In this episode of Exit Liquidity, we are kicking off our Derivatives for Degens Season joined by Nate from Adjacent. An expert in on-chain derivatives Nate gives us his insight into the beginnings of the derivatives ecosystem, his favorite player, defining terminology, and exploring the future of the sector. 

Time Stamps
(0:00) Being Exit Liquidity
(10:00) Defining Terms 
(30:00) Deep Analysis
(45:00) Q&A

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Disclaimer: Nothing said on Exit Liquidity is a recommendation to buy or sell securities or tokens. This podcast is for informational purposes only, and any views expressed by anyone on the show are solely our opinions, not financial advice. Cedo, Ali, and our guests may hold positions in the companies, funds, or projects discussed.

Exit liquidity, where you find out how not to be fucking exit liquidity.

Before we hop into that, I want to hear a little bit more about kind of your background, the classic of your start in crypto.

But we kind of center this question around the theme of the podcast, which is obviously exit liquidity.

So could you just give us a little intro on your background and kind of some of the best moments that you were eggs of liquidity or most memorable ones?

So I think my entrance was a little different than probably like a lot of people.

like around the spring time was, I don't know how many people like know this or, or, or remember, but Turkey banned Wikipedia access to, to all those residing in Turkey.

And I remember that just kind of being like a pretty like big like news article at the time.

So I kind of like filed the article and like at the end of the year, I kind of like review a lot of stuff I've saved, you know, throughout the year.

So nothing really happened like in for the rest of the year.

But when I was reviewing it in December, and just kind of like reading articles around the banning of Wikipedia in Turkey, a big thing was IPFS.

And it was kind of like a moment for IPFS to shine where they self-hosted a copy of Wikipedia for Turkey citizens and they could access it in a decentralized way.

And to me, that was just the exact use case that I feel like a lot of applications within crypto strive for, but it was just my first showing of it.

So from there, I don't know how many people really get into crypto through IPFS, but from there I just kind of started researching things around that or adjacent to it.

And pretty quickly found Ethereum, got on the way of programmable money.

Obviously, like Bitcoin kind of came with that.

And, you know, at the end of that year, right, was when everything kind of crashed, you know, at the end of 2017 there.

And I, I entered like literally right at, like right after the crash.

And then I think like maybe it was like 8, 10 months after that was when I kind of really started seeing interesting applications around Ethereum.

I think 1 of the first ones was Chai, which is back live again.

It was just token wrapper around the DAI savings rate.

And then I just kind of got into programming some smart contracts and all that.

And I finished up college a few years after that and just focused on learning about DeFi stuff, trading, researching it, operating various infrastructure and programming around it.

I'm trying to think, I think like throughout the past few years here, like the overall theme for like where I would, I'm exit liquidity is, is like markets that I am just not familiar with.

Like, I think a really important thing is to kind of like find your niche within crypto and stick to it.

So I've gotten consistently hosed on NFT trades and within NFT markets, just not understanding value within that market or just the various participants in it.

So through that, I've just kind of figured, you know, stay in my, stay in my lane, stay to what I know and what I like.

Cause that's another thing I think that's pretty important too, is, is kind of like, you know, being involved in, in, in markets and, and like projects that you're personally just interested in and passionate about as well.

I think the introduction to crypto through IPFS is pretty interesting.

I think that's like a great summary of like a person's character, honestly.

I think it's a quite special introduction.

Like focusing on a niche in this sector seems kind of not really done often.

I know I have even now and especially early on.

So we're gonna get into derivatives here a bit.

To set the stage a bit, I'm sure a bunch of people have read or kind of browsed Ali's work on this topic.

He's definitely more well-versed on it than I am.

And so the way I kind of want to approach this is like a bare bones introductory aspect, kind of allow people to be able to listen to this episode at any point and follow along throughout the rest of the season when things get a little bit more complicated with different protocols.

So if you could just kind of give us like a high level overview of derivatives contracts in traditional markets and how they're mainly used, like the main users, institutional or retail, and like highlights of the different products.

And I wanted to ask specifically with this question about if you have dabbled in that sector a bit and like what was your introduction to it there?

So I think that this maybe isn't a like that uncommon of a thing, you know, now in 2023, but maybe back around

So I had actually never traded any derivatives at all across any trad market.

