# Decentralized Derivatives
## **What are Decentralized Derivatives?**
Derivatives are financial instruments that derive their value from an underlying asset such as a stock, bond, commodity, market index or currency. Most traditional derivatives are traded on conventional exchanges such as the Nasdaq or CME, and crypto derivatives are traded on centralized exchanges such as Binance and FTX.
As the name would suggest, decentralized derivatives refer to the exchanges and protocols that facilitate the creation and trading of derivatives *without* using a centralized party.
Although it has grown over 120% in the last year, the space is still very small. According to Defi Pulse, as of late last year less than \~$3B was locked in derivatives. This is less than 3% of the centralized crypto derivative markets and barely a speck of dust when compared to the $1 quadrillion traditional derivatives market.
While the potential of decentralized derivatives is immense, the technology has yet not caught up to the promise. In particular, current offerings suffer from high fees, capital inefficiencies, poor pricing and a general lack of the level of sophistication needed for professional users.
## **How Are Decentralized Derivatives Different from Traditional Derivatives?**
There are currently three major classes of crypto derivatives:
* **Perpetuals:** Futures with no expiration date
* **Options:** Calls, puts, etc…
* **Synthetics**: Instruments designed to mimic the value of other assets
Of these, the most novel may be synthetics.
Although synthetics do exist in the traditional financial world, they are often extremely expensive, complicated, opaque and limited to select clients. An infamous example of this is synthetic CDOs, a particularly convoluted instrument that many blame for financial crash of 2008.
On the contrary, crypto synthetic are relatively cheap, simple to design, easily auditable and – best of all – anyone can create and use them! For example, let’s say that you wanted to design a token that tracks the price of oil, you would:
1. Deposit your collateral into a platform
2. Design a synthetic that tracks the price of oil through an off-chain data feed known as an oracle
3. Create and issue the synthetic to a liquidity pool
4. Allow traders to trade your newly created asset
5. Collect trading fees
There are already many tokenized synthetics that track assets such as gold, coins such as BTC and ETH and stocks such as Tesla or GameStop.
While there’s definitely a huge opportunity for synthetics in finance, “non-financial” use cases may be even more exciting.
Indeed, as Bankless points out in its writeup on [The Wild Future of Synthetic Assets](https://newsletter.banklesshq.com/p/the-wild-future-of-synthetic-assets), the fact that you can create a synthetic asset out of nearly anything that is measurable opens up a world of options beyond traditional finance. For instance:
* Politicians could incentivize public action by designing a token that rewards a desired behavior – for instance, one that increases in value with the vaccination rate
* Bookies could create “celebrity betting markets” that track the popularity of public figures by measuring their Twitter followers (and this would be difficult to regulate because of the decentralized and anonymous nature of synths)
The potential use cases are virtually endless, and the introduction of synthetic assets could spur a revolution in “user-generated finance”, potentially transforming Wall Street in the same way that “user-generated content” disrupted Hollywood.
While synthetic assets offer an enormous amount of long-term potential, there are several kinks that need to be ironed out. One of the biggest issues today is capital efficiency, as the average synthetic requires over 600% collateralization.
## **Who are the Key Players in the Decentralized Derivatives Market?**
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