A Deep Dive into Vega: Web3’s Native Derivatives Layer

Last week, we announced the Vega Token Sale on CoinList, starting June 2 at 00:00 UTC. Vega is building the derivatives layer for Web3. By design, Vega is a proof-of-stake bridge to all major blockchains, providing an open and highly flexible derivatives protocol scaling layer with all the sophistication of investment-bank grade software. This week, we sat down with the Vega team to discuss what they are building, its use cases, recent traction among target customers, and their thoughts on the crypto derivatives space more broadly.

1. To begin, what is Vega and what problem does it solve?

Vega is a custom blockchain that is optimized for trading, and provides the derivatives scaling layer for Web3 applications. It delivers investment banking grade trading software for the entire blockchain ecosystem by bridging to multiple layer-one networks, beginning with Ethereum.

Right now, crypto-assets are almost exclusively for speculation and to fund and earn income either directly, or indirectly through financial engineering in “DeFi” protocols, from projects and systems within the crypto space. We believe in a future where most financial activity and the commercial and legal execution around it happens on chain. To get there it is essential to solve several problems with the current generation of decentralised financial protocols,  including front running, low capital efficiency, and high fees. It’s also necessary to address several types of new or increased risk that are endemic to the protocols and blockchains they’re built on.

Vega addresses all these problems and creates a next generation derivatives and trading layer for the decentralised future. In doing so, Vega makes it possible to move a significant amount of real-world trading volume on-chain for the very first time.

2. Can you describe your target customer(s)? What types of projects and use cases are best suited to build on Vega?

Vega is a technical layer that provides high performance financial and trading primitives to enable all kinds of decentralised trading. It allows products and markets that are as sophisticated as traditional, centralized solutions to be created entirely on chain. This means that Vega is completely open to anyone and forms part of the core infrastructure on which a new global and decentralised financial system will be built, alongside other important technology like bitcoin, Ethereum, IPFS, etc.

Vega can appeal to builders, market creators, and traders across three key areas:

1. Moving existing centralized markets in crypto and other asset classes on-chain where this hasn’t been possible or economically viable with other decentralised alternatives.
2. Building better performing, fairer, and more capital efficient versions of existing decentralised products and markets that still integrate with other DeFi protocols and make use of the same crypto-assets (e.g. Ethereum based ERC20s).
3. Creating and launching new products and markets that take advantage of Vega’s uncompromising trading and product features and sophisticated liquidity model that incentives users to bootstrap new markets.

The type of traders that might be interested in using Vega include; professional market makers, individuals and businesses looking to hedge day-to-day risk, as well as market speculators. Vega exposes many tools that are currently only available to privileged professionals, and gives everybody the opportunity to use sophisticated financial products to their advantage.

3. What are the most important factors that derivatives traders look for when evaluating how and where to trade?

Traders look at many different factors when deciding to make a trade. These vary depending on the reason they are trading (are they hedging a business risk, speculating on macroeconomics, day trading, market making, etc) as well as the current state and maturity of the overall market.

For example it is sometimes not possible to trade exactly the product a trader would like, so they may look for a “proxy” — a market or market(s) that come as close as possible to approximating the trade they want to make. Additionally, some traders need to trade in large sizes, in which case the depth of the order book and other factors affecting slippage will be important to them. Then there are the costs, measured by spreads, capital efficiency / leverage (how much collateral is needed to make a trade), and the amount of fees and other costs associated with trading, with low spreads, high efficiency and low fees being preferable. Other factors such as the type and sophistication of products available, fairness and MEV related considerations, availability of market protections or “circuit breakers”, supported orders types, and compliance/regulatory considerations also come into play. Vega is designed to provide a base layer that will be able to address all of these factors in a way that is competitive with most traditional and centralized trading.

The most universally important of these characteristics are undoubtedly low trading fees and spreads, a fair trading environment (i.e. no-one is able to obtain preferential treatment), deep liquidity and efficient prices. The Vega blockchain, through its custom proof-of-stake design and sophisticated economic incentives, is able to optimise for all of these aspects. We anticipate that this will make it the best environment for trading derivatives on a decentralised network.

4. What about your protocol design makes it so attractive to pro traders and liquidity providers?

Unlike centralized trading venues, which are essentially rent-seekers providing infrastructure that connects traders and liquidity providers (LPs), Vega does not charge any fees for the use of its software. The Vega software is free and will be open source and implements a decentralised network, where validators compete with each other to offer competitive terms. We anticipate that competition between validators will minimize the cost of operating the Vega software, leading to increased profitability for LPs and lower fees for traders.