I had some stocks here and there, but options or futures and trad markets, nothing.

And my first introduction to it was trading on this first wave of derivative protocols within DeFi.

So we're talking like PERP V1, we're talking like Hedgek, or even early prediction markets like Augur.

And I think that through trading some of those, I just was like, all right, well, what does it look like from the side of the market where there's actually more participants, far larger volume, far larger activity?

And then I started dabbling on more of the trend side.

So with regards to the first part of your question around just what is a contract and kind of what are some examples of it, right?

I mean, like the super like easy, or like more like succinct answer, right?

Is just like any type of like derivative contract is just some financial agreement that's like generally on top of an underlying or a spot asset.

Generally, it's used for like hedging, like managing risk or, you know, like speculation on top of the underlying without needing to actually own the actual asset.

Through various derivative contracts, you can often have more efficient leverage.

You can more accurately trade your preferences with regards to time and price.

So some super common ones that are widely adopted are futures and options.

And then you can kind of get into even more super, super niche contracts that are much, much, much more so OTC based between a few parties.

But generally, features and options have pretty liquid markets within Trad5, of course, but also obviously increasingly in the past few years here within DeFi.

So often, whatever type of contract you're trading, it usually lets an investor the option to gain exposure to this underlying asset in a market where they might not be able to easily get exposure to it, which can be for many reasons, which I'm excited to talk about towards the end of this episode.

But it can become super interesting when you want to start getting exposure to validators or miners and their infrastructure.

You can't really get direct exposure, but you can get derivative exposure on top of them.

Or within DeFi here, it can be hard to reason or think about how you would get direct spot exposure to change in gas prices or something like that.

So like in this case, like a derivative contract makes a lot of sense on top of it, right?

I think that's, I don't know, for me, that's surprising that you gravitated towards the on-chain products even before you were interested in the TradFi ones, just because I think it's just not fully fleshed out enough for it to be the only introduction.

When you first kind of tested, I guess you could say these early products and these newer products, What was that experience like?

Was there like, a big shift into what we have today versus how it started and maybe tap into some of the protocols you enjoy now, why you enjoy them?

Any kind of special things that you mess with today?

So I mean, like, I, it was kind of funny, because like, when I got first like started on some of those like early protocols, right, like, I didn't really know what I was looking for.

Like, to me, it was like an entirely new concept, right?

And then like, obviously, I looked it up.

And I was like, oh yeah, these exist within like trend markets and stuff.

So I mean, on initial usage, I didn't really know what was good or what was bad with it.

But over time And as I started trading within traditional markets as well, I can kind of start seeing that.

And obviously we've seen over the past few years here, stuff drastically improved with regards to just number of markets, if we're talking about fixed derivatives, or fixed time, increased number of expiries, just better liquidity, tighter spreads.

And I think that we, we, we can, we'll, we'll move into this in a little bit, but like, I feel like, or we can move into in a little bit, I feel like.

Kind of like the overall shift towards hybrid, like, or like a mix between AMMs and order books has been a really strong driver over the past year or 2 here, along with the push for these, like, rather than these exchanges to just kind of like write all of their contracts and just kind of like throw it on top of Ethereum and let Ethereum kind of operate all infrastructure, this push towards these exchanges owning some part of their infrastructure, whether that's like an app chain that they run themselves in sequence, or it's something like an off chain, keep her network or a set of fillers or et cetera, I feel like both of those weren't really like strong concepts like 3 years ago, but now they're kind of like the adopted norm or getting to there.

And that has just generally improved kind of like the overall experience across them.

So I have 2 like favorites right now, which are on the perk side and on the option side.

So I think that for a lot of what I just mentioned on the Drift side, I think that they have built out really interesting and ineffective routing around an order where when I first place an order, it'll go to their direct to a market maker auction, which would give best price execution, or it'll then move into this off-chain order book that they have via their keepers.

And if not, your order will just always get filled against the VAM, right?

Which I think is a very elegant way of building around some of the risks of a VAM, and also allows for more niche markets to exist and exist well, just given you can ensure good price execution.

But if not, it'll just get filled by the passive liquidity providers.

And on the AVO side, I think that like, you know, like I really like that they kind of incorporated the OP stack.

