This episode is brought to you by Gnosis.
Gnosis builds decentralized infrastructure for the Ethereum
ecosystem with a rich history dating back to 2015 and products
like Safe Cow Swap or Gnosis Chain.
Gnosis combines needs driven development with deep technical
expertise. This year marks the launch of
Gnosis Pay, the world's first decentralized payment network.
With a Gnosis card, you can spend self custody crypto at any
Visa accepting merchant around the world.
If you're an individual looking to live more on chain or
business looking to white label the stack, visit gnosispay.com.
There are lots of ways you can join the Gnosis journey.
Drop in the Gnosis Dow Governance form, become a Gnosis
validator with a single GNO token and low cost hardware, or
deploy your product on the EVM compatible and highly
decentralized Gnosis chain. Get started today at gnosis dot
IO. Cos One is one of the biggest
node operators globally and help you stake your tokens on 45 plus
networks like Ethereum, Cosmos, the last year.
In dydx, more than 100,000 delegators stick with Chorus
One, including institutions like Bit Go and Ledger.
Sticking with Chorus 1 not only gets you the highest years, but
also the most robust security practices and infrastructure
that are usually exclusive for institutions.
You can stick directly to Chorus One's public note from your
wallet, set up a white table note, or use the recently
launched product Opus to stake up to 8000 ETH in a single
transaction. You can even offer high yield
staking to your own customers using their API.
Your assets always remain in your custody, so you can have
complete Peace of Mind. Start staking today at Corus .1.
Hey guys, welcome to Epicentre. I'm Maher Roy and today I'm
catching up with Shiming Yang, who is one of the Co founders of
Orbit Markets, Orbit Markets. I think he's the market leader
in the field of structured products based on crypto assets.
So I'm really interested to explore what this space
represents and where it could go.
Hi, welcome to the show, Jimmy. Thank you very much for the
invitation. It's great pleasure to be there.
So Jimmy, tell us about your background story and how you
ended up being involved in the crypto space.
Yeah, sure. Yeah.
So actually I think I, I came to crypto relatively late compared
to most people I think so we started actually in 2022, end of
2021, the beginning of 2022, so about about two years ago.
Actually it's been 2 years. I didn't realize it's time time
flies. And before crypto I I was
working in traditional finance, so I worked in at at investment
banks for the all of my career before.
So I was at I started my career in London with BNP Paribas and
then I I worked at Deutsche Bank for over 12 years trading FX,
currencies, derivatives and before leaving Deutsche Bank I
was running the FX derivatives trading business.
For APAC. So what does it mean to leave
the FX derivatives trading business?
What is the FX derivatives trading business at an
investment bank? Yeah, sure.
So at the investment banks, you have what investment bank is
very broad term, right. So everybody here is like
Goldman Sachs, JP Morgan, Deutsche Bank.
These are the investment banks. They have one side of the
business which consists of merger, acquisition, getting the
company listed. You know, that's like the
corporate finance part of things.
There's the another part. So in a sense you can think of
it like primary markets or or if you want, like if you want to
actually if you're more familiar with crypto, then it's like
getting a token listed on exchange or like a financing,
etcetera, a project. There is another side of the
investment banking which is the what we call like secondary
market. So something's already listed.
It's already trading. So now you have the whole, the
whole, the sales and trading business that actually help
clients put on the trade or whether it's for hedging or
whether it's for speculation or whether it's for investment.
So we provide those products to the clients and the clients of
investment banks can be funds, hedge funds, trading desk, high
net worth individuals, companies, corporates, all sort
of different clients And then we provide these investment
solutions or products to them for them to trade.
And then So what I do as a trader as run it as the as
someone running the desk is that we have obviously a team of
traders, we have quants, we have also meet office, back office
doing the operations. So we have actually everyday we
a client wants to trade a certain product, a certain or
certain solutions. So we have to actually have make
the price. So we have to actually calculate
the fair price of this product, show it to the client.
If client wants to trade, then the trade is done and then we
need to start managing the risk, managing the risk of those
trades and then we obviously want to make make money as well
for the bank. So that's what we used to do on
the on the at the sell side we call it sell side at at
investment Max. So now what we do in crypto is
we try to basically replicate this same sales and trading
business model from traditional finance to crypto and that's
what we do actually. So at OB markets we offer mostly
we are focusing on options and derivatives.
So we offer derivatives products and solutions to our clients.
Some of them for example use our structure products to hedge
their crypto holdings law for example a minor that they keep
producing BTC right every day and then they actually want to
hedge the the risk of price falling or fluctuations.
So we customize and and make bespoke structures for them.
Well, we also have some of the funds who wants to actually buy
tokens, accumulate certain tokens and then we have like
structure solutions to help them buy the tokens at the price that
is better than the spot price. So can I think of it like as a
as a as a crypto investor I'm used to the idea of going to an
exchange and like buying this coin or that coin and usually
I'm I'm I'm interacting with the exchange or the matching algo of
the exchange quite directly. But sometimes I might go to kind
of like an OTC desk and to your OTC desk there's a human on the
other side and and I essentially say hey that's what I have
that's what I want. Can you can you make the make
the trade for me and like this this trader on the other side
will essentially figure out how to price it and will offer offer
me a a price for then OTC price for for what I want.
But then you could imagine that that OTC desk could get even
more sophisticated where it no longer becomes about just
selling or and buying something. But it's like hey I want to I I
have this asset and I want to combine it with some kind of
derivative and the and the combined thing is, is, is the
trade I want and then the OTC desk is able to do this complex
combinations. And then as soon as you get into
the field of complex combinations, it will happen
that OK, I will have to put some asset as collateral with that
OTC desk And so collateral management will also enter which
may not be part of just like a simple trade.
