Tokenized Short Positions

Background

Over time the Inverse Synth (iSynth) offerings proved to be suboptimal in a couple of ways. An iSynth owner can only capture a limited range of the underlying asset’s price movement. In a slightly more ideal world a user might be able to have short exposure indefinitely. This means that if Alice holds iXRP and the price of XRP depreciates significantly to reach the limit, Alice misses out on any further gains from XRP’s price declining past the limit given by iXRP’s range. Alice’s play was right but she only capture a fraction of the rewards. So there is a significant motivation from a user experience perspective to move beyond the iSynths.

The process for re-setting the limits on an iSynth and re-deploying the token is manual and laborious. From a decentralisation perspective, it’s not ideal to have to rely on manual processes to execute a short. There is downtime as a result of the iSynth architecture requiring manual reconfiguration.

Tokenized Shorts

The ability to have short exposure to a crypto asset can simplify the user experience, bringing downside protection to users who otherwise may not be interested in managing margin on a borrowed short position, or who does not wish to wrestle with liquidation risks on a position using futures contracts or perpetual swaps.

With the new ability to go short sBTC and sETH on Synthetix, there exists a situation where one user can borrow and sells sBTC or sETH for sUSD, effectively putting into play a short on the price of Bitcoin or Ether.

Now, with this position in existence, there should be a way for other users to expose themselves to this same position. How? The user who initiated the short can tokenize the position, effectively dividing it up into smaller pieces for other users to participate in the same trade.

Naively, each tokenized piece of the short position should trade at the same price. Then there is a question of how to actually distribute the tokenized shorts. An automated market maker solution such as Uniswap is probably going to be very suboptimal for distributing the tokens. As the supply is absorbed into the market the same tokens would be increasing in price, setting up a situation reminiscent of the Universal Market Access (UMA) and BZRX initial dex offerings on Uniswap, where front-runners extracted virtually riskless profit by submitting buy and sell orders with very high gas prices soon after the liquidity pools were live.

Other models such as the initial bonding curve offering used by Hegic offer more promise for distributing tokens in a far way. The goal of the tokenized short positions of course is to make a play on the short position itself. The idiosyncrasies of token distributions mechanisms like Uniswap do not make it clear what the best path forward would be to distribute the tokens to users in the Synthetix ecosystem. For example, a desirable property of the token distribution mechanism is dHedge pool managers are able to access the tokenized shorts on a relatively fair basis, a feature currently provided by the inverse synths.

Challenges

The road ahead would appear to be laying out the solution for how to distribute tokenized shorts for open access. A desirable property for tokenized shorts would be two buyers buying at the same time receive the same price on the tokenized short. It would be great if the only thing that caused a change in the price of the tokenized short was a movement in the price of the underlying asset being shorted. Demand for the tokenized short itself should not be an influence on the price of the tokenized short. Maintaining this property in the tokenized short distribution mechanism delivers a similar user experience as the current inverse synths in that only the price of the underlying asset influences the price of an iSynth.

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I’m sure there is a mathematical way of holding a tokenized short on a market that still tracks the underlying price but has no limits or expiry. I think(!) this can be achieved through a dual token system. The 2nd being a debt/value correction that the holder has to realise before/while selling the synth. There would need to be a bonded relationship between the tokens though, and as you mentioned, this may be beyond the limits of solidity (or at least the DEX space currently).

The other way to do this initially could be a self contained platform on Synthetix where users can deposit sUSD as capital to trade against self contained derivative markets all under a sUSD base (not even buying the underlying synths). Similar to modern day CFD platforms where the pip value can be sUSD tokenized across the platform to determine common spreads/fee schedules across all markets. All ‘positions’ will have a + or - sUSD value which can then be ‘closed’ and user account sUSD adjusted to suit. This model ideally suits leveraged products, though it could work without I think. With leverage you could also tokenize the tomnext lending rate schedule which would then go back to SNX stakers. This would definitely need to be a L2 project I’d imagine.

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Hey, look at that. They implement a self contained version a day after i wrote this. Jinx! Borrowing from the debt pool, clever!

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