ETFs and Bitcoin

Bitcoin and ETFs

Yesterday (20 Oct 2021), the impossible had happened. Bitcoin ETF by ProShares (aka “BITO” ticker)was approved by the SEC under the mutual fund rules, which requires funds to provide investor protection.

On its debut, the ETF recorded the second-best performance in terms of volume traded, touching ~ US$ 1B.

Is the hype justified, though?

Firstly, let’s define quickly what an ETF is. An ETF is an exchange-traded fund, which means that units of funds traded to/from an asset management company can now trade on an exchange just like any other company share. ETFs have gained popularity because of their lean cost structure, with low expense ratios (typically < 1%), attracting significant investor capital.

So why create an ETF for Bitcoin when you could purchase the Bitcoin itself?

BITO is a Bitcoin Futures ETF?

Futures are financial derivative contracts that allow investors to speculate or hedge on the future prices of an underlying asset.

BITO is traded in the New York Stock Exchange (NYSE). Although the interest in this product is genuine, there are some palpable limitations, which may not be immediately felt as necessary:

  • no physical redemption
  • not traded 24/7 (although an alternative trading platform called Blue Ocean is bridging this gap)
  • not custodial
  • not collateralized with real Bitcoin

The ETF is essentially providing exposure to an asset that represents freedom from institutional go-betweens, yet, the hype has obfuscated the urgent need to have assets traded globally and across time zones without stops.

By purchasing this ETF through brokers, not only do investors abandon the idea of managing their finances by self-custodising, but they wouldn’t be able even if they wanted to: futures are not collateralized with Bitcoin. Futures are usually meant to be cash-settled as the primary purpose is to either hedge other positions (most of the time) or speculate.

Several projects in DeFi are tokenizing funds and listing them on decentralized exchanges, creating what are known as decentralized traded funds.

DEXTF is one of these protocols that provide portfolio tokenization capabilities. XTF2s (all fund tickers’ heading starting with this acronym) are collateralized with tokens, redeemable for the same tokens, and most importantly traded 24/7 because decentralized exchanges don’t take rest days.

Additionally, creating XTF2 is a permissionless operation, quickly done in a matter of seconds through the dApp. The platform has recently pushed the rebalancing module (read “The Power of Rebalancing”), enabling funds to be dynamic rather than maintain their fixed allocations.

In summary:

  • physical redemption
  • traded 24/7
  • custodial
  • collateralized with real assets

Investors can create carbon-neutral strategies and tokenize funds by pairing $MCO2 (tokenized carbon offsets) to your favorite tokens.

A first iteration is the green bitcoin.



Capital Structured Tokens

Capital Structured Tokens

In the investment world, the two critical factors that investors consider are risk and return. While everyone wants to fetch the highest return with the lowest risk for their investments, that is never the case. Risk and returns are positively correlated- the higher the risk, the higher the return, and vice versa.


Markowitz theorizes this framework in his Modern Portfolio Theory.


Financial Engineers and Wall Street Stalwarts have tried multiple ways to develop products that provide the best of both worlds (see concept explainer in Newsletter #14). Still, it’s not a one solution fits all situation, and now we have a variety of structured products, optimizing for risk and return but at the expense of transparency.


Structured products are essentially a basket of assets that returns an optimized risk-return profile. A typical structured product is a capital protected note built with two components:

  1. Interest-bearing bond (low risk)
  2. High growth derivative (relatively higher risk)


The lower risk component provides capital protection through its yield, while the riskier derivative sets the participation rate.


The participation rate is the rate at which a note holder gains when the underlying increases in price. 


Fund diversification benefits are delivered when the underlying assets also have a diversified payoff. That means you need to combine different asset classes.  


Bitcoin and crypto have been correctly lumped together as an asset class because Bitcoin had an enormous pricing power over the remaining crypto market. A reality that is changing over time as financial payoffs of different nature is tokenized.


