How?
How we tokenize risk...
Using risk-targeting, we can split any cryptocurrency into two halves or SMART tokens, and each of the SMART tokens can be programmed to have certain desirable risk-return characteristics. This is programmable money taken a step further. SMART tokens are essentially tokenized risk payoffs created when a user deposits certain collateral with TRP. TRP is a permissionless DeFi protocol enforced by open-source smart contracts.
Let’s use an example to make this more tangible. Let’s say an investor owns 1 BTC but is uncomfortable with the daily volatility. The investor comes up to TRP, deposits the 1 BTC as collateral and mints 2 new SMART Tokens--RiskON BTC and RiskOFF BTC. RiskON and RiskOFF are designed to have aggregate value equivalent to value of the underlying cryptocurrency at all times[1]. The design segregates the risk of owning the underlying cryptocurrency into a low-risk token (RiskOFF) and a levered token (RiskON). RiskOFF’s returns will generally have less risk in terms of both beta and standard deviation of returns than the underlying cryptocurrency, while RiskON will generally have a beta and standard deviation of returns that exceed the same statistics of the underlying cryptocurrency.
How do RiskON and RiskOFF get this profile? By holding synthetic options. RiskOFF is long a down-and-out barrier put that provides a floor and it is short a call that caps its upside. As a result, it floats within a band and has dramatically lower volatility than the underlying cryptocurrency. Where did it get these options exposure from? By contracting with the 2nd SMART token--RiskON. RiskON is the counterparty to all the options that RiskOFF owns. It is the seller of the put that provides the downside protection to RiskOFF and the buyer of the call that RiskOFF has sold. The simple contract between RiskON and RiskOFF is that in return for providing the downside protection to RiskOFF, RiskON gets RiskOFF’s share of the upside beyond the cap. Both initially start out with equal ownership of the underlying collateral and have equal values at the outset. Over time however, based on the movement of the underlying BTC, their values diverge. If BTC runs up, RiskON will outperform BTC because of the leverage it is getting from RiskOFF and similarly, in a declining market, RiskOFF will outperform BTC because of the downside protection it is getting from RiskON[2].
What we have effectively done is that from one asset we have synthetically extracted 2 different “risk flavors” of that asset, designed to appeal to investors/traders with different risk appetites. Investors that want some risk-controlled leverage will swap out of the RiskOFF token in the secondary market and keep the RiskON[3]. Conversely if the investor wants risk-reduced exposure to the underlying cryptocurrency, they hold on to the RiskOFF token and swap out of the RiskON.
[1] Market supply and demand might create instances where the aggregate values of the SMART token pair are not equal to the value of the underlying cryptocurrency. That will create arbitrage opportunities provided the differential exceeds the transaction costs.
[2] If the returns of the underlying are within the strikes of the options, then RiskON & RiskOFF will return the same as the underlying cryptocurrency.
[3] RiskON is 2x levered outside the options strikes
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