means we can generate yield on a crypto asset using financial instruments.
Ribbon is leveraging the power of DeFi composability and the emergence of derivatives to create structured products in which any market participants can deposit crypto assets into a vault that generates yield on their assets via automated strategies. Backed by some of the best DeFi funds and individuals in crypto, Ribbon is set to be a powerhouse in offering structured products to the masses making complex yield generating tools accessible to all.
The State of Yield in DeFi
A prominent question people ask in DeFi is where is the yield coming from? The most prominent source of yield is that of yield farming in which market participants will deposit liquidity into a protocol to receive that protocol’s native governance token. For example supplying liquidity to Compounds money markets in order to receive the COMP token. However, this source of yield is unsustainable and requires constantly rebalancing to new farms to provide a consistent source of yield.
Ribbon Finance aims to tackle this problem by the implementation of structured products in DeFi in which yield can be generated through trading strategies using derivative products. For example Ribbon Finance has a Theta vault in which anyone can deposit ETH or WBTC which is then deployed in the market using a covered call strategy using options which generates passive yield for depositors. The yields from these products are much more sustainable long-term for those looking to generate yield on a crypto asset.
Theta Vaults
The Theta vaults by Ribbon Finance allow any market participant to deposit assets such as ETH and WBTC into a vault which then runs a covered call strategy in order to generate yield to distribute back to depositors. The vault integrates with Opyn Finance an options protocol that allows the minting of oTokens which are tokenized representations of options contracts that have a specific strike price and expiry that is redeemable for the underlying asset it is representing.
A covered call strategy is an options strategy that involves selling calls and holding the underlying asset in order to remain market neutral and generate income via an option premium unless the options are exercised. In order to better illustrate this complex concept we will walk through an example below:
Say ETH was trading at $3400 and we just hold the spot asset. We are fully exposed to the upside and downside with no protection. If we take a market neutral stance meaning we do not expect large upside or downside but we want to make some income we would employ the covered call strategy. We do this by selling a call option with a strike price of 4000 and expiry date of 31/05/2021.
Now on the option expiry date 31/05/2021 if the spot price is below 4000 say $3900 we can collect a $200 premium on the option plus a $500 in appreciation of the base asset totalling at $700 profit. However, if the spot price decreases then we still collect the premium from the calls but exposed to the depreciation of the spot price.
So in essence a covered call strategy can generate yield via the option premium if the strike price is not exceeded. This is a complicated topic so if you do not understand this just understand that passive yield can be generated through financial instruments.
The asset flow for participating in a Theta vault is as follows. All the market participant needs to do is a deposit transaction to the vault. After this the smart contracts deploy the vaults assets into a covered call strategy using Opyn’s oTokens for tokenized option positions.
The yield generated from this strategy is compounded within the vault to produce higher returns. A participant can claim their principal and yield at any time they wish. The Theta vaults proved to be very popular in DeFi with their vault caps being hit within less than an hour.
Future Products
Ribbon Finance plans to launch a series of structured products that include volatility, principal protection and capital accumulation. Currently there is no information regarding these products but that does not stop us from speculating.
- Volatility – Products that a trader can use when they are certain of volatility returning to the market but unsure of the direction. Similar to the VIX but for crypto assets. Betting on volatility most likely using an option strangle strategy holding a call and a put with different strike prices equidistant from current spot price. One of these options will be out the money and the other one will be in the money based on whatever direction the market resolves in.
- Principal Protection – After some analysis of recent pull request’s in the Ribbon Finance Github repo we can see a Black Swan vault in production. This offers tail-risk hedging strategies for DeFi users. This means if the market behaves normally users will continually lose small amounts of money week on week. But if there is a significant crash like in March 2020 then depositors will profit massively. This is insurance to protect your portfolio from large deviations.
- Capital Accumulation – Another product that seems to be in the work is a yToken vault. This is a direct integration with YEarn Finance and their V2 vault products that generate yield for depositors by deploying assets in complex yield farming strategies. A new vault would accept yTokens as collateral to write options against.
Team & Backers
The Ribbon Finance team has a particularly strong software engineering background with most of the team previously working at Coinbase. The Github repository is active with 9 individuals contributing to the structured products repository with many branches and pull requests implementing new functionality into the Ribbon protocol. Ribbon is backed by some of the most prominent funds and individuals in DeFi. Dragonfly Capital, Coinbase Ventures, Divergence, DeFi Alliance and individuals such as Joe Lubin at Consensys and Kian Warwick founder of Synthetix.
Summary
Derivatives prove to be a unique way of generating yield on crypto assets by executing pre-defined strategies using options and futures. There is a whole range of structured products to be built in DeFi with Ribbon Finance being at the forefront of innovation in this sector. As derivatives gain more popularity in DeFi so will structured products that benefit from the composability of DeFi. Backed by some of the best funds in DeFi Ribbon Finance has set the stage for an entire new ecosystem in DeFi and is the prime move within it.
REFERENCES
- https://docs.ribbon.finance/products/series-y-theta-vaults
- https://app.ribbon.finance/theta-vault/T-USDC-P-ETH
- https://github.com/ribbon-finance/structured-products
- https://www.ribbon.finance/
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