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UMA Protocol's Perpetual Contracts: What's Next for OpenDAO?
Bringing into DeFi the 500 trillion-dollar derivatives market, usually restricted to accredited and institutional investors, could open up many new doors for individuals and communities. Read on to find out more about UMA and OpenDAO's work creating perpetual collateral-backed stablecoins and a functional loan market on the blockchain.
Before we look at the potential for UMA and OpenDAO, we should understand what derivatives are and how they will function on DeFi.
Derivatives are a type of financial arrangement that takes value from an underlying asset. A derivative gives investors exposure to an asset without having to hold a share. Some examples include options, futures, collateralized loans, and prediction markets. These give people opportunities to interact with bonds, stocks and currencies without having to exchange or hold them.
Because of complex regulations and frameworks, the traditional derivative market has financial and legal requirements beyond the average trader's means. Banks don't want to offer people access to higher risk investment opportunities without the certainty that they will get their money back if the trader fails spectacularly.
Smart contracts can be laid out transparently and agreed upon by all parties. There is no requirement of wealth or privilege, because your ability to meet the requirements of a derivative contract are hard-written in. As an individual holding a collateralized loan, you can decide on an acceptable level of risk in the ratio of collateral you maintain.
Other projects like Synthetix rely on price oracles to provide data that will be used to settle or liquidate positions. This is a point of weakness that has been exploited to great loss for investors, and UMA has a different solution in their priceless, oracle-minimized synthetics.
“Priceless” contracts are designed with mechanisms to incentivize counterparties to properly collateralize their positions without requiring any on-chain price feed. These mechanisms include a liquidation and dispute process that allows counterparties to be rewarded for identifying improperly collateralized positions. Unless a position is liquidated, it is assumed to be solvent (properly collateralized). Oracles are only used when a liquidation is disputed — which is designed to be rare.
For the last several months, UMA Protocol has successfully facilitated the yDollar contracts for BTC and ETH, effectively acting as 3-month rolling collateralized loans. Minters of the BTC yDollar or ETH yDollar can trade out for USDC and use their money elsewhere while maintaining a position which will be tradable back for their collateral at the end of the period. Alternatively, a liquidity mining program is available to earn UMA tokens.
The current 3-month loan period ends in March, and the contracts have over 70 million dollars locked in them between the BTC and ETH yDollars.
UMA Protocol has just successfully finished the process of having their perpetual contracts audited. What this means is we will soon have the protocols in place to create a stablecoin backed by on-chain collateral.
In many ways it looks similar to the yDollar except that it has no expiration date. This introduces many more general use-cases for the technology, but it also requires a different solution to track the price of an underlying asset.
Conceptually, this is accomplished by continuous funding payments between sponsors and token holders to correct any price discrepancies. In practice, this is achieved by applying an incremental correction to the internal exchange rate between synthetic tokens and the underlying collateral for the purposes of liquidation, or settlement in the event of an emergency shutdown. The particular funding rate is based on an external price monitoring mechanism. Since the UMA Data Verification Mechanism (DVM) resolves too slowly to be used as a live price feed, the funding rate is introduced into the system through a new “optimistic” oracle.
The optimistic oracle is a simple incentive scheme built on the recognition that as long as a price request is well specified and the UMA DVM is functioning correctly, the final resolution is predictable. Instead of waiting for the DVM to resolve, requesters can offer a reward for anyone to post the price immediately, along with a bond. Anyone else can dispute the price and match the bond. If no dispute occurs within a short time window, the optimistic oracle returns the proposed price. If there is a dispute, the oracle reverts to using the DVM, and both bonds are sent to the vindicated party.
Each contract has configuration options which changes the way it interacts with the oracle. The deployer can choose parameters like the size bond required by price proposers and how long changes to the contract take to be enforced. Users decide if the terms are agreeable and interact with the contract to the extent that they want to – by purchasing or minting a stablecoin, for example.
In the past couple of weeks, OpenDAO has been preparing to expand the platform built upon UMA to include stablecoins built on the new perpetual contracts. DSD (Dynamic Set Dollar), Ocean, and Elrond Network are just a few projects with which OpenDAO is collaborating.
For people who hold some of these currencies and believe in their success, using your bag to mint a stablecoin can allow you to "go long" on your investment while utilizing your capital for other purposes. It functions as a trustless collateralized loan with certain requirements for you to maintain to avoid liquidation of assets. You might use this to buy a car, get effective leverage on an asset (with additional risk, of course) and/or to take advantage of liquidity farming and other reward programs by UMA and OpenDAO.
OpenDAO will eventually take tokenized off-chain assets like real estate and stocks as collateral similarly to the cryptocurrencies. Each asset will have its own rules and protocols in place to protect all parties interacting with the contract. This technology could, in theory, allow people to get things like automobile or home loans from the community via a decentralized protocol, rather than interacting with the bank or government which will always be in a position of power in negotiations.
A much more effective stablecoin, USDO, will derive its stability from a simple pegging mechanism. OpenDAO's liquidity and loan markets will build around increasingly off-chain assets which will be coming over the next year(s). Unlike MakerDAO which depends largely on ETH, this stablecoin's value will be secured with assets varying from off-chain to on-chain.
Perhaps more exciting, is the project's plans to create stablecoins for other national currencies, targeting countries with large populations of young, technologically literate people. Introducing a national stablecoin with the OpenDAO DeFi loan and derivatives market to a country with an unhealthy economy, could allow individuals to gain some level of freedom by interacting with the global decentralized economy. I'm excited to see where this technology leads us as a community, and I think it has enormous potential to evolve the way we interact with one another across the globe.