So as you imagine like this OTC desks becoming more and more
complex, more and more capable, they would start to resemble
what kind of an investment bank does on the trading side for its
clients today. Is is that correct way of seeing
seeing it? Yeah, absolutely.
What you just described is is is true for crypto, but is also
very true for for traditional finance.
So in traditional finance you also have this exchange, market
venues and also the OTC side. The exchange is also very very
important part of traditional finance.
You have most of the stocks, for example trading all the
exchanges. But it has also limitations,
right? So the exchange can only list
the standardized, the products you have like standardized the
payoff, standardized maturities, strikes, etcetera.
But then what if I want something more customized or
what if I want something more as you said, more complex, right.
So in that case, you actually even in traditional finance, you
have to go to OTC desk. OTC desk in traditional finance
are typically big banks, big in investment banks.
So you go to them for for various reasons.
One, you want to execute the large amount of trade.
So if you do this on exchange, you will actually move the
market probably against you, right.
So you want to go to investment bank who can actually manages
better for you, the execution for you or you go to go to an
investment bank because you actually want something more
bespoke like not available on the exchange, so something
exotic or more more complex. So you go to them and they are
able to offer this to you and they will manage the risk
themselves. So they will rely on their
quantitative models, they will rely on their, they will manage
the, the, the product together with the other products so to
achieve efficiency. So at the moment in crypto is
the same thing. Crypto market started with the
various basic simple products which is spot which exists in
every financial market and if you look at the evolution of any
financial market gradually moves up in terms of sophistication
and complexity. Sophisticated products, complex
product doesn't mean they are necessarily better product.
I'm not saying that but they are probably they they they are
there to fit your particular view, your particular demand,
your particular budget etcetera. It just gives you more options.
If you want like exchange, you can think exchange more like a
fast food restaurants go to McDonald's, you can just choose
whatever you want or standardize you just buy food you want.
And then if you want to OTC that is more like a fine dining
restaurant, you go there, you want like personalized dishes,
you want eat this and that and they will make it like
specifically for you, like like they are dedicated service
tailor, tailor made products for you, right.
So in that case you can trade things that exactly as you want.
For example, I think Bitcoin is going to go up to 45,000 to the
next few weeks, but it will not exceed 50,000, right.
So then if you have this particular view, it's almost
impossible to to do this using is it impossible to do this
using spot or perps or futures? And even with vanilla options
you can't achieve this if you have such a particular view.
But you can do this using exotic options, right?
So that we we call like for example Barry options.
So that trade will you start make money if spot goes up above
45,000 but it will knockout it will just disappear if it's spot
goes above 50,000. And then you will be you will
buy this option really cheaply because it has this additional
condition on knockout. So this is that's something that
you can buy from the exchange. So you have to go to OTC desk
which can provide this product to you.
Yeah, that's that's really interesting.
So, yeah, you can basically like create new kinds of options that
are not available on any public options market.
And then you can also like combine these options with like
trades that make make even more sophisticated products.
Could you, could you give us like some historical examples of
this industry in in the investment banking world, like
examples where I mean there might be a story of somebody
that did something like this and either made money or lost money.
And the story is well known in the industry and will give us an
idea of how it works. You have some some stories like
that. Yeah, yeah, plenty of those kind
of stories and obviously a lot of people, some people made
money, some people lost money. That's just like any financial
market options itself. I think it's I think he, I I I
can't remember when he was invented by was invented
probably late like 70s or in the 80s in the in the US stock
market. Then there's this famous like
black shows formula as got invented and then suddenly this
becomes a very, very popular product because all the banks
suddenly have the tools, have the quantity models, the price
of risk managed and suddenly becomes really popular.
And now if I, I, I if I remember correctly last year there was a
big boom in the US stock market and options volume actually
surpassed the volume of spot stocks, right.
A lot of investors buying this like a zero day to mature, zero
day to expiry. So basically same day expiry
options to to basically take like a betting now now like a
very high leverage short term betting right.
So options market grow from zero to now the probably the biggest
financial products at least in traditional markets over the
last I think 40 years. And then over the last 20 years
there's all this very all these like rapid development around
even more sophisticated structure products initially all
led by French, French engineering engineers with a
very great like great math skills.
And then they invented all the new models to price all this
really stuff, scheduled stuff, right.
So people making money from these products, plenty of
examples. You have a lot of like very
sophisticated hedge funds for example they they trade venue
options but they also want to trade very specific payoff.
The example I said earlier for example, you won't have this
like for example you want you, you think that the on the line
will go up but you will not actually exceed the certain
level. So you actually add a knockout
barrier. So then the the product becomes
really cheap, but maybe it's only like 1/3 or quarter of the
price if you buy it compared to a vanilla option.
But then you achieve the same return in the end, right?
So you your return your your return will be 4 * 3 times or
four times more if you do exotic options.
There are also plenty of structure product that went
well. There are many that didn't go
well, but many went well as well.
For example in Switzerland there's a very popular structure
products called MBRC, so multi barrier reverse convertible.
They are every day they are like 4000 different MBRC listed on
Swiss exchange for example. There's very popular product and
linked to different underlines like stocks, indices or
commodities. Surely over over over the years
there are investors who made money but also there are times
where you know the underlines went down and then investors
lost money. I think structured products they
they they don't mean that they will help you make money more
often than you know than than simple products but that's
definitely not true. But also at the same time I
don't think they are necessarily more dangerous either because in
the end of the day your your risk is similar.
Your risk is you are long or short on the line right.
It's just that the payoff got like changed, adjusted, tweaked.
