NOTE: Since original publication, Tracer Dao has re-branded to Mycelium.
Introduction
The most intimidating aspect of digital assets for most investors is their volatile nature and perceived risk. Yet risk is unavoidable in both DeFi and the world around us. With derivatives, however, we can manage risk to tolerable levels. The problem with the traditional derivatives market is that these instruments are difficult to launch, expensive, and encumbered by layers of bureaucracy. Beyond this, more specialized derivative instruments are only made available to a privileged few, granting an unfair advantage to those who have timely access to information.
Everyday people, not just asset managers, need to be able to take advantage of the ever growing mass of data in order to make quicker, better, more well-informed decisions. The tools to hedge against these risks and make data driven decisions can become powerful instruments.
In line with this idea, Tracer’s primary mission is to reinvent TradFi by “democratizing access to financial markets and bring risk management tools to everyday people.” Tracer is developed by Mycelium and it’s main co-founders are from the RMIT Blockchain Innovation Hub.
In short, Tracer is a platform to permissionlessly trade crypto derivatives and obtain access to leverage.
How Tracer Works: The Factory
The Factory is a smart contract module that enables anyone to deploy permissionless and censorship resistant smart contracts on Arbitrum at a low cost. This is achieved by reducing the barriers to entry through the provision of decentralized oracle data feeds and templates for derivative contract creation.
It is important to highlight that the Factory layer is not limited to financial derivatives, but can serve any tokenized market requiring data feeds.
Beyond crypto price feeds, for example, Tracer could integrate oracle data for local unemployment rates, binary political voting outcomes, regional price differences for commodities, carbon markets, and even verify weather data for insurance payouts.
The full potential of Tracer, with its modular architecture, should not be underestimated. Let’s take a look at their current product range and how it can impact the DeFi ecosystem.
Perpetual Pools
Perpetual Pools are the main product launched by Tracer. They are a derivative structure for leveraged tokens, facilitating the transfer of value between long and short sides of the pool. The value transfer is determined by a transfer function known as Power Leverage, which can obtain its input from any price or data feed. The Power Leverage function acts as a rebalancing mechanism, not too dissimilar from how a funding rate is used in perpetual swaps.
Leveraged Tokens
Leveraged tokens are the ERC-20 representation of perpetual pool ownership. The pools ensure that the long (L-token) and short (S-token) leverage tokens are fully collateralized and non-liquidatable. The perpetual pool design is immune to slippage, transaction costs, and removes the need for funding. This is possible because no underlying asset is purchased or sold, the pool simply shifts the imbalance between longs and shorts and facilitates the minting of leverage tokens.
Tracer leveraged tokens can be minted, burned, and traded on DEXs, and is one of two decentralized platforms which currently supports permissionless and trustless deployment. A performance analysis indicated Tracer leverage tokens outperformed FTX and traditional forms of leverage by 6-17%.
Users can hold leveraged tokens and stake them on Tracer for additional yield. Beyond just holding long or short leverage tokens, some of the most innovative DeFi-composable yield strategies that have evolved from Tracer’s leverage tokens are skew farming and stake-able, delta-neutral Balancer pool positions.
Skew Farming
Skew occurs when one side of the pool holds more USDC than the other. Skew is calculated as “long TVL divided by short TVL.” Therefore, if the market is bullish and there are more longs than shorts, then the skew shifts above 1. If the market is bearish and there are more shorts than longs in the pool, then the skew shifts below 1.
The opportunity for skew farming exists when the leverage tokens have polarized collateral skew. A simple comparison would be a perpetual swap where a short position can earn funding (i.e. a negative funding rate). By shorting the perp on Tracer and taking an equal long spot position on a separate exchange, the farmer earns yield from this funding skew. Skew farming arbitrage opportunities can be monitored through the pools dashboard. The complexity of skew farming will likely be simplified by the upcoming release of automated strategies. The strategies will be deployed utilizing the new EIP-4626 Tokenized Vault Standard later this year. Not only will this ease future integration efforts, but it also represents a more robust implementation pattern the industry is gravitating towards.
