Traditionally, structured products in the institutional investor domain combine different assets and derivatives to create tailor-made risk-return profiles. With the advent of blockchain, the potential for this market segment is enormous and promises significant cost savings, improved composability and improved accessibility. It is currently estimated that the global market for structured banknotes is worth more than $2 trillion, and blockchain will help broaden the breadth of the market from origination to investor base.
Let’s look at this in more detail.
Streamlining processes and cost reduction
Traditional structured products involve multiple intermediaries such as brokers, custodians and clearinghouses, leading to operational costs ranging from 1% to 5% of the investment value annually. According to Accenture, blockchain technology can reduce infrastructure costs for major investment banks by an average of 30%, translating into annual savings of $8-$12 billion.
Blockchain’s cost-saving potential is especially important for structured products due to their complex lifecycle management. Blockchain’s improved transparency and audit trails can help reduce these regulatory capital requirements.
Improved composability for creating customizable financial solutions
Smart contracts are particularly attractive for managing complex financial products such as derivatives and structured products, enabling rapid and innovative financial engineering. This modularity allows investors to tailor products, such as combining return-generating DeFi protocols, tokenized assets and risk-managing derivatives such as options or futures.Improving accessibility for originators and investors
Structured products have traditionally only been accessible to institutions. Blockchain modularity simplifies structuring and creation by eliminating middlemen, while fractional ownership expands access for investors and reduces friction on both the supply and demand sides.Growth of the DeFi structured products market
Structured products provide advanced risk management through mechanisms such as head protection and downside barriers. Over the past year, DeFi has structured products such as Pendle ($6 billion TVL) and Ethena ($3.6 billion TVL) has grown significantly, showing strong demand for new derivatives. This trend is expected to continue, driven by a maturing market infrastructure and a growing product range.
Tokenization Standards: Innovations such as ERC-1155, ERC-404 and ERC-1400 address challenges in bond identification, product tranching and regulatory controls for the issuance of structured products.DeFi Prime Brokerage: Platforms Like Arkis introduces advanced margin engines for asset-specific valuations, cross-margining and cross-chain liquidation.Risk Management: Institutional quality risk management systems developed by companies such as Talos (Cloudwall) and Gloves are critical to facilitating the access of institutional capital.Decentralized Option Vaults (DOVs): DOVs are important for on-chain structured products because they provide automated revenue generation, risk management, and integration with other DeFi protocols.Oracles: Chainlink’s Cross-Chain Interoperability Protocol (CCIP) improves data reliability and cross-chain functionality, and facilitates integration between traditional and crypto markets and cross-chains.Crypto Options: Platforms Like AEVO and Hegic offers automated on-chain options, which integrate well with algorithmically structured products.Benchmark and index development: The creation of more benchmarks and indices, such as the Coin Desk 20 Index (CD20) and CESR Composite Eth Staking Benchmark provides investors with reliable and powerful references to express their market views and serve as risk management tools.Tokenization: Tokenization is fundamental to on-chain structured products, with TVL set to reach a value of $130-170 billion (including stablecoins) by 2024, according to RWA.xyz.
One of the pervasive sentiments within crypto is that the products often exhibit barbell-shaped risk-return profiles. Structured products solve this dilemma by creating a specific risk-return profile while capturing the substantial benefits of this asset class. An example of this is principal-protected notes that limit depegging risk.
The way forward for structured products in the chain doesn’t start with the technology, but with developing compelling use cases to demonstrate their potential. As tokenization progresses, the integration of traditional and crypto assets into structured products will become increasingly common, further narrowing the gap between traditional finance and crypto.
Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.