So yeah, it's really depends on the, on the, on your use case,
right. Some of the companies for
example, they use some of the hedging solutions and then
achieve the really good results. So they just systematically
hedge their financial exposures or their receivables, for
example, and then they definitely achieved better
financial results than if they did not hedge at all.
So for me like the flagship story of the this structured
products market as an entrepreneur was it's like this
story I've heard of Mark Cuban. So he's he's like this
entrepreneur that appears these days on Shark Tank or used to
appear on Shark Tank and then there was this TVC, it's called
Silicon Valley. And then there was a billionaire
in that billionaire character in that the TVC is called Ruse
Hanuman. And that character is kind of
modeled on Mark Cuban. But the Mark Cuban story was
like he he made a sort of like $1,000,000 or like couple of
$1,000,000 in one startup and sold that startup in 1989 and
retired like at the age of, I don't know, 27 or 28, he was
like, I'm I'm going to retire and then 1991 the he, he he
somehow comes across the http://web and it's too early,
but he's intrigued by it. And then this guy starts to
eventually build a business which is called broadcast.com.
So in broadcast.com what he does is OK, it's a simple idea, it's
maybe even a dumb idea. It's like radio on the Internet.
Like could you go to a website and just listen to the radio
website? That's what he starts and it
starts to get some usage as the 90s past broadcast.com booms and
then it gets IPOs and lists on the on the public market, I
think New York Stock Exchange and it lists and a few days
later the.com bubble crosses a value of a billion dollars like
and it ultimately goes like 3 or 4 billion mark.
Cuban personally becomes a billionaire in the public
markets. Then then Yahoo appears and
Yahoo is like we want to buy broadcast.com and so Mark Cuban
hashes out this deal with deal with Yahoo.
Now in this deal The thing is like he has to go and work for
Yahoo for a while after the sale and he gets Yahoo stock.
In exchange for broadcast.com stock.
He does. He gets some cash, but the
majority portion is stock and then the stock is illiquid for
three years. And this is now I think 1999 or
late 1998. And he's sitting on a billion
dollars worth of Yahoo stock. That's illiquid, That's booming
a ton in the.com bubble. And Mark Cuban's like this is
going to crash, but I don't have the Yahoo shares and so I think
he goes to one of the investment banks and.
He actually the investment bankers create a structured
product specifically for him which behaves like a a caller
meaning if the if the Yahoo stock falls down in price below
a certain price he will make in three years or whatever that
minimum level of of of price. So if he if he entered into
trade with a billion dollars, the worst position he can get is
maybe you know $950 million. But on the other side, because
this kind of insurance is being provided on the other side, if
the Yahoo's stock night double S from a billion to like 2
billion, he might only make 50 million of those.
So it's like, so his kind of payoff is bounded to a range of
950 million to 1.05 billion and he does that kind of that kind
of trade. And and the interesting thing is
that the underlying collateral that he has is completely
illiquid like is, is, is like it's like this Yahoo stock and
then the outcome bubble does collapse and mark you what ends
up looking like a genius. So, so that's that's that's like
the first point in my life when I read that story and was like
oh wow, like you could if you have like some asset in which
there's constraints or you have an interesting view about the
future like X will happen but not Y, then you could convert
that view into a a trade in the in the markets essentially
that's what like the structure products allow.
Yeah, So what you mentioned like a colour is a very popular
structure, obviously using vanilla, simple vanilla options.
It's a very simple combination of vanilla options.
You buy, you sell a coal to cap you upside at the same time you
buy a put to protect your downside, right, which is very,
very popular for this type of hedging purposes in your
particular case, obviously I I'm not very familiar with this
story, I don't know depending on the exact agreement he had with
Yahoo like she may or may not be actually allowed to do this.
While you know like in most of the these days like investment
agreement or like merger and acquisitions when you when you
you get the shares or you get some equities in a different
company and then there's usually a vesting schedule right.
And then before your shares actually got vested you you
can't you're not allowed to hedge it as you are not allowed
to shorten sell it in any form so.
So I'm not very sure about the exact agreement he had with
Yahoo. But then these days these kind
of things especially in traditional finance, I think is
people like check it very closely, yeah.
Yeah, yeah. So I'm just checking the
Internet like this story is genuine.
He hedged 1.4 billion in Yahoo stock.
Yeah, maybe she's allowed. He was allowed to do that.
But yeah, I think usually when your your your shares are
locked, when your all your tokens are locked, they're
locked for a reason, right today.
And then you should start selling it through other ways,
other means that basically defeats, defeats the purpose of
locking it or although vesting schedule.
So I don't know, yeah, but good for him, good for him.
He like he he managed to manage to hedge his positions very
successfully and at the right timing.
Right. And I mean, that's what the
Internet says. Now.
I don't know the details, but you can find the story on the on
the Internet. Like the listeners can find it
if they want to see. Yeah, Yeah, Yeah.
So, I mean, so on a similar way in like maybe, maybe like let's
kind of think of a recent crypto market event, right.
Like, I mean the recent crypto market event is kind of like,
OK, the ETF will get approved or not.
This Bitcoin ETF will get approved or not.
And now there's like increased speculation about whether
there's been Ethereum ETF or not.
So like, yeah, could you give us some examples of structured
products around the how, around the Bitcoin ETF and like the
kinds of kinds of exposures people could have constructed
before or before the event with with Orbit?
Yeah. So now there are two big things.
Well, that there were three, now there are two.
So we have the BTCETF that is already done.
Then we have the hub incoming as well.
Then we have the BTHETF news. So these are the that that could
be the catalyst that triggers a next, the next leg up.
So we've seen actually a lot of interest from our clients to to
buy tokens in actually more towards the outcoins.
