Crypto Trading

Decentralized ETFs explained

In this article we explain how decentralized ETFs can be implemented on Ethereum blockchain, their technical and economics foundations.

Decentralized ETFs explained

ETFs have long been recommended by seasoned investors as the supreme method of long-term investment. ETF stands for exchange traded fund, and ETFs for traditional stocks represent investing in a basket of stocks. For example, the S&P500 ETF allows an investor to efficiently invest in an index of top 500 U.S. businesses with one simple purchase.

This has not been the case for cryptocurrencies, however. While the big players, such as the Winklevoss brothers, are working with the regulators to bring Bitcoin ETFs to the market, the smaller currencies do not get the attention they deserve and are left behind.

Luckily, the invention of decentralized exchanges, such as 0x, Kyber Network, IDEX and Saturn Network, and the invention of smart contracts allow people to create their own decentralized ETFs (or dETFs) without major funds acting as intermediaries.

So, what is a dETF and how does it work? As you could have guessed by analogy of traditional ETFs, which are investment instruments used to track the price of companies traded on the same stock exchange, a dETF is an investment instrument whose price tracks the prices of a certain basket of tokens.

dexdetfimage1

You can make a dETF for things like top 20 ethereum tokens by market cap, decentralized exchanges, prediction markets. In the context of Ethereum-like blockchains, a dETF can itself be represented by a token. Much like how the DAI token uses ETH for collateral in order to maintain a certain price level, a dETF is also a collaterized token.

How does a dETF work

A dETF is defined by three functions that a trader can perform: mint a new token, trade the token, and unwrap the token to get underlying assets. To illustrate how this functions operate let's pick an example.

Suppose you want to invest in the industry of decentralized exchanges. Rados has prepared a dETF for that, called DEX dETF, that tracks the price of the following basket: 1 ZRX, 1 SATURN, 5 KNC.

Minting new coins

Any trader that has these three tokens can mint their own DEX dETF token by interacting with the dETF smart contract.

dexDETFexplained2

Trading the new coin

The dETF coin can be represented by an ERC20 or ERC223 token that you can trade on a whole number of decentralized exchanges, or simply transfer them wallet to wallet.

Unwrapping the dETF coin

Any trader that has a DEX dETF token can unwrap it and receive its collateral (1 ZRX, 1 SATURN, 5 KNC) by interacting with the dETF smart contract.

dexDETFexplained3

Why will dETF token price track the price of its collateral

Traders who perform arbitrage strategies are incentivised to keep the price of a dETF coin on par with the price of its collateral. Here is what is going to happen if the price of dETF diverges from the price of its underlying tokens (let's use the same example).

dETF price is higher than price of tokens

If for some reason there is a buy order for a DEX dETF whose price is higher than the sum of prices of 1 SATURN, 1 ZRX and 5 KNC. Then a trader can simply buy the necessary components, mint their own DEX dETF coin, and sell it to the buyer at a premium. The minters will effectively increase the supply of this coin and keep the supply and demand curves balanced.

dETF price is lower than price of tokens

In this case, a trader is incentivised to buy the undervalued DEX dETF coin, unwrap it to receive the collateral, and sell 1 ZRX, 1 SATURN and 5 KNC on the market independently and make a profit on this deal.

In this case, the trader burns some of the dETF tokens, reducing its total supply and this way balances our the supply and demand curves for this dETF.

Closing remarks

This is one service that we are looking very forward to launching on the Saturn Network; a simple way to invest in multiple projects at the same time. No more having to look into endless amounts of ICOs and tracking 10 different coin prices all at the same time, you can play it safe and invest in a dETF courtesy of the Saturn Protocol.

Saturn Network will in the future support dETFs and even other crypto trading services like Atomic Arbitrage. As a token holder, you will own a part of decentralized exchanges meaning you will be able to: control fees, list new tokens and receive a share of the profits.

Our goal is to innovate the world of decentralized cryptocurrency trading, making it accessible to everyone. Traders should not have to fear losing their funds to rigged markets or being manipulated by centralized exchanges, which is why we believe decentralized exchanges are the way forward.

Happy trading!

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