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Amongst the GME Carnage, which occurred on January 26th and 27th, new retail account signups flooded brokerages like Robinhood to purchase GME stock, make margin purchases and buy calls. The sheer magnitude of retail trades placed began putting immense pressure on the brokerages, clearinghouses and market makers testing the very market infrastructure itself. In reaction to this uptick in volatility, clearinghouses began increasing capital requirements tenfold, forcing brokers like Robinhood and TD Ameritrade to disable new purchases of GME, cause the stock to crash back to earth, trading below $50 today.
In what started as a bet on market mechanics, it was the market structure itself that ultimately led the GME trade to unwind, in the process exposing retail investors around the world to the opaque nature of modern capital markets infrastructure and the counterparty risk involved in interacting with custodial brokers.
The GME saga was a truly unique moment in financial markets, putting a spotlight on the counterparty risk traders are taking when they place trades on centralised brokerages while also highlighting the privileged position established market participants have in the traditional financial markets both in terms of privileged access to market information, lower transaction fees and their ability to execute trades. It is these very problems of traditional market structure, transparency and counterparty risk which DeFi aims to solve, enabling trading and settlement on top of public blockchain rails, to provide an alternative to the legacy financial markets, with open access to all market participants, free from the gatekeepers and intermediaries of old.
While DeFi has begun to deliver on the promise of self-custodial spot trading, as per Uniswap’s $84b of volume in May 2021, self-custodial derivatives remain a largely untapped market relative to the over $185b in daily derivatives volumes traded on centralised exchanges today.
To offer a truly alternative financial system, DeFi needs to provide a full suite of self-custodial trading solutions to enable the transfer of risk openly and transparently.
Vega enables derivatives markets free from counterparty risk while providing a radically new approach to creating markets.
From the outset, the Vega founding team had two key guiding design principles: 1) a decentralised derivatives platform must scale to billions in daily notional transaction volume and, 2) most importantly, such platform should be fair for all traders.
To build a fair trading platform for all traders, transactions must be ordered based on the time they are submitted and not the price they pay to submit the transaction. This is in contrast to the blockchain auction mechanisms seen in Ethereum gas markets where participants bid to have their transaction included in a block which leads to predatory front running dynamics, be it front running user trades on Uniswap, front running burn call transactions on Uniswap, or liquidation on Maker CDPs. These front running dynamics result in worse pricing, higher gas costs, unsuccessful trades, and less reliable liquidation guarantees for end-users.
For these reasons, unlike other Ethereum based self-custodial derivatives platforms, Vega has its own tailor-made consensus protocol, the "Wendy" fairness protocol, which provides guarantees on ordering at the consensus layer, ordering transactions based on the time they were submitted. Vega is, therefore, built on its own PoS protocol using the Tendermint consensus engine with its own native token "VEGA".
The Vega Network includes a collateral layer that enables traders to provide the collateral type of their choice, from among other blockchains, all while retaining custody of their own assets. This enables traders to, for example, take a long position on ETH, using native BTC while maintaining control of their assets in the Vega Collateral layer.
In addition to enabling cross-chain collateral, Vega’s collateral layer also enables margining of positions across all markets on Vega, providing much greater capital efficiency for traders. Take, for example, a trader looking to place a long basis trade on the BTC June quarterly futures: the trader could simply take a short position on the BTC/USD perpetual futures market and take a long position on the BTC/USD June Quarterly futures market with the two positions netting out providing the trader with lower collateral requirements and greater capital efficiency as a result.
In addition to providing self custodial derivatives trading, and unlike traditional derivatives venues, where the exchange administrator decides which markets to create, Vega lets its users create their own derivatives markets.
Traders using Vega can specify the market parameters by submitting a proposal to the network for voting approval by VEGA token holders. Once voted through by the community, new markets need to meet the minimal liquidity threshold (through sufficient liquidity provider commitments) before trading on the market can begin. By empowering its community of traders to create their own markets, Vega enables those closest to the market to decide which markets should be created and allows the community to help bootstrap the liquidity of those markets.
As a Proof of Stake Network and derivatives platform governed by the token holders, the VEGA token has a vital role in the security and governance of the Vega network. Token holders make key governance decisions regarding new market approvals, exchange and market parameters, network and even liquidity incentives.
VEGA token holders can participate in the validation, security and governance of the network by staking or delegating their tokens and receive 33% of the trading fees generated by the Vega Protocol in addition to inflation rewards in return for their participation and work. As the Vega Protocol grows through rising trading volumes and new markets, the VEGA tokens fee share from trading fees grows, capturing value from the protocol’s growth aligning token holders with the long term success of the protocol.
Just as derivatives brought a wave of innovation in financial engineering and market creation, self custodial derivatives will pave the way for a new wave of markets and products within DeFi. Vega Protocol is capital markets infrastructure for DeFi that will enable the creation of new markets by those closest to the market, the traders themselves.
The Vega Public Testnet is now live; you can check out the Vega wallet repo or if you’d rather not run your own wallet, you can request access to a hosted wallet in the Vega discord.
Disclosure: Eden Block is an investor in Vega Protocol
Nothing contained herein constitutes investment, legal, tax or other advice nor is to be relied upon in making an investment or other decision. This presentation contains the opinions of the author, and such opinions are subject to change without notice. Furthermore, it may also include data and opinions derived from third party sources. Eden Block does not accept liability for the accuracy or completeness of any such information or opinions which can be subject to change without notice.