So the the general thing that we have observed is like a lot of
buy interest in large layer one tokens, right.
Solana obviously is a is a star and then we also have seen
people buying Cardano RX. The other part, the other area
where a lot of buying trusts is, is the some of the L2 tokens and
that's like optimism and Arbitron and then we also see
some of the interest in newer L1 tokens as well.
So how to actually, how to position yourself actually into
these events? I think one very classical
structure of products is called accumulator.
So as the name says, accumulator is actually helping you to
accumulate a certain underlying. So this product is not invented
for crypto, it's not specific crypto.
It has existed in traditional finance for many, many years.
People use it to buy shares like Tesla shares, Amazon shares and
now we have actually basically replicated in crypto and then
you can use the same structure to buy tokens and it gives you a
discount versus the current spot.
For example, Solana spot is at 100.
If you use accumulator structure then you can buy Solana tokens
at for example 75. So it's a big discount.
How do we achieve the discount is always there's no free lunch,
right? We're not like just giving money
free money away to people. So it's achieved through this
engineering of the structure products.
It's achieved through two things.
One is this, there's a knockout, the knockout feature.
So if Solana price goes up above a certain barrier knockout
barrier, then the trade will will be terminated, meaning that
your game will be limited, right, Because you you if the
spot goes up a lot then you stop buying.
So your game is actually limited, but but you're on the
other side, if the spot goes down below 75, then you still
have to buy, and you have to actually buy more Solana at 75.
So this is obviously creating an asymmetrical payoff, right?
Is obviously asymmetrical. Your your gain is limited, your
loss is actually doubled or unlimited in a way.
And because of this you get to buy the token at the big
discount, OK. So this obviously has risk where
it doesn't come without risk. So the risk is that if the price
goes down a lot, you still have to buy the same price, right.
But then this is this strategy could be very good for those who
really want to buy Solana at. If they are, you know, if they
are comfortable and they are OK to buy the AT at the 75, then
it's fine, they can because they will just be buying 75.
Especially for those who are, you know ready to buy Solana at
the car is about 100. So why not, why not, you know,
give yourself a chance to buy a 75, right.
So it really depends on use case, right.
So if you are purely speculative, like I'm just like
going to speculate, then maybe this product is not necessary
for you. But if you have this
accumulation mandate, you just have to buy.
For example, you have a law, you you run a law only fund and this
is actually a very good strategy for your fund.
Right. So if like somebody has the view
that Solana will be amazing, right?
Like a crypto bull market is coming, it's going to go from
100 to 500 and like this like there's 80% chance that will
happen and then there's like 20% chance that it's going to stay
range bound like between like I don't know, 60 and 120, that's
their view, right? Like so if if somebody is coming
with that mindset, then this person could say, well I don't
believe Solana can go lower than 60 and if I need to buy more at
75, I'm willing to buy a lot more at 75.
But in exchange for accepting the obligation that if it falls
below 75, they will need to buy a lot more, they can instead of
buying at 100, they might be able to buy at 80 or or 85 or
however the contract is is structured.
So essentially because this individual has a individual or
even firm, this could be an entire firm.
It could be a central bank for for for all that matters, right?
Like because there's a certain view that the odds of Solana
falling to less than 60 in the next X or Y months is, is very
low because they have that view, they can sort of like monetize
that view or try to monetize that view in the form of like
this kind of structure like that's the that's the essential
idea. Yeah.
So I think the idea of structure products is really that you can,
you can do trade that exactly fits your precise views.
For example, just now your view is that Solana price will stay
around here. You will not really fall
massively below 75. It may stay here then that's
perfect. You just keep buying a 75
through the structure. So most of our clients who
traded accumulator last year all performed very well, right,
because the spot is going up gradually, slowly and then they
just keep accumulating at the at the discount.
If your view is that Solana will jump to 500 next month, that's
fine. There's there, there, there will
be a different product for you, right.
So we've seen clients buying a very low delta option.
So you can buy basically a one month maybe 200 strike Solana
cores for for virtually nothing like maybe just you know like a
few like maybe a few basis points, a very small price and
then if you're right then you can make a huge return, right.
But obviously the chance, the likelihood of you winning is
also very low, right. But if you have like a really
strong view that this talker will just shoot the moon next
month, then you can also, you should also try options.
Because if you buy options you will always spend a very tiny
amount of premium because you this this option would be like
super cheap because the core strike is very very far away and
then if you're wrong you just lose.
You know the premium which is very cheap, but if you're right
you can get huge profit you. If you do this using using curbs
or using futures, you have a lot of risk, right?
What if it doesn't go up? And if it goes down, then you
will lose a lot of money, right? So I think that's where options
actually comes in. Quite useful for some of the
investors with very specific market views.
So previously in this call you mentioned like the case of like
minors being being users and could you like give an example
of how cryptocurrency minors could could be users of Orbit
products? Sure.
Like we we have clients for some of the clients are even listed
miners and then they again the idea of hedging like for miners
is actually also from inspired from traditional finance.
In traditional finance you have like the oil producer, you have
the gold miners, they also have this exact demand for hedging
their production or their inventory of oil, gold.
So we basically used very say similar structures for the
miners. They can use like very simple
structure as you actually earlier mentioned like a color,
you can sell a core option on Bitcoin price and then you buy a
put right. And this way you are you know
like you your your risk is actually limited within this
range, right, Because your upside is kept, you are giving
up some of your upside gains at the same time you are you are
protected on the downside as well.
This is very simple structure obviously.
But then we also have other type of structures that helps miners
actually sell their tokens on the regular basis at the price
that is better than the than the spot price, right.
