Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Zhiming Yang: Orbit Markets – Crypto Derivatives and Structured Products

Episode Date: February 17, 2024

Prolonged range bound markets are a hallmark of bearmarkets and they usually end up chopping inexperienced or over leveraged traders. Customised structured products offer a solution for market participants that want to limit their downside, but also the upside, by introducing knock-outs at certain levels or triggers. Such custom options, usually with lower probabilistic chances of occurring, naturally come at a discount. This allows traders to hedge their risk, while also betting on certain outcomes or market scenarios.We were joined by Zhiming Yang, co-founder of Orbit Markets, to discuss crypto derivatives and how TradFi expertise applies to customising structured products for crypto markets.Topics covered in this episode:Zhiming’s background in investment bankingFX derivative productsExotic optionsCrypto structured productsCustom solutions for crypto minersHedging Uniswap V3 impermanent lossOptions based on prediction marketsManaging counterparty riskProtocolising structured productsDifferences between TradFi and DeFiEpisode links:Zhiming Yang on LinkedInOrbit Markets on TwitterOrbit Markets websiteSponsors:Gnosis: Gnosis builds decentralized infrastructure for the Ethereum ecosystem, since 2015. This year marks the launch of Gnosis Pay— the world's first Decentralized Payment Network. Get started today at - gnosis.ioChorus One: Chorus One is one of the largest node operators worldwide, supporting more than 100,000 delegators, across 45 networks. The recently launched OPUS allows staking up to 8,000 ETH in a single transaction. Enjoy the highest yields and institutional grade security at - chorus.oneThis episode is hosted by Meher Roy. Show notes and listening options: epicenter.tv/535

This episode is brought to you by Gnosis. Nosis builds decentralized infrastructure for the Ethereum ecosystem. With a rich history dating back to 2015 and products like Safe, Cow Swap, or Nosis chain, Nosis combines needs-driven development with deep technical expertise. This year marks the launch of NOSIS pay, the world's first decentralized payment network. With the 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 a business looking to white-label the stack, visit nosispay.com. There are lots of ways you can

join the NOSIS journey. Drop in the NOSIS Dow governance form, become a NOSIS validator with a single GNO token and low-cost hardware, or deploy your product on the EVM-compatible and highly decentralized is NOSIS chain. Get started today at NOSIS. I.O. Korse 1 is one of the biggest node operators globally and help you stake your tokens on 45 plus networks like Ethereum, Cosmos, Celestia and DYDX. More than 100,000 delegates stake with KORS1, including institutions like BitGo and Ledger. Staking with Kors 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 stake directly to Quarice 1's public note from your wallet, set up a white table node or use the recently launched product, Opus, to stake up to 8,000 eth in a single transaction. You can even offer high-year staking to your own customers using their API. Your assets always remain in your custody, so you can have complete peace of mind. Startsaking today at Chorus.1. Hey guys, welcome to Epicenter. I am Meher Roy. And today I'm catching up with Shaming Yang, who is one of the co-founders of orbit markets. Orbit markets, I think is 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 here. 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 came to crypto relatively late compared to most people, I think. So we started actually in 2020, end of 2021, the beginning of 2022. So about two years ago, actually, it's been two years. I didn't realize it's time, time flies. And before crypto, I was working in traditional finance. So I worked at investment banks for all of my Korea before. So I started my career in London with B&P Paribati.

And then 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 APEC. So what does it mean to lead the FX derivatives trading business? What is the FX derivatives trading business at an investment bank? Yeah, sure. So at investment banks you have, well, investment bank is very broad term, right? So everybody hears like Gomez, C, P. Morgan, Deutsche Bank, these are 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 another part. So in a sense, you can think of it like primary markets 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, et cetera, a project. There's 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 then you have 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 hedge funds, trading desk, high net worth individuals, companies, corporates, all sorts of different clients. And then we provide these investments. solutions or products to them for them to trade. And then so what I do as a trader or as someone running the desk is that we have obviously a team of traders. We have quants.

We have also middle office, back office doing the operations. So we have actually every day, 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 money as well for the bank.

So that's what we used to do at the sale side. We call it a cell side at the investment banks. 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 plants. Some of them, for example, use our structured products to hedge their crypto holdings.

