Volatility in crypto markets has always been notoriously high, and it’s not going away anytime soon. And while simply HODLing crypto assets was once the preferred approach, today’s Web3 investors are seeking new ways to make the most of their digital asset portfolios. That’s why more and more crypto holders are turning to structured products.
In this latest installment of PsyFi Learn, our educational series that sheds light on decentralized finance (DeFi) in general and PsyFi specifically, we are going to take a closer look at this class of investments, and how they can help DeFi investors shape their portfolios to suit their appetites for risk and yield.
So if you’ve ever shied away from structured products because they seem too complex to grasp, this primer is for you.
So What Are Structured Products?
Simply put, structured products are financial instruments made up of a mix of two or more underlying assets. These combinations, which often include interest-bearing assets such as loans and bonds along with various types of derivatives, are calibrated to suit the return objectives and risk tolerance of an investor.
Because they are adaptable and can help investors achieve high returns relative to investment, structured products have been a mainstay in traditional finance since the 1990s. In the crypto space, however, they’re a relative newcomer.
That’s why PsyFi exists: to provide crypto holders with structured products that suit a wide range of investment types, payoff structures, and risk profiles.
To understand how structured products can benefit you, it’s important to understand their most fundamental building blocks: derivatives.
Derivatives are so-named as such because they don’t carry inherent value. Instead, their value is derived from an underlying asset or a set of assets. In traditional finance, these can be stocks, bonds, commodities, currencies, or even other derivatives. And in the DeFi world, derivatives get their value from fungible and non-fungible crypto tokens.
Derivatives can serve several purposes in both TradFi and DeFi: they allow investors to speculate on price movements, hedge against risks, or gain exposure to specific market conditions without directly owning the underlying asset.
For instance, if you own a certain amount of a particular cryptocurrency, you can hedge against risk by taking a derivative position that will allow you to profit if the token’s price declines. Derivatives can also be used to improve price discovery, diversify your portfolio, or benefit from arbitrage opportunities when there are gaps between bid and offer prices.
When creating a derivatives contract, users can choose among a range of characteristics, including expiration dates, contract sizes, and the predetermined price at which they have the right to buy or sell the underlying asset – also known as the strike price – to align with their risk management strategies.
There are a few other factors that determine the nature of a given derivative. For instance, American-style derivatives can be exercised by the holder at any time, while European-style derivatives can only be exercised on their predetermined expiration date.
Cash-settled contracts are paid out in (you guessed it) cash, while physical derivatives are settled in the underlying asset itself.
And when derivatives are described as vanilla, it doesn’t mean they taste good, but rather that they are basic with straightforward terms and structures. Those known as exotic, in contrast, have more complex structures that may involve unique payoff formulas, non-standard contract terms, or customized conditions that suit specific objectives.
There are many more types of derivatives that can be tied to different kinds of assets, including interest rates, crypto and fiat currencies, equities, and commodities.
Looking at the Options
When investors want to use derivatives to speculate on the future price of an asset, a special type of contract called an option comes into play. Options come in two varieties – call and put – and allow you to make directional bets on the price movements of the underlying assets.
Call options offer speculators the opportunity to profit from anticipated price increases in an underlying asset. If the price rises above the option’s designated strike price, you can choose to either exercise the option or sell the contract at a higher market price.
Conversely, put options let you profit from anticipated price decreases in an underlying asset by locking in a price at which you can sell the underlying asset.
Options are somewhat similar to futures contracts, which give their holders the right to buy or sell an asset at a predetermined price on a specific date in the future. But unlike futures contracts, options do not oblige the contract holder to buy or sell within a specific timeframe. Instead, holders can choose to let their contracts expire rather than exercise them.
What Role Do Options Play in PsyFi’s Structured Products?
Options are the derivative type used in PsyVaults, PsyFi’s suite of option strategy vaults designed to generate sustainable yield for single token assets for our users.
The options infrastructure allows us to offer a variety of different vault categories that suit a range of risk appetites. PsyFi’s Covered Call Vaults and Secure Put Vaults, for instance, are designed to produce a relatively moderate return, and therefore may be best suited for an investor who is neutral to moderately bearish/bullish.
Market Making Vaults are useful for users who are willing to accept relatively lower returns in exchange for reduced risk, while Leveraged Call Spreads are best suited to investors with higher risk appetites.
To view the full range of PsyVaults, click here.
Structured Products For All
PsyFi’s mission is to provide DeFi users around the world with best-in-class financial tools that dovetail with their risk appetites and levels of experience. This mission has shaped everything we have done – and all that we will do in future.
Unlike traditional structured products, every financial instrument PsyFi creates is fully open source, meaning that any user can view and audit the code behind each product at any time. PsyFi's code is also regularly audited by trusted third parties – the results of our most recent audit can be found here.
The infrastructure that supports the PsyFi ecosystem is also fully community-owned, via our decentralized autonomous organization (DAO). It is our users who shape the future of what PsyFi supports and creates. Learn more about current governance proposals here.
This is the second in a series of PsyFi Learn guides covering the essentials of DeFi and the basics of PsyFi. Click here to check out other posts in this series.