Before we take a deeper dive into how or from where the money flows for financial derivatives, it may be useful to read up on what the traditional financial derivatives are, and how the multiparty derivatives can reshape the legacy structures.
In this post, we will talk about where the money comes from for the derivatives markets and why it does not need to remain how it currently exists.
All traditional derivatives: be it options, forwards, swaps, CFDs or whatever other exotic variant you find; are a one-to-one contract between the derivatives issuer and the trader. One of these parties will lose money and other will make money. So it is clear that the money being used to settle these derivative contracts either comes from the trader or the derivatives issuer (normally banks or other authorised institutes).
The money that the derivatives issuers use to settle the derivative trades are commonly terms as owned pool, house-pool or dark pool of funds. Essentially this is a large sum of money that the derivative issuers will keep at hand in case they need to pay out a trader who made a correct prediction and bought derivatives contract from them. This pool of funds essentially gives the trader a sense of comfort that his trade will be settled and that the other party does have the funds to pay him out if he is right.
These derivatives issuer fund pools are not ring-fenced to a particular contract or asset type and are often times simply a reserve used for all the derivatives an issuer issues across all asset types and risk corridors (not all derivatives are equally risky to issue and sell). In most cases, this huge spread of assets and risks covered by a single pool are not an issue. But, they can become an issue when the issuing bank took on an extremely risky bet that went wrong and all the funds are drained out; making it impossible to honour the remaining less risky derivative contracts they issued. Think Lehmann 2008.
In multiparty derivatives, there is no centralized issuer that keeps such owned/house/dark pool of funds. Instead, the funds are pooled by the traders themselves that deposit their monies into a ring-fenced smart contract. These same funds are then used to settle the derivative trades between the traders themselves, thereby ensuring that there is always a pool of funds available to traders that they helped create themselves.
For example, lets say that there are a thousand traders making various price predictions a week out for NASDAQ. There will be a specific smart contract that will govern the NASDAQ closing value a week from now and allow the traders to make predictions on the up, down, stability or volatility parameters. All in a single smart contract that covers all these 1000 traders and all of their price predictions.
Every time the traders make a prediction, they will back it up with money that will be sent directly to the pooled funds for this specific NASDAQ derivative contract. There it remains, untouched and secure, until the settlement time. This mechanism eliminates any risks of non-settlement of trades and also reduces risk by not relying on a centralized derivatives issuer to mange their own risks of ensuring the dark pools.
The traders, hence, are in full control and have no risk of the derivative trades not being honoured.
To learn more about how multiparty derivatives can benefit you, the trader, in reducing risk yet giving a shot at outsized returns without leverage*, go to https://closecross.com Enter trader pooled multiparty derivatives on a variety of assets such as crypto, fiat, indexes, stocks, commodities, etc. with time horizons available from a few hours out to months ahead.
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*You must get your prediction right to generate profits.
Founder, CloseCross - Decentralized derivatives driving democratic participation
The views and opinions expressed herein are the views and opinions of the author and should not be considered as an investment advice.