Exploring Returns Along the Risk Curve of Structured Products

Introduction:

As time progresses, the cryptocurrency industry is evolving its own structured products. These products are predominantly found in the DeFi sector, meaning that investors leverage smart contracts to represent their investment strategies, without the need to connect to any centralized exchanges.

Structured products in DeFi are a new type of financial instrument based on blockchain and cryptocurrencies, similar to structured products in the traditional financial sector. These products can be composed of a variety of crypto assets and derivatives, featuring predefined maturity dates, diverse yield curves, and return profiles, such as capital protection products, yield enhancement products, and leverage products. In the DeFi domain, structured products are primarily dominated by options products. Unlike traditional structured products, the underlying assets of DeFi structured products are cryptocurrencies. This grants DeFi structured products greater flexibility and innovation, but also exposes them to higher risks and uncertainties.

Source: Bing Ventures

Trends in DeFi Structured Products

DeFi structured products offer investors a simplified way to participate in cryptocurrency asset investments, attracting a broader audience to this market. The emergence of these products is a response to the increasing number and complexity of projects and returns in the cryptocurrency asset market, necessitating more streamlined investment methods. DeFi structured products are designed based on existing financial products and strategies, innovating and improving through the use of blockchain and smart contract technologies. These products typically follow the DOV and PPV models.

DOV Model

The initial crypto structured products appeared in what are known as DeFi Option Vaults (DOVs). DOV, standing for Decentralized Option Vaults, are on-chain option vaults where users can buy and sell options. Users must lock their tokens in the vault to prevent counterparty action in exercising options, ensuring the vault’s funds are always sufficient. The initial strategy of DOV operation was a simple call and put option strategy, but investors still faced the risk of a decrease in ETH’s value. The development direction of the DOV protocol is to offer more advanced financial derivatives, ultimately evolving into a complete solution akin to private banking products.

PPV Model

Principal Protected Vaults (PPVs) can be understood as a type of capital-protected investment tool, similar to structured products in traditional financial markets. They operate based on smart contracts, offering users a low-risk investment opportunity while ensuring the safety of their principal investment. The basic structure of Principal Protected Vaults includes three components: collateral, asset locking, and margin. Users can purchase this investment tool by depositing cryptocurrencies or other digital assets as collateral. These assets are then locked in a smart contract until the contract expires. During the asset lock-in period, users can earn certain returns, while the margin is used to protect the safety of the principal investment.

Products themed around “Principal Protected Vaults” have gained significant attention. They are an extension of the DOV model and are expected to become the next innovation point, offering risk-averse investors methods to generate low-risk, high-return investments. While these products protect the investor’s principal to some extent, they still carry certain risks, especially in terms of stablecoin exchange rate risks. Additionally, the returns on these products mainly come from governance token rewards. Increasing these rewards might help enhance returns, but such earnings are limited.

Source: DefLlama

Future Evolution of Structured Products

As the cryptocurrency market develops, the number and types of DeFi structured products continue to increase. These products are designed to provide investors with a simplified way to invest, attracting more people to participate in cryptocurrency investment. DOV and PPV are currently the most common DeFi structured products, based on existing financial products and strategies, and improved through the use of blockchain and smart contract technologies. Although DOVs have some issues, as the market develops and technology progresses, the future of DeFi structured products will become more diverse and innovative. We believe that DeFi structured products will evolve in the following directions:

Increased Mainstream Adoption

As the DeFi market expands and the number of users grows, DeFi structured products will increasingly capture the attention and recognition of investors. In the future, these products will become more mainstream and serve as important tools for investors in asset allocation and risk management. These products will cover more types, more fields, and provide different types of services for different types of investors. For example, in the lending sector, there may be a greater variety of loan protocols in the future; in the trading sector, more types and forms of trading strategies might emerge.

With intensifying market competition, DeFi structured products will become more specialized, like liquidity staking, synthetic assets, etc. In the future, these products will require a higher level of technology and expertise to meet investor needs for risk control and yield optimization. For instance, in the field of quantitative trading, there might be more strategies based on machine learning and artificial intelligence technologies.

Tranched Lending

Tranched lending is an important form of DeFi structured product. It’s an investment tool that divides debt investment opportunities into different parts, each with its own risk/reward ratio. Investors can choose different parts to get different risks and returns. For example, in tranched lending, investors can obtain more stable returns by investing in higher-level debt parts, and higher returns by investing in lower-level debt parts. This type of product is very popular in traditional financial markets.

However, the current demand for higher-level debt parts in the DeFi market is not large, resulting in relatively low returns for lower-level debt parts. However, this also provides opportunities for institutional investors to enter the DeFi market. As technology continues to develop and the market matures, DeFi structured products will become an important means for institutional investors to enter the DeFi market.

Sustainable Yield Generation Opportunities

Yield generation opportunities in the DeFi ecosystem are gradually moving towards sustainability. Providing financial insurance or capital to borrowers for stable returns has become an important form of DeFi structured products. In the future, DeFi structured products will focus more on providing valuable products and services to better meet user needs and achieve the sustainable development of the DeFi ecosystem.

Principal protection is very important in DeFi structured products. There is a growing demand for products that can trade and invest in a decentralized environment. More and more DeFi structured products are using external DeFi protocols to provide base returns and creating derivative structures with on-chain/off-chain hybrid methods to provide users with safe, efficient, and transparent investment methods.

Source: STFX

With the rapid development of the DeFi industry, we believe that outstanding DeFi structured products in the future need to have the following characteristics to adapt to the direction of industry evolution:

1. DeFi structured products should offer more attractive returns. Designers of structured products need to deeply understand the DeFi industry and use rule-based investment strategies to effectively capture industry trends and achieve better investment returns.

2. DeFi structured products should provide a diverse range of asset allocation options. Future DeFi structured products should cover assets in the main areas of the industry and be able to adjust the asset allocation in a timely manner according to market changes, ensuring the diversity and flexibility of the asset portfolio. In addition, the inclusion of some non-standardized asset types should be considered to expand the range of market participants.

3. DeFi structured products should offer relatively lower risk levels. Structured products should use scientific risk control methods to reduce the overall risk level of the product portfolio, ensuring the stability of the products.

4. DeFi structured products should meet various customer needs. Future DeFi structured products should offer different investment thresholds and return levels to meet the needs of institutional and professional investors. At the same time, the flexibility and customizability of the products are also important features of future outstanding DeFi structured products.

5. Future DeFi structured products need to integrate better with the traditional financial system. Strengthening risk control for DeFi products, such as enhancing compliance audits, establishing risk control systems, and enhancing fund security management, can effectively improve the stability of DeFi products and better serve institutional and professional investors.

Disclaimer：

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