For the first time in DeFi's history MetalSwap deployed the derivative financial instrument known as "Hedging Swap": up to now it has been called so in order to better explain it to traditional finance users who have never tried DeFi, speaking about that tool in comparison to the one covering traditionally metals, and other commodities.
As MetalSwap's narrative has evolved in the DeFi space, we can now take a new reference: in 2014 the Ethereum founder Vitalik Buterin devoted an entire chapter of his presentation to the topic of "Hedging Contracts"
That's why it's time to change the payoff in:
RiskOff Hedging Contracts
Let's delve deeper and see what this is all about!
Why should you open a position on MetalSwap?
The main purpose of using this financial instrument is to cancel out the volatility of a specific asset, using the dApp as insurance against volatility.
Through MetalSwap, you can open positions that safeguard your counter value in dollars, keeping it stable for the period you set and the underlying operation is very simple.
If you open a position with 1 Ether, where 1 ETH = $1500:
- If the price falls, for example, to $1200 during the set period, MetalSwap will pay you $300
- If the price rises, for example, to $1700, MetalSwap will require you $200 at the end of the predetermined period.
In any situation, your counter value in dollars will remain stable at $1500. This security against volatility opens the doors to countless use cases that the team is discussing in dedicated articles on the blog.
MetalSwap can also be used as a dApp for speculating on future market movements. By using collateral that is smaller than the size of the actual open position, leveraged positions can be opened, allowing for potential gains if the market moves in the direction we've bet on, but increasing the risk of liquidation if the market moves in the opposite direction.
Premium, target size and leverage
Every insurance comes with a cost, and MetalSwap also requires a premium to use its service. The size of the premium depends on various factors, such as the size of the open position, the underlying asset, or the duration of that position's opening.
To open a position within MetalSwap, it is necessary to deposit a cover in case the price moves against the open position. It is from this collateral that MetalSwap will deduct the price difference at the end of the position if the underlying asset had increased in value.
Depositing a cover equal to the target size of the position will provide neutral leverage, usually used for hedging positions. However, the dApp also gives the possibility of offering a lower cover than the target size of the position, effectively making it possible to open leveraged positions.
How does it actually work?
Once a position is opened, the price of the underlying asset will begin to move for or against our position. By having a position where target size and cover are equal, we will be protected up to a 100% opposite price movement. The smaller the cover made available, the closer the threshold that will lead to liquidation of the position. In the case of the position shown above, by opening a position at $1569 with target size and cover of 1 ETH; we will be protected until ETH price increases to $3059.
Another parameter to be decided is the set duration or expire date, which is the time period of opening that position. Unlike other derivative financial instruments, Hedging Contracts give the possibility to determine the duration of the position in advance.
The Hedging Contract therefore has 3 possible outcomes:
- The position closes in Profit, so the user who opened the operation receives back the Cover plus the Profit.
- The position closes in Loss and the user receives back the part of the Cover that has not been eroded, based on the price of the Digital Asset at the moment of the Expire Date.
- The position is liquidated because the price of the Digital Asset has reached the Threshold Price and therefore the coverage has been closed prematurely, and the Cover completely eroded.
Customize your position
The open position is always modifiable, mainly in two ways:
- If the cover is eroding and is close to the threshold, the user can increase the position cover, reducing the leverage and moving away from the liquidation price.
- By paying a penalty, the position can be closed early before the pre-set expire date.
Make MetalSwap easy
This introductory article about Hedging Contracts has come to an end, hoping that it has helped to reduce any doubts about this dApp that offers one of the most complex yet widely used derivative instruments.
In the next article in this series, we will delve into more specifics and analyze the practical functioning of a long position on MetalSwap.
-The DeFi Foundation
✎ What is MetalSwap?
MetalSwap is a decentralized platform that brings Hedging Contracts on financial markets with the aim of providing coverage to those who work with digital asset and an investment opportunity for those who contribute to increase the shared liquidity of the project. Allowing the protection for an increasing number of operators.
With MetalSwap we enable Hedging Contracts on the DeFi field, AMM style.