So for example, one of the products called Target
Redemption Forward which is from traditional finance where you
can actually sell your for example, right now the the
Bitcoin that 42,000, you can sell Bitcoin at let's say 47,000
Every week you can sell 47, seven thousand and then if if
the spot is below 47,000 you sell 47,000, if it's above, you
still have to sell at 47,000 and then you just count the number
of times where you make money. So.
So if this week is below 47,000, you count one time and then the
next week if it's below 47 that you count 2 two times and then
when this count reach let's say five times, this trade will
terminate. So basically the if the spot
stays at 42,000 every week for next five weeks, then you just
keep selling at 47,000 and then the trade will expire.
The trade will be able to terminate right?
But then if the spot goes above 47,000, the count will not
accrue because the count will stop.
It cuts only if it's below, right?
So it will not stop and then you will still have to sell at
47,000. So all these structure products
in a way is trying to create an asymmetric payoff, right?
And then because if you you accept this asymmetric payoff,
then you will be compensated with a better strike than the
current spot. So in this Bitcoin case, it's
almost like if the market is kind of range bound like going
up going down and it like and it's it's crossing the 47
barrier many times that's the case that might be bad.
All these type of trades, right, Your view has to be have.
You need to have a bit of range bound view.
You need to think that the spot will stay around here.
You can go up a bit, you can go down a bit, that's fine.
But then if your view is, that spot will.
Let's say if your view is that Bitcoin will go to 100,000 next
next month, then obviously you shouldn't hedge.
You shouldn't do any hedge, right.
You should just hold now and then you should probably
increase your long position, right.
And if your but if your view is that you will stay in this range
around the like below 47,000 up and down slightly then then
that's yeah then these products can be useful.
So there's there's no like there's no product that will you
know be the perfect product that will that guaranteed to make you
money that doesn't exist. So you always need to have your
views. So we we we have like minus
client who you know have a good size of the market.
You know they they they they put on some hedges when they think
the market is like top ish. So then for example before the
ETF news right their their clients selling bitcoins back
then like that then yeah all these trades went pretty well
because now the Bitcoin price has come off right.
So on your website I saw a a product that that felt really
cool which is kind of like the hedging UNISWAP V3 impermanent
loss, right. So maybe to provide some
background, when you provide liquidity to UNISWAP pools or
maybe not just UNISWAP but similar mechanisms like Joe or
Trader Joe's or Avalanche or something AMM.
Then then there are these cases in which.
So the essential idea is if I'm if I'm supplying 2 assets ETH
and USD, my best case is that ETH does not move against the
USD. The more these assets move
against each other, the worse my performance could be compared to
like maybe just holding those pair of assets 5050 or something
like that. And so like the quantification
of how much worse my position is in A in an AMM compared to what
would have what I would have achieved just by holding them
5050 is like this called this imponent loss and and you have a
product to hedge that like. So could you explain how it how
it works? Yeah.
So as you just explained, so your swap or this like yield
farming was really popular right in in 20, especially in 20 and
two or last year, still a little bit, but the all the liquid
providers, they face a big problem, right.
So initially they just look at the yield, but then they realize
there is a, there's a cost, the cost is actually implemented
loss, right. So you basically have a question
on one side, you earn the fees from the protocol from UNISWAP,
on the other side you will lose implement loss.
So how do you actually hedge it? So the implement loss, as you
said, is actually, at least for UNISWAP, is deterministic.
There's a formula, there's actually a deterministic
mathematical formula that calculates the implement loss.
If you know the initial spot level and the final spot level,
then you know exactly how much is the implement loss, right?
So for us we actually when we start to look at it, we realize
that this is deterministic. So it's actually just an option
or derivative in a way is not a normal derivative, but it is an
exotic derivative with a very special formula.
But in the end of the day is a formula, the payoff is depending
only on the final price and the initial price.
So we by that time we did build our model to you know like run
all the Monte Carlo simulations and then you know, so that we
can actually price any payoff. So not just like the regular
European value option payoff or the futures payoff, we can price
any payoff. You write me a math formula that
depends on the final price. I can actually calculate
expected value of that formula as of today, right.
So then in the end we realize that OK, it's nothing but just
exotic exotic option. So there we actually can price
this option, offer it to clients and then we have the theoretical
value of this option. So the clients basically they
can pay us an upfront premium, let's say 1% is unknown fixed
cost 1%. And then at the end we will
reimburse this clients the actual, the actual input, the
loss and how do we hedge it, right.
We we obviously not just taking the the other side and do
nothing that is not what we do. So we actually have to hedge it.
So we hedge it as if it was option, right?
It is actually an option. So we will decompose the risk
into the the Greeks, right, the delta Vega and all these risk
and then we will hedge this risk accordingly using Perps, the
options etcetera. So we we have this basically a
very quantitative and scientific framework for us to decompose
the implement loss risk and then to hedge it in the market.
Yeah, that's really cool. So the essential thing is if
somebody wants to provision liquidity to a pool and they
expect the fees that they earn from provisioning liquidity are
going to be high, higher than probably like the market
expects. And they're willing to give us
some of the give up some of these fees in order to protect
against the impermanent loss. So if you have a pool where the
essential structure of it is, is there's two assets, you expect
volatility between those two assets, right?
Like you expect one of those assets to move quite a lot
against the other assets. So there's underlying
volatility, but you also expect a lot of fees to occur.
Then probably for such a user, it's like giving up some portion
of their fee income or maybe all of that fee income in order to
protect against that volatility is kind of what your engineering
allows. Exactly.
So these two things are usually correlated.
So which means it is very interesting, right.
So if a pool is generating a lot of fees, usually the underlying
asset underlying pair is also a very volatile pair, right.
