We are progressing through our series on what it will take to give the Hive Backed Dollar (HBD) inherent value.
In the first article, we showed the importance of collateralization.
We will now embark upon a very misguided subject that gets a lot of attention, most of it negative. However, when it comes to the financial world, derivatives play an enormous role. For this reason, one of the quests of HBD is to have it serve as the basis for other derivatives.
The media frames these financial instruments as dangerous. They do, nevertheless, serve a much needed purpose for businesses.
Source
Risk Adjustment
One of the core functions of financial markets is risk allocation. There are different appetites, something that markets seek to fulfill. It is this flexibility which allows business to function.
What is a derivative?
Basically, it is a contract that derives value based upon the price of another asset, one that is not required to be help by the individual. In other words, it is an asset upon an asset.
Most people are familiar with stock options. Let us use Apple (AAPL) as an example. People can buy 100 shares of AAPL or they can invest in an options contract. This gives the person the right to either buy or sell the shares without actually owning them. Thus, the person can gain exposure to the price movement in the stock. For this, a premium is paid (the cost of the option).
How these the derivatives truly work is outside the scope of this article. Yet, we can point to a situation which business use and is not speculation. Actually, this is utilized to reduce risk while avoiding the speculative nature of things.
Everyone knows the price of oil is volatile. This is something we see on a regular basis in watching the markets. It is also something that can be death to an industry such as the airlines. They go through more than 600K barrels of oil per day. As we can imagine, a move of $10 or $20 can make a huge difference.
To the executives at these companies, they look for price stability. Here is where they will purchase option contracts to limit their risk. By doing this, they remove the mystery as to what they will be paying for fuel.
It is a way for them to hedge.
In addition to this, derivatives allow for other people to speculate while also providing opportunities to arbitrage.
Enormous Market
How big is the derivative market?
This is something that few have an answer for. It is impossible to know exactly since the banking and financial system are actively creating different assets all the time. Thus, we get a wide range.
The best estimates appear to be a market size of between $750 trillion and $1.5 quadrillion. Even if we go with the low number, it is enormous.
Like was discussed in the previous article, here is one of the areas that makes the USD so powerful. Whatever the number of derivatives out there, a majority of them are priced in USD. Hence, it is the denomination of all activity.
With hundreds of trillions of dollars in contracts out there, do you think the USD is vulnerable to replacement? The answer is no.
With derivatives the base asset is actually strengthened. Here is where value is built beyond any backing mechanism. With the USD, it is a stabilizing factor that cannot be understated.
Consider for a moment trillions in dollars in contracts that pay out in USD. These are varying in length of time. All participants know that USD is going to change hands during the contract. In fact, it is legally obligated to be used.
This is what needs to be replicated.
Crypto Derivatives
We are just getting started in the derivative game with cryptocurrency. There is a lot of talk about synthetic derivatives through tokenization. This can be done with commodities, stocks, and an assortment of other assets. Of course, infrastructure has to be built out to achieve that end.
Keep in mind, these instruments are designed to reposition risk throughout the markets. Since risk tolerance levels differ, we can see how appeasing the spectrum is vital. Here is where derivatives come in.
We already have an example with HBD.
The Leofinance Team introduced pHBD. This is truly a derivative of HBD. The value is derived from the underlying asset. Here it is not a tricky situation since it is basically designed to be a 1:1 correlation. Nevertheless, these are two totally different assets.
Also, as mentioned, one can gain exposure to the price movement by holding pHBD. Since it is a stablecoin it is not meant to be a wide spread. However, we do know there are fluctuations. This also present arbitrage opportunities.
pHBD enhances the value of HBD. Since it is a derivative tied to the underlying asset, the more success the former has, the better it is for HBD.
Part of the road map on Polycub is to provide collateralized lending. Imagine if this was done in pHBD. Just think of how that enhances the value of HBD. Even though it is not involved directly, we can see how the layers start to build.
Consider the value of HBD if this situation was repeated 150 times.
Build Around HBD
As we can see, the development of these assets is what enhances the worth. By building around the coin itself, value is given inherently. When settlement is made in that currency, there is an instant market for it. It will also create the situation where a lot more HBD will be required.
Another area that is starting to get a bit of attention within the cryptocurrency world is Contract for Difference (CFD).
This is what a CFD is according to Investopedia:
A contract for differences (CFD) is an arrangement made in financial derivatives trading where the differences in the settlement between the open and closing trade prices are cash-settled. There is no delivery of physical goods or securities with CFDs.
The "cash-settled" is emphasized to make a point. There is no reason this cannot be set up to settle in HBD. Here we see it at the core of all this activity that could be built on decentralized infrastructure.
Suddenly, the entire world of synthetic assets is opened upon to HBD. It could be a base token that is used in these contracts. We also showed how even if the mechanism uses a derivative of HBD, it still enhances the value of the core asset.
Derivatives play an important role in both the financial and business worlds. By giving people the opportunity to speculation, hedge, and arbitrage, differing market needs can be met. This is what derivatives excel at.
If we see an assortment of derivatives built with HBD incorporated, we are adding to the strength of this coin. It is fairly easy to see how robust this market can become. Capturing even a fraction of the derivative volume out there will make HBD a heavily utilized coin.
And this should be the ultimate goal. Utility is what will separate HBD from a lot of other things that are being promoted out there.
For this to occur, it requires building. That is the difference. There are no shortcuts.
What are your thoughts? Do you see how derivatives can vastly expand the utility and, hence, the value of HBD?
Let us know in the comment section below.
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