UMA is created following the concepts borrowed from fiat financial derivatives, as an open-source protocol that allows any two counterparties to design and create their own financial contracts.
It is designed to offer the financial innovations made possible by permissionless, public blockchains like Ethereum.
But unlike traditional derivatives, UMA contracts are secured with economic incentives alone, making them self-enforcing and universally accessible.
UMA, the project builds “open-source infrastructure for ‘priceless’ financial contracts on Ethereum.”
The infrastructure of UMA is composed of two main parts: priceless financial contract designs and Data Verification Mechanism (DVM).
Working of UMA as a financial derivative (for apples)
Custom 2 party agreement
Alice thinks the price of apples will go down over the next six months.
Bob thinks apples are cheap and want to go long.
Bob and Alice formalize their trade using a UMA smart contract.
Both sides deposit a margin requirement of 10% that will be lost if they misbehave.
Over the next six months, the price of apples shifts up and down (but mostly down).
As the price shifts down (as verified by UMA’s oracle), Bob automatically contributes money to cover his margin requirement.
The more it shifts down the more he contributes.
After six months, the price of apples has fallen by 30%.
Alice’s bet was right.
Because Bob was consistently contributing funds to re-margin his position and not risk losing his 10% margin requirement, the contract can be instantly settled.
Implications of the protocol
- Trustless, permissionless risk transfer eliminates almost every barrier blocking access to financial markets. Anyone with access to the internet and internet money (aka crypto) could gain access to any financial market.
- Countries with weak financial systems are no longer restricted by their local infrastructure: individuals in developing countries could access any financial product available anywhere via a trustless financial derivative.
- Risk becomes universally programmable: smart contracts could hedge, trade, or invest in financial markets of all types, opening up massive opportunities for decentralized financial products.
What will you build with UMA?
Synthetic tokens for tracking
With the token builder, it is easy to track the price of everything.
Choose the price and deposit DAI and it’s done.
Under the hood, the Dapp creates a token facility by launching a smart contract.
After you deposit DAI into your token facility, you’re able to mint synthetic tokens that are fully backed by the DAI you deposited.
Overcollateralization of your token facility ensures that the synthetic tokens are fully backed at all times.
This helps reassure anyone buying the synthetic tokens that they’re fully backed (by you).
At any time, anyone can ask the smart contract to check if your token facility is undercollateralized.
During this process, the smart contract checks what the latest price is from the price feed and checks if the amount of DAI you’ve maintained in the contract meets the required amount.
If you do, you’re all set. If you don’t, the smart contract freezes all the collateral in the contract (you can’t deposit or withdraw) and assesses a penalty.
Anyone who holds synthetic tokens that were minted by this token facility can redeem them for a proportional amount of the backing collateral, plus any penalty.
Ideas to build with synthetic tokens –
- Create a token that tracks the price of CNY in DAI and uses it to power a China-focused wallet.
- Get levered short exposure to TSLA by creating tokens that track the price of TSLA and then selling them on a DEX.
- Create a version of PoolTogether that pays the performance of the S&P 500, rather than interest on DAI.
Decentralized crypto futures
UMA protocol offers :
- Trustless tokenization: meaning, how to create an ERC20 token for synthetic crypto or ‘ real – world’ asset exposure in ETF – like format.
- Context: Investor wants gold exposure with notional N and is willing to pay a fee F for this service. The provider is responsible for passing the total return of gold to investors through the smart contract and earns fee F for doing so.
Context cont’d: Investor and Provider back their promise with margin. The provider uses digital asset M as collateral, which must be above margin requirement MR at all times. A default penalty DP is assessed if the Provider fails to maintain M > MR at all times.
- Creation: Investor deposits N into a smart contract and Provider deposits M into a smart contract. Smart contract issues “gold” tokens, worth N, to investors. The margin in the smart contracts should always be ≥ the value of “gold” tokens.
- Re-margin: Provider passes total return of gold to the Investor, accrues fee F, and if needed, tops up margin by depositing D to prevent default. Smart contract watches for default by checking if Total Margin is still > MR.
- Redemption: At end of trade, “gold” tokens are burned and Investor’s margin balance is returned. The provider margin balance is also returned. The investor earns a total return of gold and the Provider earns her feel F. Both are happy with their trade.
- Default (abnormal outcome): If Provider’s Total Margin ever falls below the margin requirement (MR), “gold” tokens are redeemed with add’l default penalty DP paid to Investor. The investor still happy because she earns a DP.
Building yield curves on ether
- First, start with the implementation of ytokens ( yield tokens ) using UMA’s protocol synthetic tokens.
- yTokens can be implemented super easily as a UMA protocol synthetic asset to create fixed-term loans.
- yTokens are just synthetic assets collateralized by ETH that pay out $1 worth of ETH at expiry.
- The creator of the yTokens sells them at a discount to $1 because the market right now wants to borrow USD more than $ETH. This allows us to measure the “interest rate differential” between ETH/USD over the term of the loan.
- Theoretically, by the no-arbitrage concept of “interest rate parity”, the rate differential between USD & ETH represents the market’s expectations of the future ETH/USD exchange rate.
Teams and supporters of UMA protocol
UMA is backed by a diverse team driven by a passionate belief that financial markets should be universally accessible.
The team of eight includes alumni of Google, Goldman Sachs, five venture-backed startups, and three economics doctoral programs.
Risk Labs, the company supporting this protocol development, raised a $4M seed round led by Placeholder with participation from Bain Capital Ventures, Blockchain Capital, Box Group, Coinbase Ventures, Dragonfly Capital, FinTech Collective, and Two Sigma Ventures.
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