Furthermore, as there is no centralized exchange or entity receiving fees and revenue from trading on Vega, this instead flows to the community that creates value by creating markets and providing liquidity. The unique model built into the protocol for rewarding market creators and LPs with an equity-like share in the market means that they are treated as owner-operators by the protocol, being required to make decisions (via the governance protocol) that keep the market functioning well and receiving a significant share of the fee revenue in the market for doing so. This new model of decentralised operation, sometimes called the “ownership economy”, aligns incentives and distributes both risks and rewards better than the existing highly centralized, slow moving, and elitist financial infrastructure.

5. As a decentralized bridge to the world of finance and trading, Vega leverages features and capabilities from both the decentralized paradigm and the traditional financial systems. How do you shift the incentives away from rent seeking exchange owners towards the liquidity providers?

The Vega protocol leaves no room for rent seekers. Every participant from validators to market creators and even normal traders is part of an economic, market driven system that fairly prices access to markets based on the costs of providing the service and the principles of supply and demand. Fees charged are distributed to those providing value to the network, and the amount charged is always subject to open and fair market forces, preventing an incumbent from overcharging or gatekeeping.

As a result of this, markets can be originated, serviced with liquidity, and accessed by anyone in the ecosystem in a completely fair manner. This can happen quickly, in hours and days rather than months and years, and with minimal cost. Those receiving rewards do so because they are adding value, and have no ability to prevent others from competing. The practical upshot of this will be a shift in the economics of market operation away from infrastructure providers (exchanges) and towards the market creators and liquidity providers that support the ecosystem. This will create a virtuous cycle that reduces cost, encourages innovation, and attracts liquidity.

6. How does Vega open up new markets and new flow? Can markets on Vega be derivatives on any underlying asset or benchmark?

Markets on Vega are created through governance voting, conducted by token holders. As a result, there is no limitation on the markets that can be created. The highly flexible market and oracle framework allow the creation of  markets on any underlying for which settlement data can be sourced, including indexes, baskets of assets or other markets, and industrial metrics. These underlyings may be related to the crypto and web3 space or may come from traditional industries and markets.

In the alpha mainnet, Vega will implement cash-settled futures, followed by other common products such as perpetuals and options. Longer term it will be possible for users to design, code and launch markets on any arbitrarily complex derivatives product, supported by a wide range of risk models and primitives, and a suite of liquidity types and price determination methods.

There are many interesting examples of derivatives beyond those simply tracking a spot market, such as weather derivatives helpful to farmers that need to hedge risk, or prediction markets on the outcome of sporting events and elections. The possibilities are endless, and the power of self-determination will be in the hands of the stakeholders of the network, who will decide the markets they wish to create and trade.

7. What is the inherent value and use case for Vega’s native token, VEGA?

The Vega blockchain implements delegated proof-of-stake to secure the network. VEGA tokens secure the network through staking. Tokens are required to be staked in order to operate a node, and token holders play a crucial role in determining the active validator set by delegating their tokens. In exchange for delegating stake, the validators are required to distribute a portion of the trading fees that they earn to token holders.

Additionally, the VEGA token is used to control the network functionality and creation of new markets through governance voting. For example, token holders would vote on whether to create a new TSLA/USDC market after reviewing the proposed market’s details and oracle specification. Token holders are also able to propose and vote on additional governance proposals that direct the development of the network and set key parameters, such as the amount of fees paid to node operators or the level of liquidity coverage required for a market to operate.

8. What trends are you most excited about in the crypto derivatives space and DeFi more broadly?

We’re excited to DeFI maturing and start to be applicable to “real world” use cases outside of crypto. The rise of sophisticated quantitative analysis of the risks, efficiency, etc. of DeFi protocols from individuals and firms in the space is particularly exciting, as is the increase in focus on capital efficiency and solving problems like MEV. These things will all be essential to the future success of DeFi and we’re very excited to contribute to them and help move the whole community forward, for example with our research on MEV and the design of Wendy, the fairness protocol.

9. What is the best way for the community to get involved with Vega?

Community participation and engagement is at the heart of the project. The easiest way to join is through our Discord channel where you can chat to the team, learn about Vega and the most recent community initiatives.

To learn about Vega we suggest trying out the testnet, Vega Fairground, which is open to everyone and we have a weekly Fairground Jam Twitch/Zoom session where community members can join the team in learning something new about Fairground, give feedback and get support. We also have monthly Community Calls, weekly educational sessions and are about to launch a Community Moderation program. For the keen builders we have a series of bounties to apply to (and open channels to suggest new ones) and sponsor several hackathons.

To find out all the official sources of information on Vega and how to get involved see our linktree.

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