Crypto Valley Exchange Promises Efficiency Boost to Complex Derivatives Pipes in DeFi

The complex pipes that keep derivatives trades moving are about to get a major efficiency boost in DeFi, according to Crypto Valley Exchange.

Crypto Valley Exchange is introducing a "smart clearing" protocol designed to enhance the efficiency of derivatives trades in DeFi. Unlike the current practice of requiring 100% collateral for every trader in a trustless environment, the protocol will set collateral levels based on the traded assets' correlations in price. This approach, inspired by traditional financial markets, could make DeFi more competitive with the mainstream financial markets it's trying to replace, according to Crypto Valley Exchange CEO James Davies.

In a conversation with Blockworks, Davies explained that while institutions trading futures and options on CME and NYMEX have a trusted counterparty in the clearinghouse, they still need to put up some portion of the trade’s value in collateral. However, in DeFi, there's no trusted middleman, necessitating full collateralization.

"The issue with that is it limits how much capital traders can use in other markets," Davies said. "If you look at the size of the futures and options markets in TradFi, and then compare them to what we have in crypto, we’re massively, massively undersized."

He attributes this size disparity to the lack of efficient clearing in DeFi.

"This is the one place where all of crypto is much more conservative than TradFi. We’re really, really undersized in this space, and that’s because clearing is needed to create this efficiency."

Davies highlighted the absurdity of demanding full margin for trades involving highly correlated assets.

"If I was to go to, say NYMEX as an oil company and want to buy crude oil and sell jet fuel, and you asked me to put down full margin on both parts, I'd laugh at you, because those things are 90% correlated. I'd say ‘no, just put down the delta, the difference in price, on both of these products, and then I'll take the commonality in price and put that in a basket' - which is what they do."

He believes the same logic should apply in DeFi.

"Ethereum isn't going to 10,000 on the day Solana goes to zero. So, if I'm trading a relative-value bet on ETH up and SOL down, I shouldn't need to post full margin for both of those."

In his view, clearing is the missing piece in DeFi's effort to gobble up traditional finance. If protocols can better manage the risk, and also do so transparently, on a blockchain, so that everyone can see what's happening and how, then they'll become competitive with the financial rails they're trying to replace.

"You can't just build a perps DeFi platform for, say, treasuries or commodities, go up against NYMEX or go up against CME, and expect to win when you have to lock up so much more collateral than you would do to trade on those platforms. It's just not going to happen."

If crypto's real-world asset (RWA) subsector delivers on its promise of bringing tokenized versions of everything on-chain then, according to Davies, DeFi will need a solution to the clearing efficiency problem such as this. Institutional investors won't put up with requirements for triple the collateral capital they're used to – especially on correlated trades, he said.

The first user is Crypto Valley Exchange itself. Already, the Arbitrum-based futures and options DEX is running dated futures orders through its smart clearing. More capabilities are coming later this year to support commodities markets beyond crypto, and Davies hopes for other protocols to plug into smart clearing, too.