Delta Neutral Balancer Pool Positions
More complex strategies, which currently have to be manually executed, are composed of a combination of short and long leverage tokens. These positions earn fees as they are used to provide liquidity on Balancer, and additionally earn Tracer (TCR) rewards when staked. Triple stacked, triple-digit yields are just a simple example of how Tracer’s derivatives can be utilized.
Positions can first be established on Balancer by minting 3x long/3x short leveraged tokens or from obtaining them on a DEX (provided there is liquidity). In this first strategy, a staked Balancer pool token composed 50% of WETH, 33% of 3x Short ETH (3S-ETH) and 17% of 3xLong ETH (3L-ETH). This forms a delta neutral position – provided the skew is 1 (i.e. the perpetual pool is perfectly balanced with longs and shorts). The screenshot indicates the ETH neutral strategy is yielding 82% APR, BTC at 99% and USDC 57/52% (excluding fees earned in the Balancer pool).
Although these pools are designed to be delta neutral, it is important to highlight that they were constructed assuming skew is greater than one (i.e. the market has more longs than shorts). Therefore, in a situation of adverse skew (i.e. there are more shorts than longs in the pool), you can have a loss. These pools are also susceptible to volatility decay and impermanent loss.
V2 Perpetual Pools
After 5 months of market testing V1 Perpetual pools, Tracer recently announced the launch of V2 – and with it, a series of improvements. The most notable change is the release of permissionless markets, meaning anyone can now deploy a custom perpetual pool market with no limit to leverage. Users can choose their own oracle and pick their own settlement token.
Volatility decay is a phenomenon that leverage tokens suffer from. Over time, with repetitive rebalancing, your leveraged token returns will deviate from the underlying asset. This is magnified with greater leverage and greater volatility, significantly reducing the performance of 3xLong/Short leverage tokens. In V2, this has been remedied by implementing a Simple Moving Average (SMA) on pricing. This allows the leveraged tokens to resist decay and provides a greater benefit to long-term holders.
Tracer also announced its own index product, whereby a custom index can be deployed by wrapping a series of oracle data feeds into a single token. Indices can provide holders exposure to anything from real-world assets like stocks and commodities to crypto-native assets like CryptoPunks. The platform currently takes a 1% annual fee with their V1 pools, which is significantly lower than most leverage products available on the market today.
Nominal GDP (NGDP) Stablecoin
The original concept for the creation of Bitcoin was to detach society from a currency reliant on the trust of governments and banks. Despite this, a great deal of crypto transactions still occur using stablecoins pegged to the US dollar. Recognizing this as an area of improvement for DeFi, Tracer has identified the need for a new breed of stablecoin.
The DAO recently released a paper on their approach to a “Purchasing Power stablecoin” and how Tracer’s Perpetual Pools can facilitate this. A true decentralized stablecoin should allow DeFi protocols to price contracts based on an asset parties can agree on, and which remains stable over the long term.
An NGDP stable coin is one that “appreciates in line with nominal GDP growth estimates – ensuring that a user’s purchasing power stays stable over time”. In short, it is a currency that is stable with respect to the economy. To take it one step further, individuals can customize their NGDP stablecoin relevant to their local area. A person living in the US, for example, may be subject to entirely different changes to purchasing power when compared to someone living in Nigeria.
The mechanics of this proposal leverages the Tracer factory with a GDP oracle coupled with a NGDP futures market to determine NGDP stablecoin price. The NGDP stablecoin will be minted in a Maker-style dynamic where over collateralized stablecoin loans can be made. Needless to say, the successful adoption of such a stablecoin would place Tracer on stage within the $181 Billion stablecoin market and could disrupt current dynamics.
There are a few obvious drawbacks to this design, the most prominent of which is a lack of fungibility. Stablecoins are the go-to transfer asset in crypto because 1 USDT is always 1 USDT. But if users use NGDP stablecoins tied to different rates of NGDP, you no longer have a fully fungible medium of exchange.
The TCR Token
There is currently $13.9M of TVL in Tracer contracts, down from a peak of $50M. It is difficult to accurately measure the full potential of the derivative markets Tracer can serve, but a conservative approach is to use its existing product line for perpetuals as a comparison. Below is a valuation analysis of decentralized derivative protocols offering perpetuals. To understand more about token value accrual refer to our previous research on Vega’s token model.