For example, a miner that they keep producing BTC every day. And then they actually want to hedge the risk of price falling or fluctuation so we customize and make bespoke structures for them. 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 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 interacting with the exchange or the matching angle of the exchange quite directly. But sometimes I might go to kind of like an OTC desk and to the OTC desk, there's a human on the other side and I essentially say, hey, that's what I have, that's what I want. Can you make the trade for me?

And like this trader on the other side will essentially figure out how to price it and will offer me a price for an OTC price 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 and buying something, but it's like, hey, I have this asset and I want to combine it with some kind of derivative. and the combined thing 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, okay, 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 that correct way of seeing it? Yeah, absolutely. What you just described is true for crypto, but it's also very true for traditional finance. So in traditional finance, you also have this exchange market venues and also the OTC side. The exchange is also a very, very important part of traditional finance.

You have most of the stocks, for example, trading out exchanges, but it has also limitations, right? So the exchange can only list standardized the products you have like standardized the payoff, standardized maturities, strikes, etc. 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 an OTC DOTC in traditional finance are typically big banks, big investment banks. So you go to them for various reasons.

One, you want to execute a large amount of trade. So if you do this on the exchange, you will actually move the market probably against you. So you want to go to investment bank who can actually manage this better for you, the execution for you. Or you go to an investment bank because you actually want something more bespoke, like not available on the exchange. So something exotic or 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 manage the product together with their other products. So to achieve efficiency. So at the moment in crypto is the same thing. Crypto market started with the very 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 are there to fit your particular view, your particular demand, your particular budget, etc. It just gives you more options. If you want like exchange, you can think exchange more like fast food restaurants, go to dollars. You can just choose whatever you want. It's all standardized. You just buy food you want. And then if you want OTCDAS is more like fine dining restaurant, you go there, you want personalized dishes, you want eat this and that, and they will make it like specifically

for you, like their dedicated service, 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 off. to 45,000 in 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 do this using, is it impossible to do this using sport or pubs or features. 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 call, like, for example, barrier options. So that trade will use that, make money if spot goes up above 45,000, but it will knock out. It will just disappear if spot goes above 50,000. And then you will buy this option really cheaply because it has this additional condition of knockout. So this is not 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 really interesting.

So yeah, you can basically like create new content. kinds of options that are not available on any public options market. And then you can also combine these options with like trades that make make even more sophisticated products. Could you give us like some historical examples of this industry 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 story is well known

the industry and would give us an idea of how it works. You have 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 in any financial market. Options itself, I think it's, I think I can't remember when it was invented, but it was invented probably late 70s or in the 80s in the, in the U.S. stock market. Then there's this famous, like, Black Shoals formula got invented and then suddenly

this becomes a very, very popular product because all the banks suddenly have the tools, have the quantitative models, the price of risk managed it and suddenly becomes really popular. And now, if I remember correctly,

last year there was a big boom in the US stock market and options volume actually surpassed the volume of sports stocks. A lot of investors buying this like a zero day to mature, zero date to expiry.

So basically same day expiry options to basically take like a betting, I don't know, like a very high leverage short-term betting. 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 rabbit development around even more sophisticated structure products initially all led by French French engineers with a very great mass skill and then they invented all the new models to price

all this really sophisticated stuff. So people making money from these products, plenty of examples. You have a lot of like very sophisticated hedge funds, for example. They trade Vinyl options, but they also want to trade very specific pay-off. The example, I said earlier, for example, you want to have this, like, for example, you want, you think that the underlying will go up, but you will not actually exceed a certain level. So you actually add a knockout barrier. So then the product becomes really cheap, right?

Maybe it's only like one third or quarter of the price if you buy compared to a vanilla option. But then you achieve the same return in the end. right. So your return will be four times, three 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. Every day, they are like 4,000 different MBRC listed on Swiss exchange.

for example. So it's a very popular product that linked to different underlines like stocks, indices or commodities. Surely over, over 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 don't mean that they will help you make money more often than, you know, than simple products. That's definitely not true. 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 risk is similar. Your risk is you are long or short on the line, right? It's just that the payoff got like a change, just to twigued. So yeah, it really

depends on your use case, right? Some of the companies, for example, they use some of the hedging solutions and then achieved 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 this structured products market as an entrepreneur was, it's like this story I've heard of Mark Cuban. So he's like this entrepreneur that appears.

these days on Shark Tank or used to appear on Shark Tank. And then there was this TV series called Silicon Valley. And then there was a billionaire in that billionaire character in that TV series called Rus Hanemann. And that character is kind of modeled on Mark Cuban. But the Mark Cuban story was like he made a sort of like a million dollars or like a couple of million dollars in one startup. and sold that startup with 1989 and retired at the age of, I don't know, 27 or 28, he was like, I'm going to retire. And then 1991, 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, okay, 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 public market, I think New York Stock Exchange.