So so and and in the end of the day there's no free lunch as I
said earlier, right. So you you on one side, you have
the expected fees, so you you kind of do a research, you do
estimation, you you kind of OK, I expect to receive maybe 15%
annualized fee from this pool. And then on the other hand, I'm
willing to maybe buy protection, but then obviously the the price
of the production needs to make sense, right.
If like the production cost 20% annualized, then it doesn't make
sense. So maybe the price is 7%.
OK, then I buy the protection and then I'm left with 8% almost
risk free returns, right. So this sounds like too good to
be true, which again it is too good to be true because over
time I think UNISWAP, even though the UNISWAP liquid
provision is a completely separate supply demand system
ecosystem minds own. On the other hand, when we price
the protection, we are not looking at UNISWAP at all,
right? We're not looking at UNISWAP,
the size of the pool, the supply demand.
We are only using one parameter which is the implied volatility.
And the implied volatility is decided by exchange.
For example terabits, so terabit trays options which has the
implied volatility. So we are talking about two
separate completely separate supply and demand markets and
systems. But surprisingly all the time
these two markets are convergent, which means that
initially if you expect to earn a lot of fees from UNISWAP and
then you buy a protection from us which is based on derivative
implied role. Initially.
Let's say you you expect there is a bit of difference between
the two and then you can make money like you can, you are left
with the risk free returns. But all the time this return
will actually is actually disappear, right, Or at least on
the probabilistic basis, on the average, right, maybe on one
trade, you can still make money. But on average, you probably end
up with no, no, no return or no expected return at least, which
means that the market is actually getting efficient,
right. It's getting efficient, yeah.
So, yeah, I think in the end of the day a lot of the funds who
run this decree provision or yield farming strategy realize
that it's actually very hard to actually to make money if you're
just looking at the fees. Because in the end there in the
end of the day, your fees and the impermanent loss will just
be the same on average in the end or maybe you are left with a
risk risk free rate. Like if you are talking about
dollars, you are left, you make 5%, but you're not making more
than that, you're not making extra performance compared to
that. And so I think that this overall
yield farming strategies have become less popular over the
last one or two years and especially when the funding rate
of dollar itself has gone up so much, right?
If you do nothing, you just lend dollar, you'll probably get ten
1520%, right. So why bother doing all this
yield farming and then you still have to take the impairment
loss? Yeah, that's that's that's
really interesting. So actually like my curiosity is
kind of in all of these examples that we have taken, right, like
it might start from actually Mark Cuban example, but it could
also be the accumulator or the TARP or this liquidity
provisioning example. In a sense, when I look at the
contract between like one of your clients in orbit, the
underlying is the price of some asset, right?
It's the price of some asset against some, some reference
asset. Could the underlying be the
occurrence of an event? Like could the underlying be for
example a bridge will get hacked, it's a binary event or
an ETF will get approved? And can you do create, yeah,
derivatives or structures based on like events, not prices?
Or is that the role of a prediction market, not of
structured? Products, I mean what you
mentioned, what you describe is like buying a lottery, right, or
or or prediction or something like that.
Yeah, I mean theoretically is all possible, but we need a
primary market of the underlying asset first, right.
So when we do the accumulate, when we all do a TAFE or do all
these like barrier options, we need to be able to hedge the
primary risk which is the directional, the underlying
directional risk. When you say I want to run this
like whether ETHETF will be approved, I have nothing to use
to hedge my risk apart from taking your taking the other
side of you right. But, but if we can like some of
the like a betting house, right, they can still run this because
they try to adjust the the, the, the ratio, the odds right to
match both sides, right. They're not taking any risk,
right, they're just like a match the two sides.
So it's very different. So for us we still need to have
markets where we can hedge the underlying assets.
So for if for example if you have underlying, if you have a
market where people starts to trade the all of ETF getting
approved then we can create options and structure products
on top of that. But we still need to have a
market where we can hedge our risk first.
So that means like if you had highly liquid prediction markets
on crypto for these events, then you could do like these fancy
options on top and. We could, yeah, yeah, we could.
But the. Constraint is more that those
highly liquid prediction markets don't exist today.
Yeah, exactly. Yeah.
So, so right now I think those prediction market or prediction
products, I think it's still more the job of the like the
betting betting house, right rather than a trading desk.
So at the start of this interview, you mentioned that
you kind of like entered the crypto space in the last two
years and you founded Orbit, Co founded Orbit in the last two
years. And I think like that's an
interesting time, right? Because in this time first Terra
went bust, but then kind of like this Genesis went bust and this
Genesis was was a huge was a huge event because people
actually took counterparty risk against Genesis.
Like when I told he there is ideally no counterparty.
But in the case of Genesis Products, Genesis used to be the
counterparty and this huge counterparty went bust.
And you were also doing a business in which like in many
of these products, Orbit is a counterparty.
So how was that period like when the market was scared of
counterparty risk and yet you were building a business that
was based on counterparty risk? Yeah, I think that market is
still scared of counterparty risk, which is good.
I think at the beginning of crypto market people don't are
not really aware of this risk. But now people are very aware of
this risk and we are also very off this, this risk.
There are many ways to mitigate this risk.
For example, we have signed ESA, which is at the framework of
traditional finance, managing the counterparty credit risk.
And so we have actually signed this with many of our
counterparties, right? So 'cause then we actually just
managed this daily margin and collateral that I mean that
still doesn't remove the counterparty risk completely,
but it actually mitigate the risk significantly because your
exposure is very limited to mostly just your initial margin
and also some of the gap risk during the day.