The current primary use case for TCR is governance. The initial max supply of the TCR token was capped at 1,000,000,000 with a five year token distribution plan. Token distribution to insiders accounted for 35% with Mycelium (core dev team) holding the majority amount, vested on a pro-rata basis over three years starting Feb. 12, 2021. Market distribution included emissions for liquidity mining on perpetual swaps and pools, futures contract liquidity mining, and allocations to governors and alpha testers.
A generous 64% is being held by the DAO treasury which can be actively monitored on Dune Analytics. The dashboard also gives a detailed breakdown on the largest TCR holders, their connection to Tracer, and multisig transactions. Changes to their emission plan based on protocol needs are currently underway and being evaluated to maintain sustainable liquidity incentives during their migration to V2 pools
Although the TCR token accrues little protocol value at the moment, vote-escrow TCR (veTCR) was recently introduced. This could materially improve value accrual and give greater utility to holders. veTCR will represent a non-tradable governance right of a TCR token locked up to four years. Similar to the Curve model, veTCR holders can direct emissions to different pools and gain special access to future Tracer vault strategies.
Tracer’s transparent approach towards DAO governance and token distribution is commendable and speaks volumes of their approach to building. Their values are also well reflected in their token distribution philosophy, summed up in several venues where they present constant self re-evaluations and assessment on how it can better accrue value to their stakeholders.
Approach to Adoption
Tracer’s DAO structure means that they will be heavily reliant on a contributing community, industry collaborations, and well thought out incentive mechanisms. The presence of derivative protocols on almost every chain spells tough competition for Tracer DAO. Despite having launched new leveraged markets for TOKE, LINK, EUR, and AAVE, the utilization for these markets are low and the lion’s share of protocol TVL lies with ETH and BTC.
To boost secondary market liquidity, a TCR Tokemak reactor was ignited which currently yields 24% APR. A Rari fuse pool is also available, although it is underutilized. On the development front, a Growth Fund was formed to engage advisors and developers in a grant structure to incentivize contributors. It is also promising to see governance proposals for potential industry partnerships with LobsterDAO, Ondo Finance, and Messari Governor being discussed in forums. The first step Tracer has taken towards institutional access to derivative platforms in DeFi is its recent partnership with Fireblocks to enable access to leverage tokens.
The Tracer Perpetual Pools SDK release will also reduce the friction for developers building on top of Tracer in the future. Possible applications include a skew farming bot or automated management of derivative positions.
Integral to the core of Tracer is the reliability of data feeds. Backed by Chainlink, they are building the infrastructure for a data layer to support new markets. Mycelium is also working on Reputation DAO, which will act as a “credibly neutral reputation service” for oracles to provide the institutional layer it envisions the future crypto economy will need.
Conclusion
The current global derivative market is estimated at $610 trillion dollars versus the total equity market cap of $125 trillion. The crypto market lags in comparison, where options volume is only 2% of spot versus equity markets where this number is 35x. Much of this volume is concentrated on centralized exchanges. In the past, this was attributed to the lack of supporting infrastructure for decentralized trading venues.
However, the development of L2 scaling solutions and more affordable alternative L1s over the last year has enabled the launch of projects spanning across perpetuals, options, futures, synthetics, indexes, and leveraged tokens. The number of decentralized derivative platforms has subsequently grown exponentially providing investors with the tools to hedge risk in DeFi.
Most decentralized derivatives platforms focus their services on a single product like dYdX with perpetuals or Dopex with options. Others like Vega and Tracer are instead building from a base infrastructure level. Whilst Vega is attempting to develop a standalone blockchain as their solution for derivatives, Tracer DAO is building peer-to-peer financial software by simplifying derivative smart contract deployment. Tracer provides the infrastructure for derivative markets using any data feed, in a permissionless, inclusive manner.
Standardized templates for derivative creation that leverage oracle data will greatly reduce the barriers to launching derivatives – in cost, technical knowledge, and access. The one caveat to this model is that we must consider wisely the source of oracle data, particularly from centralized entities. For Tracer to realize its full potential, it will depend on how effectively they can organize quality contributors to launch new markets and deploy strategies easy enough for investors to understand. This is arguably their greatest challenge for successful adoption.