And it lists, and a few days later, the dot-com bubble crosses a value of a billion dollars. And it ultimately goes to like three or four billion. Mark Cuban personally becomes a billionaire in the public markets. Then Yahoo appears and Yahoo is like, we want to buy broadcast.com. And so Mark Cuban hashes out this deal with Yahoo. Now, in this deal, the thing is like, he has to go and work. work for Yahoo for a while after the sale. And he gets Yahoo stock in exchange for broadcast.com stock.

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 dot-com bubble. And Mark Kupin'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 caller. Meaning if the Yahoo stock falls down, in price. Below a certain price, he will make in three years or whatever, that minimum level of price.

So if he entered into trade with a billion dollars, the worst position he can get is maybe around $950 million. But on the other side, because this kind of insurance is being provided, on the other side, if the Yahoo's stop like doubles from a billion to like $2 billion, he might only make $50 million of dollars. 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 the interesting thing is that the underlying collateral that he has is completely illiquid. Like, is, it's like, it's like this Yahoo stop. And then the dotcom bubble does collapse. And Mark Kuber ends up looking like a genius. So that's like the first point in my life 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 trade in the markets essentially. That's what like the structural products allow. Yeah, so what you mentioned, like a color is a very popular structure. obviously using simple vanilla options. It's a very simple combination of vanilla options. You buy, you sell a call to cap your upside. At the same time, you buy a put to protect your downside, right?

Which is a very, very popular for this type of hedging purposes. In your particular case, obviously, I'm not very familiar. This story, I don't know, depending on the exact agreement he had with Yahoo. Like, he may or may not be actually allowed to do this. Well, you know, like, in most, you know, Most of the these days, like investment agreement or like merger and acquisitions, when 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 are vested,

you are not allowed to hedge it. As you are not allowed to short it, sell it in any form. So I'm not very sure about the exact agreement he had with Jabu. but then these days these kind of things especially in traditional finance I think people like check it very closely

yeah yeah so I'm just checking the internet like this story is genuine he hedged 1.4 million in Yahoo stock yeah maybe he's allowed he was allowed to do that but yeah

I think usually when your your shares are locked when you all your tokens are locked they are locked for a reason, right? Ted Day. And then if you start selling it through other ways, other means that basically defeats, defeats the purpose of locking it

or the best in schedule. So I don't know. Yeah, but good for him. Good for him. 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 internet. Like, the listeners can find it if I want to see. Yeah. Yeah, yeah. So, I mean, so on a similar way, 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, okay, 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 an Ethereum ETF or not. So, like, yeah, could you give us a. some examples of structured products around the Bitcoin ETF, right? Like the kinds of exposures people could have constructed before the event with orbit. Yeah. So now there are two big things. Well, there are three. Now there are two. So we have the BTC ETF that is already done. Then we have the halving coming as well. Then we have the ETH, ETF news. So these are the,

that could be the catalyst that triggers the next, the next leg out. So we've seen actually a lot of interest from our clients to, to buy tokens in actually more towards the out coins. So 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, ABEX. 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 arbitram.

And then we also see some of the interests in newer L1 tokens as well. So how to actually, how to position yourself actually into, these events. I think one very classical structure 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 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 token at, for example, 75. So it's a big discount. How do we achieve the discount? There's no free lunch, right? We're not like just giving free 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 there is a knockout, the knockout feature. So if Solana price goes up above a certain barrier, knockout barrier, then the trade will be terminated, meaning that your gain will be limited, right? Because if the spot goes up a lot, then you stop buying. So your gain is actually limited, right? 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? It's obviously asymmetrical. 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 a big discount. Okay, so this obviously has risk, right? It doesn't come without risk.