I think they have some of the top designers in the game.

Like the UX is really fantastic all the time on everything they've kind of put out.

I think with Zeta having like their futures and options paused and just having their perps, Avio is the only exchange to have integrated perps and options.

I'm not entirely sure on that, but I'm pretty sure, which is obviously a really nice thing to have when you're kind of like trading them together.

I also think that like Avio definitely has a pretty good start given just like the amount of liquidity that they have gained across their vaults on the Riven side.

So like, you know, they're going through this like token merger and stuff.

But like, as they like, as they like incorporate the flow from the vault into the exchange, I think that would be pretty, pretty powerful as well.

Yeah, I think those are definitely some good ones.

I wanted to kind of double tap into bringing these products on chain.

I think it's a very basic question and a very big 1, but it's 1 I think is gonna be like a theme across a lot of the protocols that we discuss.

At the very top, like the overarching question is, why do you think these protocols and these products need to be on chain?

I think with lending and borrowing, it's a little bit more clear around like the ethos of crypto and DeFi in general.

But with these specific products, what are the things gained when they're brought on chain besides like the basic decentralization?

Are there any extra features or cool things that product protocols are doing that they couldn't do if they weren't on chain?

And do you see it as like a better product?

Can it, Can an on-chain product be better than an off-chain 1?

Yeah, I think definitely an on-chain product can be better than an off-chain 1.

I think that right now there's not that many that are.

But I think that as you think of the benefits of being on-chain, right, outside of the decentralization piece or outside of the transparency piece or the access side, a few of the things that you get are obviously you have like really strong composability between a lot of these products that like in turn build out, you know, things that like might be possible, like off chain, right with like agreements between like multiple parties and stuff, but like, you can kind of like remove a lot of that trust and just like compose yourself or like the teams can compose together.

And you can have like kind of like, pretty interesting things like just because I see Z on here, like I think like Draft released like a few days ago, like this like leverage, like these leverage swaps, which were like composed across a few different protocols, which was super interesting.

I think outside of that too, outside of the composability, you can also build more efficient structures, particularly around newer markets.

And not to keep going back to some of the stuff that we've been saying around just VAMs and new market discovery, but the ability to build structures around like passive LPs, create vaults around it, you know, utilize kind of just like, like various like oracles to kind of like build markets around assets that like just generally would not have 1 like in a given trad market is really powerful as well.

I think that like, there's definitely a lot of things that you can say, well, like, you know, just like talking about just like various like med stuff or just like slower transaction speed or worse price execution.

There's a very, very long list of things that are worse.

But I think that as new teams continue building out the next generations of their exchanges and their products, all of those become less of a problem.

And in turn, we're given transparency, access, composability, and the potential for more efficient structures.

I want to, you've mentioned drift and VMMs a little bit, and I think that recently especially that's been a pretty hot topic with FTPerps on setting for V2.

And then obviously, you know, I think Biggs was actually the 1 who he's listening right now is the 1 who wrote that thread about conflating good VMM with bad.

I'm wondering if you can, I guess, explain real quickly what a virtual AMM is and kind of what your take is on that debate, whether you're on the side of, you know, it's inherently flawed, it's still a new technology and has a lot of promise to it, it just needs to be implemented right?

So like the like VAM versus like not VAM debate is like kind of like this month, like AMM versus like club debate.

And they're like both like all kind of similar.

I think like in the past I've shared that I'm not really on the side of AMMs or on the side of clubs.

And similarly, on the to VAM or not to VAM, I think that it has its use cases in being implemented or not being implemented.

And I think that ultimately a combination of utilizing a VAM as part of your exchange alongside more traditional order books with an off-chain network or something like that, yeah, is the way to go.

I can see how it's very easy to point out the risks of improperly developed fans, just with regards to, I don't know, I think you probably named like 3 or 4, like obviously like NFT perp v1, and like drift v1, or like perp v1, like a lot of the initial implementations did have some problems with regards to their insurance fund and payouts.

And each protocol handled those a little bit differently, or their sunsets, or their pausing, or migrating to their V2.

So it becomes a pretty easy thing to say that due to just like certain implementations, like it can very easily just drain an insurance fund and like traders kind of like cannot get out of the exchange.

