Credit Default Swap (CDS) for wBTC now tradeable on Opium Exchange | by Andrey Belyakov | Opium Team

A CDS is a financial derivative product that is used to hedge credit default events. CDSs are useful for assets that bear counterparty risk, such as centralized stablecoins (eg. USDT, USDC) and other custodial assets (eg. wBTC, tokenized gold). CDS buyers insure themselves against insolvencyof the counterparty, and CDS sellers provide this insurance and get paid a premium for this.

As the DeFi space matures, we will likely see an increase in custodian assets being used (eg. centralized stablecoins, tokenized bitcoin, tokenized real estate, tokenized shipping documents) and an increase in demand for credit risk management.

wBTC is a custodial asset that is minted by BitGo — an institutional digital asset custodian. Every wBTC in circulation is backed by one BTC, held by BitGo. At the time of writing, over 800M USD worth of wBTC was issued and broadly used in DeFi as collateral.

BitGo has been providing services since 2013, is backed by serious investors and has a critically acclaimed multi-sig system for digital asset management. BitGo seems like a competent and trustworthy organization, but cannot provide the same guarantees as smart-contract based systems.

Fundamental financial theory tells us that limited exposure to multiple types of uncorrelated risks makes for a drastically better risk-return profile compared to unhedged exposure to systemic risks. Derivatives will be crucial to capital efficiency.

Holders of wBTC might seek to hedge this counterparty risk. Other traders might want to bet on the solvency of BitGo by selling insurance. In theory, even BitGo themselves could sell this CDS and provide insurance whilst earning a premium on top of their existing yields. A decentralized CDS market is the perfect solution to facilitate this transfer of risk and using Opium Protocol, we can create any kind of CDS product while preserving composability with the DeFi ecosystem.

Collateralized derivatives are great for managing risks, but they bear opportunity costs since the required margin could otherwise be used to generate yields in DeFi protocols such as Aave and Yearn. However, by leveraging the composability of Opium Protocol and other major DeFi projects, we can “unlock” the billions locked in DeFi by using interest-bearing tokens as collateral. This CDS is the first derivative product that leverages this benefit.

Sellers of this wBTC CDS are able to use yearn DAI (yDAI) as collateral, which means that they can earn an extra premium on top of the yields generated by the Yearn Vault. In the near future, we plan on implementing compatibility with Aave’s aTokens — this standard is by far superior to other token standards.

Using interest-bearing tokens as derivative collateral — another revolutionary feature of decentralized derivatives that enables capital efficiency in DeFi markets!

Opium Team will continue innovating on this front, integrating with major DeFi protocols to even further increase the flexibility of our protocol.

How does it work?

The CDS is available for trading on Opium Exchange. Traders and investors can purchase or sell CDS contracts on wBTC by posting orders with the desired price to the order book on Opium Exchange. When a buy order is matched to a sell order, the buyer pays an upfront premium to the seller.

We recognize the high demand for easy-to-use risk management instruments in DeFi today. Therefore, we will soon deploy a simple stand-alone frontend for buying and selling insurance using professional CDSs on Opium Protocol.

At maturity, Opium Protocol leverages robust and decentralized price oracles to determine whether the CDS should be triggered and which percentage of the locked margin should be paid out to the CDS buyer.

Details of this wBTC CDS

Contract size: 0.1BTC
Required margin: 1000 yDAI (yearn DAI)
Maturity: November 1st, 2020 at 8:00am UTC
Trigger event: 10% depreciation of wBTC price vs BTC price
Payout: Linear payout to CDS buyer, based on the relative depreciation of wBTC price relative to BTC price (20% depreciation results in 20% payout of margin to CDS buyer)
Oracle used: Combination of Uniswap V2 TWAP (wBTC/ETH pair) and Chainlink price feeds (BTC/ETH and ETH/DAI)

Last month we launched the very first CDS product in DeFi, based on Aave’s Credit Delegation feature. We received a ton of positive feedback back then, which motivated us to continue innovating with this type of derivative. The next CDS we launched was focussed on the most widely-used centralized stablecoin — USDT.

We recognize the high demand for easy-to-use risk management instruments in DeFi today. Therefore, we will soon deploy a simple stand-alone frontend for buying and selling insurance using professional CDSs on Opium Protocol. This simple frontend will enable non-technical users to easily cover their risks and allow traders to earn extra interest on their capital that is already generating yield in DeFi protocols. We will also continue exploring use-cases in DeFi for derivatives such as CDSs.

DeFi users are often exposed to systemic risks that could be catastrophic when left unhedged. Risk management is important because limited exposure to multiple types of uncorrelated risks makes for a drastically better risk-return profile compared to unhedged exposure to systemic risks (based on fundamental financial theory). Derivatives are needed for such advanced risk management strategies. Because of its flexibility and robustness, Opium Protocol seeks to become the universal protocol for decentralized financial derivatives.

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