DERIVATIVES in DeFi

Derivatives are financial contracts whose value is dependent on an underlying asset or group of assets. The commonly used assets are stocks, bonds, currencies, commodities, market indices, and in recent years cryptocurrencies. The value of the underlying assets keeps changing according to market conditions. The basic principle behind entering derivative contracts and staking are to earn profits by speculating on the value of the underlying asset in the future. The four major types of derivative contracts are options, forwards, futures, and swaps.

Options: Options are derivative contracts that give the buyer a right to buy/sell the underlying asset at the specified price during a certain period.

Futures: Futures are standardized contracts that allow the holder to buy/sell the asset at an agreed price at the specified date.

Forwards: Forwards are like futures contracts where the holder is under an obligation to perform the contract. But forwards are unstandardized and not traded on stock exchanges.

Swaps: Swaps are derivative contracts wherein two parties exchange their financial obligations. The cash flows are based on a notional principal amount agreed between both parties without the exchange of principal.

In Defi, unlike in Cefi, there is no broker required. Instead, settlement automatically takes place on-chain, where the terms of the contract are fulfilled. The intersection of Defi and derivatives is a gamechanger, bringing yet another borderless, low-barrier, financial instrument to the world.

Decentralized derivatives markets are much more accessible. They can be used by anyone with an internet connection and an Ethereum wallet, no matter their location or social status. This contrasts with the traditional financial sector, which mostly serves those who reside in rich and powerful countries. Creating a custom derivative in Defi is easy, cheap, and can be done by anyone.

In the traditional financial system, the process for creating and listing a new derivative is very complex and costs involved are close to a million USD. Because of this, most derivatives are created by big banks which potentially can make it an unfair and inefficient market relative to DeFi