I think like Noodles or CryptoNoodles wrote really well about this and it was like VAM, PVP, perpetual Ponzi or something like that.

I think that was a great article, but I think that it's very hard to understate the benefits that a VAM gives you, which is just like more, it's more efficient.

It allows you to trade virtually any price feed or Oracle, which isn't necessarily like a thing that you can, you can do quite easily with like a given spot market.

I think, you know, like a few things to think about are like the majority of perfect exchanges that have gotten like significant traction within DeFi, right, are like, generally, VAM based, or have components of it.

Yeah, I guess like, I think that like, it's, it's, It's something that is going to be utilized in the future.

It's just a matter of taking the good components of it, implementing it, and then incorporating it into an overall exchange that features other components of, could be a spot AMM, could be like off-chain club, I think all of this stuff is just going to be mixed together as we kind of see the like pros and cons of each 1 as, as like more protocols, you know, are, are, are built and fail or succeed.

I think 1 interesting thing was, I think this was maybe back in.

Missari conference in New York, the co-founder of, I remember being at a talk with the co-founder of Perpetual Protocol, and he ended his talk, he was just giving an overview of Perpetual Protocol, and he ended his talk saying that the next 2 to 3 years are going to be huge for VAMs, and that they are going to be a very significant component to the majority of exchanges going forward.

And it took me a while to think about that because at the time, I think that they had an archived post of what a VAM is.

So there wasn't really much information on it or anything, but it's cool.

It's kind of cool to see now like in the last like few months here, like the conversation around it has really like heated up.

I think There's a lot at play there that I think still has yet to be filled out.

I think my kind of like simple thesis there, which I apply to a lot more than just perps, is just that when you have a new novel technology like this that's being implemented in different ways, it's just gonna take time before we see anything that really gets it right.

I feel like you can apply that to like NFT finance, like all L1s, L2s.

I mean, people are always, always trying to dunk on Solana, but I think that that's like, you know, the biggest thing to have going for them is just that they're early and that people are, I think people are holding them to, are trying to hold them to too high a standard before they should.

So shifting over to options a little bit, I think I kind of have the same view there.

I'm wondering, You mentioned you like AVO.

The ribbon integration is obviously really exciting.

I think that's, I mean, it's clear that that's going to do a whole lot for their volume and subsequently help everything else.

Where do you stand on what the future of options needs to look like, on-chain options needs to look like?

What will kind of get us more adoption in that sector?

And what do you think is like a fair timeline for something like that?

Yeah, we're just like super like, When you kind of narrow down the DeFi derivatives market just into the option side, it's just like super interested and fragmented with tons of different ideas about where we should go going forward.

On the future side, I'm not entirely sure what year it was, like 2015 or

or whatever, like when like perpetuals were like introduced, right?

Like those just very like quickly became the like preferred way to trade futures.

So as everything like moved on chain, it was just kind of very like, oh yeah, like of course we're just gonna implement perks.

But on the option side, they didn't really like have this like perk like product yet.

So almost every option protocol today has struggled with like liquidity fragmentation across like their strikes.

And just like due to that, like not as many, it's also like not as easy of a thing to trade as just 5X leverage long.

So it's kind of gotten stuck in this weird spot where there's a lot of options protocols and they're all implemented differently and have their strengths and their benefits and stuff.

But it's kind of like, where do we see adoption coming in?

Like, I think that there's a, there's a few like kind of threads going right now.

You know, there's like some stuff around like everlasting options, right.

From, from the kind of that like initial paradigm post, which like, I think like only a few exchanges ever ended up implementing it and didn't really see that much traction.

Outside of that, I don't really know many other changes that implemented Everlasting, but I'm sure there's a few.

Then there's also this concept of replicated options With RMMs and stuff.

There's also this concept of building option payoffs that are creating LP positions that look like option payoffs, kind of like panoptic.

And then there's also just like Open ended up pivoting to power thresholds.

Rather than just spot normal options, I think 1 of those 3 or 4 will end up being the preferred option type.

I think I would lean towards EOs, but I don't know.

And I just don't really understand why more people haven't implemented them, I guess.

But it's going to be an interesting thing to watch.

I'm watching projects in all 4 of those verticals as well, of course, as just exchanges that offer normal options.