But otherwise your exposure is collateralized the with the with
the collateral, right. So that's what traditional
finance use the framework, the traditional finance has adopted
to manage the counterpart risk. Traditional finance also learn
it after the Lehman Brothers crisis, I mean it existed
before, but it is really after Lehman and the great financial
crisis that traditional banks started to be become more aware
of this and then set up all these credit risk desk within
the bank, so the same. So we're doing this in crypto.
We also use this multi stick wallet solution with some of our
counterparties, right. In traditional finance you would
actually use a third party custodian bank to to do this for
you, right? So to sit between the two
counter parties and and then people basically send and
receive money to one from this custodian.
So in crypto we have actually a innovative solution, a crypto
based innovative solution to solve this problem.
So instead of actually involving a third party, they are third
parties obviously in crypto as well, but they are just not
financially as strong, as strong as the real custodian in
traditional finance right, Some of the custodian.
So instead of actually having to take their credit risk, why not
just to set up a framework between the two counterparties
directly using the crypto solution.
So for example, we use this multi SIG wallet, so we give for
example 4 total, 4 keys, 2 keys on each side.
And then for each transfer in and out, we need, sorry, each
transfer out, you don't need approvals.
But to transfer out of this wallet, you need, let's say
three out of four keys to enable this transfer, right.
So in this case, we only need to actually agree between the two
quarter parties and we don't, neither party needs to give the
money to a third party and then in that case, both party will be
exposed to the credit risk of that third party, right?
I mean if that third party was JP Morgan, I'm probably fine.
But in crypto there's no JP Morgan, there's no, you know,
there's no like big banks with trillions of assets.
So I I I don't necessarily trust a third party more than I trust
my counter party directly, right.
So then we actually use this solutions with many of our
counter parties that again greatly reduced the counter
party concerns and this is something that is actually
didn't exist in traditional finance and I think this is a
great thing. I mean traditional finance maybe
one day will actually also use this to save, I don't know
millions of cost of using a third party custodian because
that third party custodian doesn't do much more than just
you know sending the money you sent to me to the other party or
return the money back to you. And, you know, so there's
something that you can do yourself.
That's that's really interesting, right?
Yeah. Like somebody like you that's
coming in from Deutsche Bank, maybe this was not the first
thing you started off with, but you're like, OK, actually smart
contracts can provide utility in removing the custodian and maybe
saving you the 40 or 50 basis points on a particular trade and
maybe on a single trade that's not so big.
But then added across all of your clients that might end up
kind of increasing your gross margin of your business.
That's interesting. Absolutely, yeah.
So using like this kind of like smart contract collateral
management systems, you can address some forms of
counterparty risk, but not all of them.
Would that be accurate? Absolutely.
I I, I I think that it's impossible to remove
counterparty risk completely. You do a, you do a transaction
with someone. You have to accept some level of
counterparty risk. So you mitigate the risk by
doing due diligence at the beginning.
You need to know your contour party, right.
So then and then you have different ways to mitigate the
risk. But there's no way, I don't
think at this stage there's no way to completely remove it
without sacrificing efficiency there.
Obviously, there are ways to to remove it completely, but then
you will lose other things like efficiency.
You have to be fully collateralized, etcetera,
etcetera. And then if the whole financial
system runs that way, if everything has to be fully
collateralized in financial system, the financial system
doesn't work right, There's no efficiency anymore.
Yeah, nothing will will really happen and nothing will move
forward. So often in crypto that is I
come across this mindset that like people want to build
protocols for for financial products.
Right. Like in a sense maybe the
classic example is actually Bitcoin where it's like there's
a there's a thing the central bank does.
And Satoshi's question was almost like can just can you
just replace that with an algorithm And yes you can but
but then of course there has to be a new asset and it has to
build liquidity and and it's possible, right.
But often like you see like defy asking that question often right
like so overnight borrowing markets, can you do that And
then Robert Leschner asks that question and then comes up with
compound where it's like OK if he algorithmizes so overnight
borrowing, overnight lending part of it probably and then
that's that's compound. So what do you think like in
this, in the structure products on the market, are there parts
of it that can be protocolized like that or does it necessarily
have to be a human on the other side because like structuring is
hard and there is always going to be counterparty risk.
So do you think protocolization of of the market you are in is
is possible or is it intrinsically not possible?
I think it's possible. I think it's possible but is
very far from the current stage. I think we are still far from
there is possible. I think the problem we we
obviously work with some of the D5 applications and also I did
some research myself. I think the, the, the few issues
I think with the D5 applications right now first of all I think
it's the the efficiency, I think the the, the capital efficiency
generally pretty poor right. The traditional financial,
traditional financial industries thrives because of all these
capital efficiency. You have the custodian, you have
prime brokers, you have all the banks facilitating you know
lending, borrowing etcetera. You can rehabilitate the assets.
So it creates a really efficient market here to ensure security
and safety. Everything is fully
collateralized etcetera. And then this just is not really
viable in the long term. So to solve this problem we
need, I would say we need a very integrated and broad framework
for all the D fabrication. So that you know we can actually
integrate not just the 1D file on its own, but the D files can
integrate and be connected with each other and also with
exchanges so that your capital can be reused, rehabble you know
across different venues. But this I just don't see how
this is happening anytime soon unless some someone is leading
this effort to create a big platform where all the DIF
applications get on this platform including exchanges
including, you know other institutions.
This is number 1, #2 is I think the user experience is still
pretty bad these days with most of the DIFA app definitely not
designed or built for institutional players.
They may be OK for retail but for institutions like sometimes
like, yeah, we we just don't think that is good enough for
usable at all for our for our purposes right.
For example some of the protocols we make a simple trade
or transfers we need so many different approvals and the
like. It's just it's just crazy And
then if it's one retail guy it's fine.