The above tweet is no longer accurate. However, Tradfi may still have the extreme view that crypto is a $ 2.3T market in bubble.


And when these structured product dynamics are applied to crypto, things become more attractive. Investing in crypto may seem appropriate only for degens (abbr for degenerates, read this poetic definition of it here), however volatility is what attracts traders with their capital to grow this space. Everything needs bootstrapping, and to start a new industry, financial volatility provides the best risk-reward environment to get achieve growth for everyone involved.


Volatility however is not great when it comes to the actual consumption of the services that crypto project may provide. In fact it is inversely correlated to its utility. That’s why liquidity providers exist to reduce slippage to trade in and out of assets. Insurance against smart contract bugs and hacks are helping to reduce the risk as we speak. Options markets to provide indeed more avenues of exposure to crypto assets. 


The equivalent of structured products in DeFi are structured tokens. 

The first ever structured token was developed by DEXTF Protocol, that launched the Structured Floor Token (SFT) on ETH. The SFT on ETH returned your original capital if the price was below the strike price at expiration and profit as if you were holding 1:1 ETH if above the strike price.


Today we have a better understanding of what a floor price as evangelized through NFTs on Opensea. SFTs are therefore capped on the downside and unlimited on the upside.


While these may sound like fantastic products, these tokens would be intended only for those investors who want to have:

  • A diversified portfolio and want to protect their principal while still gain exposure to large uponly movements 
  • An exposure to a highly performant cryptocurrency like Ethereum but wouldn’t want to invest in the same directly


So if we look at it at a glance- 

  • Structured tokens are a hybrid investment made up of a bond and an option
  • They offer a relatively higher return considering the risk they mitigate 
  • Structured tokens are a low-risk investment and may receive up to 100% capital protection depending on the market condition and other factors 
  • This product is ideal for investors who wish to enter the crypto markets but are afraid of volatility and the risk it brings with it. 


Bonding Curves

Bond, bonding, bonding curves

Bond, bonding, bonding curves. A quite abstract word, to begin with, is starting to appear more frequently in the DeFi realm.

A bond is a relationship between two parties.

In the context of DeFi, many projects have started to consider using bonding to bootstrap token liquidity and demand more sustainably.

One way of understanding this is that bonding with someone assumes you have a vested interest.

Similarly, a protocol can purchase “liquidity bonds” or “reserve bonds” in exchange for the native token that is sold at a discount to the buyer.

Liquidity bonds are liquidity provider tokens. Reserve bonds are other tokens that are not LP.

The native token purchased is said to have a discounted “bond price”, which vest over a period of time. The cool thing though is that there exists a secondary market for the bonds that can affect the discount that the protocol might offer on the subsequent bond sales.

Bond sales generate profit that can be distributed to stakers.

This is an extremely powerful idea because, with liquidity bonds, the protocol purchases liquidity which means that it owns the pools, ensuring both stability and profitability. All fees generated by trading utilizing the pool are then distributed to stakers.

If compared with liquidity mining, the bonding ensures that interests between the protocol and users are aligned. Liquidity pool tokens are not owned by the users, but they now have exposure to the native tokens that are vesting and compounding if they are also staked.

But bonding curves are also fair…

Yes, bonding curves are also about relationships and specifically between supply and demand.

Bonding curves are used by projects to raise funds, fairly and deterministically, as these are mathematical formula built into smart contracts that have mint and burn functions.

Traders interact with the bonding curve as they buy and sell.

Bonding curves are Automated Market Makers, because the counterparty of a trader is the smart contract, as opposed to another trader as it works with orderbook-based exchanges where bid and ask has to be matched by a centralized party. It’s also fair because, at any time of the process, anyone can determine the price at which the token is going to sell. When token supply is low, the price is also low. Price increases deterministically as more tokens are minted, providing the early birds a sizable return.

Despite the price automation, the curve can be customized and include fees that can then be used by the protocol to bootstrap liquidity or community initiatives.

