🎯Introduction: Our Thesis
Why Ostium? In this section, we take a step back and outline key trends in the perpetuals and onchain trading space before diving into how – and why – Ostium fits in.
A Changing Macro Paradigm
The pandemic and resulting massive liquidity injection, inflation shock, and aggressive Central Bank interest rate reaction ruptured the market trends of the prior 15 years. Supply chain disruptions, geopolitical uncertainty, and dramatic commodity price shocks further cemented that change. The infinite-money, zero interest rate, large tech stock market hyper-dominance days are over (for now).
This change has had several important impacts on non-institutional trading activity:
Increased awareness and trading of macro events like interest rate policy, CPI prints, and geopolitical events, rather than near-exclusive focus on internal asset class or asset-specific dynamics.
Demand for diversification. From multi-year highs in micro commodity contract volumes to fractionalized fine wines and Private Equity exposure, younger generations in particular are moving away from vanilla 60/40 stock/bond portfolio construction and driving demand for newer alternative asset classes.
More retail trading. The first wave of market democratization, enabled by no-fee trades and fractional equity ownership on platforms like Robinhood, facilitated a rapid rise in individual stock ownership and trading, turbocharged by liquidity injections pumping asset prices.
We expect points 2) and 3) to act complementarily going forward, with the next wave of market participation driven on the demand side by appetite for alternative assets and on the supply side by technological advances enabling cheaper, faster, and more fractionalized access to these very assets.
These trends also appear fractal, mirrored in many ways within the onchain ecosystem. CPI print days consistently see outsized BTC & ETH volumes. There has been a rapid rise in infrastructural support for and onchain TVL into alternative, non-crypto native assets like tokenized Treasurys and gold.
On-Chain Finance: Recent Trends & a Return to Fundamentals
CEX vs. DEX. If there's been one major takeaway and positive spillover effect from the 2023 turmoil in the centralized exchange space, it's the return to fundamentals. Our conviction has never been higher in the mandate for the decentralized, programmatic, and permissionless trading that DEXes enable.
Spot. Price discovery is increasingly happening on DEXes. Swaps volume on Uniswap overtook Coinbase in daily volume in Q1 of 2023.
Perpetuals. The past year has seen the first signs of this trend echoed in the perpetuals space. Leading perp DEXes have seen continued growth in volumes, with chains like Arbitrum emerging as a laboratory for DeFi innovation with a proliferation of new perpetuals protocols.
Innovations in Perp DEX Architecture. The growth in onchain perps has been turbocharged by innovations in both protocol architecture and in the infrastructure these exchanges are powered by (e.g. oracles, chains with improved throughput & transaction costs). While hybrid models are increasingly popular (e.g., Drift), perpetuals DEX models can be grouped into three main categories:
AMM/vAMMs. At a high level, AMMs use a liquidity pool of two assets valued relative to one another, with the price varying along a pricing curve (e.g., x*y=k) as assets are traded in the pool. While initially designed for swaps, the model has been adapted to leveraged trading of perpetuals by protocols like Perp Protocol. However, pure AMM models face liquidity constraints for leveraged products that have historically created a natural cap on leverage that can be offered and are best suited to the exchange of ERC-20 tokens representing the underlying assets. Overall, this makes the design less than ideal for Real World Assets that both currently have no tokenized onchain equivalent and are less volatile than most crypto assets and thus typically traded at high leverage levels.
Order Books. Most traditional markets operate using an order book to match buyers and sellers of an asset. However, few chains currently support the throughput required to conduct large-scale order matching entirely onchain. Due to these infrastructural constraints, the majority of order book-based DEXes conduct order-matching off-chain (e.g. dYdX). Running core components of DEX architecture off-chain both i) creates centralization risk and ii) creates excess reliance on a small number of market makers for good pricing and execution for users.
Pool-based perpetuals. Much of the recent growth in onchain perpetuals has been driven by innovation in and adoption of this model. Pool-based perps aggregate liquidity, typically into a single pool, in which LPs act as counterparties to trader PnL during periods of imbalance in Open Interest. Pricing at position open is determined via oracles, which feed in spot reference price data, effectively outsourcing price discovery at open to markets with greater liquidity. Compounding fees accrued during the lifetime of a position minimize the risk traders pose to LPs. While this model faces drawbacks – LPs run the risk of directional exposure and oracle pricing under conditions of low reference market liquidity can create the opportunity for negative EV arbitrage – it has many advantages. In particular, pool-based perps i) minimize liquidity fragmentation and ii) have the potential to enable price exposure to off-chain assets with no tokenized onchain equivalent, given pricing is determined entirely via oracles. To read more about our definition of this model, consult section 1.1 of our research article on pool-based perpetuals DEXes here.
The Search For Onchain Diversification
With the worst depths of the bear market behind us and a rise in institutional acceptance – and adoption – of crypto with recent spot ETF approvals, it's worth reflecting both on 1) what aspects of the stack showed resilience through the bear and 2) what crypto's increasing intertwinement with traditional markets means for the path ahead for DeFi.
Stablecoins showed remarkable resilience throughout the bear market, with both increased adoption in emerging economies and a stable market cap during a tumultuous time.
While recent focus has been on crypto integration into TradFi (e.g. Bitcoin ETF on Fidelity), we expect integration to grow dramatically in both directions through increased TradFi integration into crypto rails (e.g. stablecoins, tokenized equities). Fulfilling crypto’s promise as a technology will mean using blockchains as a financial settlement layer for all sorts of assets – not just crypto-native assets.
In general, this means capital has and will increasingly remain onchain through market cycles, even when token holders de-risk into less volatile assets, propelled by stablecoin adoption, improved crypto UX, and onchain diversification opportunities into un- or less-correlated Real World Assets.
While the direction the space is going is clear, opportunities to diversify onchain into a broader set of assets not native to the blockchain still remain few and far between today.
Tokenization has made inroads, particularly in the Treasury space as demand for stable yields has risen through the bear market. Aside from Treasurys, however, asset tokenization remains in its early days as legal and technical tokenization standards remain in flux.
Further, a majority of tokenized assets – in particular yield-bearing government bonds – naturally cater to a user base of long-term holders, rather than traders.
This is despite the popularity and generally greater prevalence of short-and mid-term trading behavior in crypto through e.g. leveraged perps than in most traditional asset classes. In other words: while crypto trading infrastructure disproportionately serves traders rather than long-term holders, the RWAs currently being onboarded into our ecosystem via tokenization disproportionately serve holders rather than traders.
Thus: the space for a trader-focused Real World Asset platform is wide open.
Enter Ostium
The Ostium Protocol is a set of smart contracts enabling onchain price exposure to off-chain Real World Assets via synthetic perps.
We contend the best way to serve demand today among onchain traders for leveraged, short- and mid-term price exposure to RWAs is via oracle-based perpetuals.
These can be onboarded onchain directly with fewer upfront logistical hurdles and more nimble technical infrastructure than tokenized assets. RWA perpetuals require a high-fidelity, low-latency oracle price feed for the asset and a liquid exchange venue designed to safely and programmatically support the unique features of most RWAs (e.g., market closures, contract rollovers).
While at genesis the protocol will only support stablecoin deposits and trading collateral, our vision is to ultimately act as a nexus, uniting the "holder" and "trader" RWA user base by supporting collateral and vault deposits of the tokenized equivalents of listed perpetuals.
For instance, the XAU/USD (gold) perpetuals market would support PAXG (Paxos Gold), XAUT (Tether Gold) or equivalent collateral deposits; the XAG/USD (silver) perpetuals market tokenized silver, etc.
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