So the risk is that if the price goes down a lot, you still have to buy at 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 okay to buy at the 75, then it's fine. They can, because they will just be buying at 75, especially for those who are, you know, ready to buy Solana at the carrie spot 100. So 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 necessarily for you. But if you have this accumulation mandate, you just have to buy. For example, you have a law-only fund, then 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. So if somebody is coming with that mindset, then this person could say, well, I don't. 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 85, or however the contract 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 all that matters. Because there's a certain view that the odds of Solana falling to less than 60 in the next X or Y months 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. That's the essential idea. Yeah. So I think the idea of structured products is really that 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 discount. If your view is that Solana will jump to 500 next month, that's fine. 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 calls 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 a really strong view that this token will just shoot to the moon next month,

then you can also, you should also try options. Because if you buy options, you will only spend a very tiny amount of premium because this option will be like super cheap because the core strike is very, very far away. And then if you're wrong, you just lose the premium, which is very cheap. But if you are right, you can get huge profits. If you do this 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 the case of miners being users. And could you like give an example of how cryptocurrency miners could be users of orbit products? Sure. Like we have clients for some of the clients are even listed minors. And then they again, the idea of hedging like for miners is actually also from Twitter. 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 or gold. So we basically use very 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 your your risk is actually limited within this range right because your upside is kept you are giving up some of your upside gains by the same time 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 spot price right so for example, one of the product is called Target Redemption Forward, which is from traditional finance, where you can actually sell your, for example, right now, the Bitcoin is at 42,000, you can sell Bitcoin at, let's say, 47,000. Every week you can sell 47,000, and then if the spot is below 47,000, you sell at 47,000.

If it's above, you still have to sell at 45,000. And then you just count the number of, times where you make money. So if this week is below $47,000, you count one time. And then the next week, if it's below $47, you count two times. And then when this count reach, let's say, five times, this trade will terminate. So basically, if the spot stays at $42,000 every week for the next five weeks, then you just keep selling at $47,000 and then the trade will expire. The trade was it will terminate. But then if the spot goes above $45,000, the count will not accrue because the count will stop. It count 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 structured products, in a way, is trying to create an asymmetric payoff, right? And then because if 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's crossing the 47 barrier many times. That's the case. That might be bad. All these type of traits, right, your view has to be, 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, can go down a bit, that's fine. But then if your view is that SPOW will, let's say if your view is that Bitcoin will go to 100,000 next month, then obviously you shouldn't hedge. You shouldn't do any hedge, right? You should just hold low and 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 that's, yeah, then these products can be useful. So there's no product that will be the perfect product that will that guarantee to make you money. That doesn't exist.

So you always need to have your views. So we have like miners clients who have a good size of the market. You know, they put out some hedges when they think the market is like topish. So then for example, before the ETF news, right, 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 product 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 on avalanche or something, AMM. Then there are these cases in which... So the essential idea is if I'm supplying two 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 50-50 or something like that. And so like the quantification of how much worse my position is in an AMM compared to what I would have achieved just by holding them 50-50 is like this called this impermanent loss. And you have a product to hedge that. So could you explain how it how it works? Yeah. So as you just explained, so Yuli Swap or this like yield farming was really popular, right?

especially in 2012 or last year, still a little bit. But all the liquidity providers, they face a big problem, right? So initially they just look at the yield, but then they realize there's a cost. The cost is actually implement a loss, right? So you basically have an equation. On one side, you earn the fees from the protocol from univiswap. 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 implant loss. Right. So for us, we actually, when we started to look at it, we realize this is deterministic. So it's actually just an, an option or derivative in a way. It's not a normal derivative, but it is an exotic derivative

with a very special formula. But in the end of the day, it's a formula. The payoff is depending only on the final price and the initial price. So by the time, we did build our model to, you know,

like run all the multicolos simulations and then, you know, so that we can actually price any payoff. just like the regular European Vandel Option pay-off or the futures pay-off, we can price any pay-up. You rewrite me a math formula that depends on the final price. I can actually calculate the expected value of that formula as of today. So then in the end, we realize that, okay, it's nothing but just exotic option. So then 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%. It's a known fixed cost, 1%. And then at the end, we will reimburse these clients the actual input loss. And how do we hedge it? We obviously not just taking 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 Greeks, right, the Delta, Vega, and all these risks, and then we will hedge this risk accordingly using pubs, the options, etc. So 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, 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 that 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, which means this is very interesting, right? So if a pool is generating a lot of fees, usually the underlying. that underlying pair is also a very volatile pair.

And in the other day, there's no free lunch, as I said earlier, right? So on one side, you have the expected fees. So you kind of do a research, you do estimation, you kind of, okay, 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 price of the production needs to make sense, right? If like the production costs 20% annualized, then it doesn't make sense. So maybe the price is 7%.