Fees can be charged on:

  • spreads between buy and sell
  • swaps (against ETH or stablecoins)
  • transaction fees with the bonding curve



What are synthetics?

Synthetics are derivative assets whose value can be custom-built to mimic a particular situation.

We refer to a situation because a situation can either be temporary or persistent, in which case we say that something expires or it doesn’t.

Options are synthetics as we say these can be written and sold.

If you wanted to take a position on 1 BTC without forking out 55k, you could long a call and sell a put at the same strike of, say 55k.

In this situation, by longing a call with strike 55k, you’d be purchasing BTC if the spot price is greater than 55k. Conversely, by selling a put, you’re still long on BTC because the put buyer will be short (as he/she hopes to gain a profit if prices fall, while you wish to cash in on the premium). Therefore, if the price fall below 55k, the put buyer will sell the BTC to you at 55k. In both cases, you end up with BTC at 55k by paying the difference between the premium received (selling the put) and premium paid (purchasing call).

Options are just an example of the potential of synthetics. Issuing synthetic assets is no longer the prerogative of investment bankers. Anyone with an internet connection can create synthetic assets without knowing anything other than the price of the asset it’s tracking.

In crypto, several projects have figured out that by locking some collateral capital, you can guarantee the creation of any asset that you can imagine. What used to be a thought experiment is now a reality; you can gain exposure to gold, FX, real-world stocks without the need of a broker that necessarily follows an opening and closing time. However, a synthetic asset position does not give you, on first analysis, the same peace of mind that an actual spot position gives you. You can hold a spot position for as long as you need, while a synthetic position can be liquidated if undercollateralized or if it expires when overdue.

Collateralization drives DeFi value capture, as it represents the value locked in a protocol/platform.

While a relatively big over-collateralization ratio minimizes systemic risks, it might not be sufficient to withstand the violent price action in crypto. This is especially true when the collateral is different from the asset it’s tracking.

Imagine if you have a synthetic position on BTC that you can mint by collateralizing ETH. Let’s assume that the collateral ratio is 2. For every BTC you mint, you need to deposit 110k in ETH.

Now you have 1 BTC.

Suppose that next week BTC goes to 100k while ETH suffers and halves in price. Your collateral suddenly is valued at 55k, but your synthetic BTC is now worth 100k. The collateral ratio has fallen, and now you need 200k to guarantee that the synthetic BTC is liquid if you want to cash out. How do you mitigate this issue? Collateral could be converted to BTC if it falls below a certain threshold, stopping the collateral bleeding.

Synthetics is an up-and-coming section of DeFi as its value derives from composability through payoff engineering. As a result, incentive schemes can be built for example, to align a community around achieving a certain TVL on a platform by distributing synthetic rewards that have binary payoffs based on whether a target is achieved or not.

Although use cases are not limited to trading assets, you could build a contract with its conditions tied to payoffs that incentivize the parties to comply with the agreement through oracles that observe the state of the world.

Therefore, synthetic assets are a compelling human invention that seeks to create what exists but are too expensive to buy outright and arguably makes abundant what is scarce.


DeFi Markets

DeFi Markets

Everything you need to know about DeFi markets 

  1. DeFi market: AMM (Automated Market Makers a.k.a. DEXes)


DeFi (read Decentralized Finance) markets refers to a collection of decentralized digital marketplaces where DeFi services are exchanged, often incentivized using tokens as rewards (chicken-and-egg problem in crypto). 


DeFi discards the idea of centralized financial intermediation. 


What does that mean? By joining DeFi you’re not exactly disintermediating the middleman just yet, in fact, DeFi replaces it with a black-box smart contract which is supposed to abstract away all the back-end complex operations to spit out only what gets investors excited about.


Everything that required a trusted centralized party to guarantee the authentic and ethical execution of an instruction between customer and service provider is now replaced by code within a fair smart contract.


