How to short ETH via Derivatives within DeFi?

Margin/Futures & Options: A review of all DeFi platforms

Introduction

Ethereum’s success is increasingly linked to the success of dApps built on top of it, in particular DeFi dApps which lets you do almost anything traditional finance can do: lend/borrow, investment and insurance.

But the topic of going short ETH (betting on a decrease of ETH price) via derivatives is almost never discussed in the DeFi community.

We take a look at the different possibilities which currently exists within the DeFi world to short ETH via derivatives, either via margins/futures or put options.

Trading with leverage and buying options are risky and not suitable for all investors. If you are not familiar with these products and you don’t know what is a liquidation price or a strike price, we highly recommend you to not trade any of these products.

For those still interested to use leverage, here is the full list of possibilities to short or long ETH within the DeFi world.

Margin & Futures

Trading on margin or via futures is simple to understand: you buy or sell more than you currently have in your wallet, you use leverage to do that. Leverage is the ability to borrow more funds then you currently have in your wallet for an additional fee.

The trading platforms allow you to use leverage to buy or sell more. Why? Because they make more money thanks to higher fees, as you buy or sell a higher quantity. They might also charge a funding fee on your position to allow you to keep your position.

So as you have a higher quantity of crypto, your return will be magnified by the leverage you used.

However, there are also risks, with leverage you can be liquidated, meaning your position is worth 0 because losses will be magnified as well due to leverage. Leverage works both way: higher return but also higher loss.

The higher the leverage, the higher the risk to lose your full position.

The higher the leverage, the higher your potential return or potential loss.

Let’s take an example to illustrate the risks, if you are short ETH for $10K USD 40 ETH at $250 per ETH with a leverage of 10, meaning you have invested $1K USD and that ETH goes up by 10%, your position will be liquidated and you lose your $1K USD when ETH goes to $275. If you did not use leverage and went short with your $1K USD, you would have been liquidated only if ETH reached $500.

On the contrary, imagine ETH goes to $100, you make $6K with a leverage of 10 ((40*250) - (40*100 = $6K USD) compared to $600 USD with no leverage.

The same logic applies to go long ETH with leverage.

Leverage is highly risky.

dYdX

dYdX is a trading platform offering margin and futures’ products to traders. The platform is non custodial and offers the possibility to short ETH on margin against DAI or USDC with up to x4 leverage. They will also release a ETH perpetual contract with up to x10 leverage soon.

Platform is available, here.

Nuo

Nuo Network offers margin trading with up to x3 leverage for ETH, either against DAI or USDC.

Platform is available, here.

FutureSwap

It is the decentralised version of BitMEX for leveraged products. You can short ETH with up to x20 leverage. The product has been released for a few days in alpha version to gather feedback from users but is now closed. We should see a beta version soon enough.

Platform is available, here.

Options

Options are derivatives, which offer you the right to buy or sell an underlying product at a pre determined price within a given time frame. Buy options is like buy a car insurance.

To bet on a decrease of ETH price, you buy put options. To bet on an increase of ETH price you buy call options.

Buying a put option can be compared to buying an insurance for your car. You take an insurance in case your car is damaged. The insurance company will reimburse you the value of your car if it is destroyed but you have to pay your insurance company a premium per year to do that.

In the case of buying put options, it is the same mechanism. Someone is selling you a put option (an insurance) that if ETH falls below a certain threshold (the strike price) within a given time frame (the expiry date), they will cover your loss if that arises. You buy a put option to cover yourself in case ETH goes south. Put options are used to hedge your risk or to speculate.

Buying options has unlimited upside and limited downside, you can only lose the premium you have invested but can you make x100 your investment.

On the contrary, writing or selling options has unlimited risks and limited return. That’s why writing options should only be done by professionals. Only professionals sell car insurance.

The value of options are governed by different factors such as the time to expiry, the implied volatility of the underlying asset, the changes of the underlying asset in value and the moneyness of options:

  • at the money, when the price of the underlying asset equals the strike price of the option

  • in the money, when the price of the underlying asset is higher than the strike price of the option

  • out of the money, when the price of the underlying asset is lower than the strike price of the option

Some rules:

The higher the implied volatility, the more expensive the premium paid to buy the option.

The longer the expiry date, the more expensive the premium paid to buy the option.

The higher (the lower) the strike price, the cheaper the premium paid for call options (put options).

We do recommend you to read at least a book about options before trading them such as “Option Volatility & Pricing” by S. Natenberg, or the Derivatives’ Bible: “Options, Futures and Other Derivatives” by John C. Hull (a much bigger book).

Opyn

They offer put options (protective puts) on ETH with different strike prices (210, 200 & 180) and expiry (less than one month).

Platform is available, here.

Hegic

They offer a wide range of call & put options on ETH. You can select the number of contracts, the strike price and the period of holding.

Note that they already had two “bugs” in the code resulting in significant losses for option holders, but have so far been fully repaid by Hegic’s founders.

Platform is available, here.

The Synthetix way

Synthetix, which offers Synthetic assets, has an inverse ETH (iETH) which replicates the inverse of ETH performance. The price of iETH will go up when ETH goes down.

To buy these synthetic, you need to buy sUSD, the stablecoin of Synthetix and then you are able to trade on their platform.

Note that there is no leverage involved here.

Platform is available, here.

Conclusion

DeFi is not only about lending and borrowing stablecoins but also about pure speculation or hedging.

There are many interesting projects which have developed unique features for the DeFi user. Being able to hedge your portfolio of ETH for a given period of time via put options is, while still being highly dangerous, a major innovation.

Derivatives are dangerous financial products which should be understood carefully before doing anything.

The ecosystem is growing and that’s nice because it offers tremendeous arbitrage opportunities as there are still many price discrepancies with derivatives offered by centralised exchanged.

If you are interested to generate alpha with such opportunities, please like this article or let us know on Twitter. If there is enough interest, we will explain our strategies for our subscribers.

Thanks for reading

Secret Salsa

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