Okay, 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 liquidity provision is a completely the separate supply demand system, ecosystem on its own. On the other hand, when we price the protection, we are not looking at uniswap at all. 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, derivatives. So thereabit trace options,

which has the implied volatility. So we are talking about two separate. completely separate supply and demand markets and systems. But surprisingly, over 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 a derivative implied role, initially, let's say you expect there is a bit of difference between the two and then you can make money, like you are left with risk-free returns, but over time, this return will actually disappear,

or at least on a probabilistic basis on the average. Maybe on one trade, you can still make money, but on average, you probably end up with 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

liquidity provision or yield farming strategy realize that it's actually very hard actually to make money if you're just looking at a fees. Because in the end of the your fees and the impermanent loss will just be the same on average in the end. Or maybe you are left

with a 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 done up so much. Right. If you do nothing, you just lend dollar, you'll probably get

10, 15, 20%. Right. So why bother doing all these yield farming and then you still have to take the imp permanent loss? Yeah, that's the only interesting. So, So actually my curiosity is kind of in all of these examples that we have taken, right? Like it might start from actually the Mark Cuban example, but it could also be the accumulator or the tarb or this liquidity provisioning example. In a sense, when I look at the contract between like one of your clients and orbit, the underlying is the price of some asset, right? It's the price of some asset against 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 could the, 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 described is like buying a lottery, right, or prediction or something like that. I mean, theoretically, it 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 tar, 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 ETF will be approved, I have nothing to use to hedge my risk, apart from taking the other side of new. But if we can, like some of the betting house, right, they can still run this because they try to adjust the ratio, the odds, right, to match both sides. right, they are not taking any risk, they are just like 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 example, if you have underline, if you have a market where people start to trade the all of ETF getting approved, then we can create options and structural products on top of that. But we still need to have a market where we can hedge our rights.

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 right now I think those prediction market or prediction products, I think it's still more the job of the like the betting,

house, right, rather than the 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 a interesting time, right? Because in this time, first Terra went bust, but then kind of like this genesis went bust. and this Genesis was a huge event because people actually took counterparty risk against Genesis. Like when I hold E, 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 market is still scared of counterparty risk, which is good. I think at the beginning of crypto market, people are not really aware of this risk, but now people are very aware of this risk.

And we are also very of this risk. There are many ways to mitigate this risk. For example, we have signed EISDAS. which is the framework of traditional finance managing the counterparty credit risk. And so we have actually signed this with many of our counterparties, right? So because then we actually just manage

this daily margin and the credentials. That, I mean, that still doesn't remove the counterfeit risk completely, but it actually mitigated 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 with the collateral, right? So that's what traditional finance use, the framework that traditional finance has adopted to manage the counterpart of risk.

Traditional finance also learned it after the Lehman Brothers crisis. I mean, existed before, but these really, really after Lehman and the great financial crisis that traditional banks started to become more aware of this and then set up all these credit risk desk within the banks. So it's saying. So we're doing this in crypto. We also use this multi-seek wallet solution with some of our counterparties. In traditional finance, you would actually use a third-party custodian bank to do this for you, right?

So to sit between the two counterparties. 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, their third parties obviously in crypto as well, but they are just not financially as strong as strong as a real custodian in traditional finance, right? Some of the custodians.

So instead of actually having to take their credit risk, why not just 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, total four keys, two 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 can't transfer out, you 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. Neither party needs to give the money to a third party. And then in that case, both parties will be exposed to the credit risk of that third party. I mean, if that third party was J.P. Morgan, I'm probably fine. But in crypto, there's no J.P. Morgan. There's no, you know, there's no big banks with trillions of assets. So I don't necessarily trust a third party more than I trust my counterparty directly. So then we actually use these solutions with many of our counterparties

that, again, greatly reduced the counterparty concerns. And this is something that 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 costs of using a third point. 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 it's something that you can do yourself. 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, okay, 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 think that it's impossible to remove counterparty risk completely. 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 counterparty, 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 remove it completely, but then you will lose other things like efficiency. You have to be fully collateralized, et cetera, et cetera. 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 really, happen and nothing will move forward. So often in crypto, at least I come across this mindset that people want to

build protocols for financial products. In a sense, maybe the classic example is actually Bitcoin where it's like, there's a thing the central bank does. And Satoshi's question was almost like, can you just