He just approved for himself. But as a institution we have our
own approval policies and processes so it becomes really
bad. The third one and also the most
important one I think is the hack risk.
So the smart contract risk and the hack risk.
So this is the biggest problem, right?
I think even well established protocols can still get hacked.
So let alone some new app, new protocols.
So we we can't really be comfortable enough to put our
company's money in there. For example, a new protocol what
if it got hacked, right. So I didn't I I I don't know I
don't have the answer to this question.
I think the second one probably is probably probably the easiest
to solve but then the hack risk, the smart contract risk is kind
of inherent to this DEFY growth, right?
I hope like one day there will be better technology or better
ways to ensure that smart contracts are safe.
What's what's really interesting as a as a technologist here is
when it TDM was being built they were like I groups of dissenting
technologists that were like we should build smart contracts
differently such such that you know the properties of smart
contracts can be mathematically proven and and it actually it is
possible to build such systems but they lost out to kind of
like this Ethereum stack and the solidity where this is kind of
hard but maybe they actually now they're smart contracts are
proliferating more and more. We would have those kind of
ultra secure mathematically proven systems come to fruition
someday and maybe actually for the real trillions of dollars of
institutional money to come in and do fancy things with kind of
smart contracts maybe like that high level of quality assurance
is just needed and our industry doesn't have that at at this
stage. I mean we kind of pointed out
like these that even for you kind of like OK, using smart
contracts, the way you do structured products in crypto is
different from the way Deutsche Bank would do structured
products with its clients and you're using smart contracts
underneath. What are other such differences
that that exist in your, in, in your industry in like the side
of it and the crypto side of it? Like, are there other large
differences in the operating environment?
I think the the business model is essentially the same, right.
The business model and then also in terms of financial products
are also similar. We do have a few like crypto
specific crypto specific products like the AL protection
for example, but the overall largely they are the same in
terms of pricing. Quantitative models I would say
is also quite similar. The difference is here we try to
combine the best practice of financial industry and what's
crypto blockchain has to offer. For example, in traditional
finance things settle T + 2, SO two days later, right?
But in crypto like you can settle anytime.
So we for example, for all our clients and counterparties, we
settle almost instantaneously, right?
So, and then we also have this, the margin system, the
collateral system that runs 24/7 because the crypto market is
24/7. So that actually greatly reduced
the counterparty risk as well because in traditional finance
you send the margin call, you have to wait the next day or
sometimes and then you wait another two days for them to
send the Fiat currency through the banking system to hit your
account. So you actually exposed for like
2 days or or or more, whereas here we do it instantaneously,
we send the, we send the valuation or margin report
immediately and then we can actually exchange the culture
immediately. So that actually reduced the
counterparty risk a lot something that something for
traditional finance to actually also follow I think in the in
the in the future, right. And then you mentioned smart
contract, we also use some of the smart contract solutions to
manage collateral for example. And then I think what is most, I
think if we you're asking about the difference fundamental
difference I think in crypto in in in traditional banks, we
emphasize a lot on risk cultures, compliance and ethics.
I still think this is quite important like we saw how many
things went wrong in crypto over the last two years and how many
people went to jail, right. So I think what is really good
at investment banks is really emphasize these things we have
like compliance training every other week.
So this is kind of after working traditionally for over like 14
years, I have this like in my genes already.
So we actually really focus on this.
I think it's good, it's good in the long term.
We've seen that the the the industry is changing slowly
towards this. People are becoming more aware
of compliance and risks and and ethics, so I think that's some
encouraging changes that we have seen.
So beyond orbit any other interesting start-ups or
projects in the in the structure products or yeah, derivative
space in in the crypto industry? Well, I I I can't really speak a
lot about like other outside options or structure
derivatives. So focusing on this, I think
it's good that a lot of exchanges are promoting outgoing
options. So initially we've seen there
was there's only like BKCI if banned options for very long
time and now many exchanges new and the existing exchanges are
launching outgoing options. I think that's very good because
we've definitely seen a lot of interest in outgoing options.
We've also seen exchanges launching structure products as
well. So it's all very encouraging.
I think it's great that people push, promote these products
together. It's a big pie in just we just
grow the pie, the size of the pie bigger and and then there
there will be plenty of opportunities.
Yeah. So if you look at for example,
the trading volume, spot and perps and futures have all
shrunk over the last two years from the peak.
Whereas the only the option market is like the the only that
bright spot and the the volume keeps going up, which shouldn't
come as a surprise because this is just exactly the same path as
traditional markets took. Cool.
Yeah, it was great to talk to you Jimmy.
Any last comments? Or would you like to tell your
listeners like how they could find you if if they are
interested? Yeah, sure.
I think if you can just maybe add add a link to our website or
our, our, our yeah Telegram group something after this and
yeah happy to share more like about options and then I think
this is still the early stage of this option markets in crypto,
yeah. Cool.
And wishing you loads of success in hopefully a bull market to
come. Thank you very much.
Thank you for joining us on this week's episode.
We release new episodes every week.
You can find and subscribe to the show on iTunes, Spotify,
YouTube, SoundCloud, or wherever you listen to podcasts.
And if you have a Google Home or Alexa device, you can tell it.
To listen to the latest episode of the Epicenter podcast, go to
epicenter.tv/subscribe for a full list of places where you
can watch and listen. And while you're there, be sure
to sign up for the newsletter so you get new episodes in your
inbox as they're released. If you want to interact with us
guest or other podcast listeners, you can follow us on
Twitter and please leave us a review on iTunes.
It helps people find the show and we're always happy to read
them. So thanks so much and we look
forward to being back next week.