1/ Another day, another exciting Arbitrum project…
Today, let’s break down @Contango and how they are bringing expirable futures to DeFi.
Contango is a decentralized exchange offering expirable futures without order books or liquidity pools. To explain Contango, let’s first go over expirable futures and how they are applicable to DeFi.
3/ What Are Futures?:
Futures are derivative contracts to buy or sell an asset at a specific date and price in the future. There are 2 main categories of futures, those being expirable and perpetual.
4/ Perpetual Futures:
Perpetual futures are currently much more popular in DeFi with projects like @GMX 🫐 and @dYdX rapidly growing in usage. Perps are somewhat straightforward, which is why we've seen such explosive growth in their use in DeFi.
5/ Expirable Futures:
Expirable futures are a bit different. When opening an expirable future, there is an expiry date. The expiry date is when the contract is redeemed for its equivalent value. Expirable futures also have their own price that differs from the underlying asset.
6/ Another difference is there are no funding rates with expirable futures since all costs are known upfront. Perpetual futures tend to be better for short-term trades while expirable futures tend to be better for long-term trades.
7/ Funding Rates:
This tweet shows how much @GCR has spent on funding rates while shorting Luna. This highlights the benefit of using expirable futures where the fees would've been substantially less and known up-front.
8/ Market Size:
The graph below depicts the total volume traded in TradFi. While expirable futures only make up 5.8%, that still equates to almost 7 trillion of volume in 2021 alone, up 2.4x since 2020.
9/ Use Cases:
Contango highlights the three biggest use cases of expirable futures which are:
1. Speculation. This one is pretty self-explanatory.
Someone is bullish on BTC, they go long BTC. Someone is bearish BTC, they go short BTC.
2. Hedging. By hedging with expirable futures, you can achieve being completely delta-neutral without paying funding rates. Users can stake an asset while shorting it over the same staking period, which allows the trader to stay delta-neutral while receiving yield.
3. Arbitrage. Since expirable futures have their own price, there will be arbitrage opportunities between Contango and other TradFi/DeFi expirable futures markets.
12/ How Contango Works:
This is the interesting part. Contango will be built completely on top of fixed-rate borrowing markets (@Yield Protocol and @Notional at Messari Mainnet). This means that Contango won’t have an order book or liquidity pools. Let’s go a little deeper into how this works.
13/ Let’s say you wanted to buy a 2x ETH/DAI future. After buying this future, Contango borrows the quote currency (in this case DAI), sells the borrowed currency for the base currency on the spot market (buys ETH with DAI), then lends the base currency (lends ETH).
14/ This creates a long position and the only fees you’d have to pay is the difference between borrowing DAI and lending ETH. And since the fee is at a fixed rate, you would know your costs up-front. This works the same way when selling a contract.
Since Contango is built on top of fixed rate lending markets, it may seem difficult to enable leverage since most/all require being overcollateralized. This is where flash swaps come in.
16/ Flash Swaps:
Flash Swaps allows a user to buy a token before actually paying for it. This works by buying "X" token at the beginning of the block and then paying for it with "Y" token at the end of the block. This allows for Contango to support leverage.
17/ Positions as NFTs:
Another interesting thing about Contango is that positions are given as NFTs. This allows for some interesting use cases, such as strategy vaults or lending/borrowing.
- Expirable futures is an untapped market in crypto
- Liquidity is leveraged from current lending/borrowing markets
- All costs are known up-front
- Can only leverage fixed-rate lending/borrowing markets
- Liquidations are determined by underlying protocols
- Smart contract risk (but that’s with any project)
From what I’ve seen, there isn’t much information on utility, but we do have some info on distribution and unlocks.
Overall, Contango is a new Arbitrum project that is aiming to lead the expirable futures market. Leveraging current fixed-rate lending markets allows Contango to be another building block in DeFi, and they should be launching sometime in the fall.