replace that with an algorithm? And yes, you can, but then of course there has to be a new asset and it has to build liquidity. And it's possible, right? But often like, you see like DFI asking that question often, right? Like so overnight borrowing markets, can you do that? And then Robert Leshner asks that question and then comes up with compound where it's like, okay, he algorithmizes overnight borrowing. overnight lending, part of it probably, and then that's compound. So what do you think like in this structured products 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 structuring is hard and there is always going to be counterparty risk? So do you think protocolization of the market you are in is possible or is it intrinsically not possible? I think it's possible. I think it's possible, but it's very far from the current stage. I think we are still far from there is possible. I think the problem, we obviously work with some of the defy applications and also I did some research myself. I think the few issues, I think with the defy applications right now. First of all, I think it's the efficiency. I think the capital

efficiency generally is 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, etc. You can rehabit it. So it creates a really efficient market here. To ensure security and safety, everything is fully collateralized, etc. 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 defy applications so that, you know, we can actually integrate, not just the one defy on its own, but the defies can integrate and be connected with each other and also with exchanges so that your capital can be

reused, re-happle, you know, across different venues. But this, I just don't see how this is happening anytime soon, unless someone is leading this effort to create a big platform where all the defabications get on this platform, including exchanges, including, you know, other institutions. This is number one. Number two is, I think the user experience is still pretty bad these days with most of the Defy app,

definitely not designed or built for institutional players. They may be okay for retail, but for institutions, like, sometimes, like, yeah, we just don't think that is good enough for usable at all for our purposes, right? For example, some of the protocols, we make a simple trade or transfers. We need so many different approvals and that, like,

It's just crazy. And then if it's one retail guy, it's fine. He just approved for himself. But as an 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 contractor risk and 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 can't really be comfortable enough to put our company's money in, for example, a new protocol. What if you get hacked? Right? So I think I don't know. I don't have an answer to this question.

I think the second one probably is probably the easiest to solve. But then the hack risk, the smart contract risk is kind of inherent to this defy. bros, right? I hope like one day there will be better technology, better ways to ensure that smart contracts are safe. What's really interesting as a technologist here is when Ethereum was being bailed, there were like groups of dissenting technologists that were like, we should bail smart contracts differently, such that, you know, the properties of smart contracts can be mathematically proven. And 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 their 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 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 this stage.

I mean, we kind of pointed out like this, that even for you, kind of like, okay, using smart contracts, the way you do structured products in crypto is different from the way Deutsche Bank would do structured products. its clients and you're using smart contracts underneath. What are other such differences that exist in your industry in like the Tadfai side of it and the crypto side of it? Are there other large differences in the operating environment? I think the business model is essentially the sale, right, the business model. And then also in terms of financial products are also similar. We do have a few like

crypto-specific products like the aisle protection for example, but 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 crypto or blockchain has to offer. For example, in traditional finance, things settle T plus two, so two days later, right? But in crypto, you can settle anytime.

So we, for example, for all our client 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're actually exposed for like two days or more.

Whereas here we do it instantaneously. We send the valuation or margin report immediately, and then we can actually exchange the contract immediately. So that actually we do it. the counterparty risk a lot, something that, something for traditional finance to actually also follow, I think, in the future, right? And then you mentioned smart contracts. We also use some of the smart contract solutions to manage collateral, for example. And then I think what is more, I think if you're asking about the difference, fundamental difference, I think in crypto, in traditional banks, we emphasize a lot on risk cultures, compliance, and ethics. I still think this is quite important. 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 traditional 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 industry is changing slowly towards this. People are becoming more aware of compliance and risks and ethics. So I think that's some encouraging changes that we have seen.

So beyond orbit, any other interesting startups or projects in the structure products or, yeah, derivative space in the crypto industry? Well, I can't really speak a lot about like other outside options or structured derivatives. So focusing on this, I think it's good that a lot of exchanges are promoting outcoin options. So initially we've seen there's only like BTCI if vandal options for a very long time. And now many exchanges, new and the existing exchanges are launching outcoin options. I think that's very good because we've definitely seen a lot of interest in out coin 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. We just bro the pie, the size of the pie bigger. and then 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 only the option market is like the only that bright spot and 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 they are interested? Yeah, sure. I think if you can just maybe add a link to our website or our telegram group, something after this. And yeah, happy to share more about options. And 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.

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