DEX trading, borrowing/lending, stablecoins, derivatives, fund management, insurance, payments and lottery. As the sector matures, these macrocategories within crypto will increasingly be treated as different asset classes for the purpose of diversification.


DeFi markets would not be complete without an easy way to exchange value for value (among fungible tokens – for now) through AMMs or Decentralized Exchanges.


Automated Market Makers( AMM)- The differentiator


An Automated Market Maker (AMM) is a smart contract that wraps pools of assets and facilitates trades permissionlessly for anyone.


An AMM is decentralized because:

  • Anyone can decide to supply liquidity to improve the slippage on a market pair
  • Anyone can trade provided that you have a wallet and sufficient network tokens to pay for gas
  • It cannot be shut down
  • All trades are recorded on the blockchain, thus giving everyone the necessary information to trade


AMMs are therefore not orderbook based but liquidity pool driven platforms. 


One of the earliest projects in the spac 

It’s a kind of decentralized exchange (DEX) in which the price of assets is determined by a mathematical formula (each AMM has a different formula which is why each AMM is different from the other) which also has a progressive revision to the age-old method where pricing algorithms decide the price of assets. AMM also replaces the traditional order book system that keeps track of all purchase and sell orders used to duplicate the price and quantity of crypto assets. The matching of buyer and seller orders takes up part of the traders’ valuable time and has several serious drawbacks, such as slippage and lag in price discovery.


How does an AMM work?


In every trading exchange, an Automated Market Maker functions similarly to order books. However, the user doesn’t require a counterparty on the opposite side to complete the transaction. Instead, smart contracts interact with you, automating the trade and creating a market for the user so he can save on the valuable time waiting for a counterparty. In AMM’s, the trading takes place directly between user wallets with no requirement for a buyer or seller, thus allowing digital assets to be traded in a permissionless and automatic way by using liquidity pools. AMM users supply liquidity pools with crypto tokens, whose prices are determined by a constant mathematical formula, thus enabling the transfer of an asset from the seller to a buyer at a fair price.


The variations in  AMM models


While several AMM’s have come up with their unique formula, three dominant AMM models have emerged to prominence: Uniswap, Curve, and Balancer.

  • Uniswap’s pioneering technology allows users to create a liquidity pool with any pair of ERC-20 tokens with a 50/50 ratio and has become the most enduring AMM model on Ethereum.
  •  Curve specializes in creating liquidity pools of similar assets such as stablecoins. As a result, it offers some of the lowest rates and most efficient trades in the industry while solving limited liquidity problems.
  •  Balancer stretches the limits of Uniswap by allowing users to create dynamic liquidity pools of up to eight different assets in any ratio, thus expanding AMMs’ flexibility.

 Advantages of AMM

As we have seen how AMM radically changes some concepts of traditional centralized exchanges, there are several advantages to come with these changes. These are

  • AMM has to the creation of a lot of New trading models
  • Price slippage between the execution of trades reduces down dramatically to as low as a penny
  • Orders are created in seconds and for a fraction of the cost.
  • Latency on trade calls also diminishes drastically and can now be measured in milliseconds.
  • The AMM help in developing high comparative liquidity thanks to its liquidity pools
  • AMM’s reduce the ability and number of bad actors doing things like front-running, price manipulation, and wash trading.
  • AMM’s reduce the price fluctuation to acceptable levels, which in turn leads to less slippage.


Disadvantages of AMM

Like everything coin has two sides, AMM’s too have disadvantages. 

To list a few

  • A disadvantage of this lack of oversight and lack of legal framework, which might be there as there are no governing authorities to monitor transactions, offer assistance, or provide a legal framework or redressals systems.
  • As more financial transactions are conducted via decentralized markets, they can pose challenges for regulators and legal enforcement. In comparison, centralized markets give regulators a clear path for taking action, if necessary, regarding trades that might be suspect