But I think it's pretty hard to say that given just the dominance of perks on the future side, that trading options with fixed expiries and stuff would be the preferred options trade, right?

I think given that options is definitely the more niche of the 2 main derivatives products right now, I think it's definitely possible there's a good number of people who aren't feasible with the main approaches.

You mentioned that you're kind of keeping an eye on all 4 of them.

And you mentioned EOS is kind of your favorite right now.

Can you talk a little bit about what each 1 is and what you see as the trade-offs?

So first 1, which has been getting like a pretty good amount of traction recently, I think would be like Panoptic and kind of these like, these like option payoffs, or like, like building LP positions in a way that they like kind of like replicate option payoffs, right?

And the kind of like the really core benefit for something like Panoptic is that they're just tapping into Uniswap liquidity.

So you can essentially, you know, trade options on any spot market, like on Uniswap, they're perpetual.

And you don't have to worry about unit sizing.

And you also don't really have to worry about picking specific strike prices.

I think that is a lot going for them, just all of that customizability and freedom around the instrument that you want to trade.

The con to that is that rather than a normal option contract where the seller would kind of like receive like a premium upfront from, from, from the buyer, like the, within Panoptic, this like premium is like accrued over time and paid out over time, which could definitely be something that people might like or might not like, right?

But it's just a very different concept than maybe someone that's more familiar with traditional options.

I think they ended up like releasing the, like a pricing model for this called like streamer, which, which is, is interesting and helpful.

see that is like, I wasn't, you know, a market participant at the time, but as perps initially entered, I would assume that people were very like, what is this funding rate concept?

Why does it change every hour or whatever.

So I would hope that like in Panoptic's case, that is kind of like the initial sentiment now, but looking forward a few years out, it would become kind of like a standard.

Panoptic's pricing is really interesting For those who aren't familiar, given that the underlying infrastructure is Unibit 3LP positions, the premium that a buyer pays for an option is the fees that that position accumulates when it's in range.

And I'm not fully sure how, but that does also converge with traditional options pricing models.

And I think that's a lot easier to wrap your head around as well compared to if you're crypto native, but you've never really looked at options, trying to wrap your head around black shoals is a different thing versus understanding like, okay, if my position's in range, I will start to accumulate premium there.

I would like to hear a little bit about, you alluded to this a little bit, but I didn't, you know, I myself am not very familiar at all.

What are some other like more, I guess, more crypto native derivatives that are being worked on right now, something outside the realm of futures or options, because that's really where all the attention is right now, I feel like.

But obviously, those are trad 5 first products that are being brought on chain.

What's some interesting stuff being built that's more unique to crypto?

Yeah, so I think like the kind of like the interesting thing is like, it's either like these like unique products that are being brought in are either unique from the aspect of like they exist, but like they really are only like trade traded like institutionally, right?

And not necessarily like to like a wider market or like, they exist, but like maybe like the asset that's being traded or the price fee that's being traded is unique and different.

So on the first side, that would be kind of like, I think over the last few months here, we've kind of started seeing a lot more interest with protocols like Pendle, right?

And these concepts behind like yield stripping, which is like a traditional thing, but like it becomes like kind of interesting when you pair the stripping around, like around like validators, right?

And all of a sudden you can kind of have this collateral that's needed for your validator.

And then you can kind of separate that from, you can separate the yield of that collateral out and then you can kind of like trade either of them, right?

It's kind of interesting how like a yield strip was like something I feel like if I was like in...

If I had like learned about them first via traditional markets, I might not have really understood them as much.

But coming at it from like the DeFi side, like it's kind of like...

I feel like it's a little bit easier to understand because to me it's just, oh yeah, they're just 2 separate tokens.

We just take this aspect of Steeth and we just separate 2 tokens out.

And then on the more unique price feed side, 1 area that I've been really, really interested in probably for this year has been starting to trade around block space derivatives.

So again, these are traditional instruments like swaps or futures or forwards.

But now you can trade swaps around state and yield on each side, or you can trade like forwards around like Bitcoin, like miner, like production, right?

Or like estimated like future production, right?

And I think that like, these can become like kind of interesting for a few different reasons.

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WTF is a Derivative w/ Nate from Adjacent Research