Topic 1: Emerging Topics Flashcards
What is a stable coin and what is its key purpose in the DeFi system?
Stablecoin is an asset whose value is pegged to traditional currency. Its key purpose is to fulfil financial contracts which require low volatility assets.
Define NFT
- blockchain-based tokens that each represent a unique asset
- irrevocable digital certificate of ownership and authenticity for a given asset, whether digital or physical
Define walled garden and its implication for liquidity and arbitrage trading
Early decentralized exchanges were implemented as “walled gardens” with no interactions between the different exchanges and no shared liquidity.
This resulted in low transaction volumes, large bid/ask spreads, high network fees, and slow movement of funds between exchanges, which created barriers to arbitrage trading.
Define flash loan
Unsecured loans available on decentralised loan platforms
Loans must be repaid atomically; ie borrower receives and repays within the same blockchain transaction. if not, then the whole transaction is invalid.
Peer to peer protocol
- query on network for counterparts who wants to trade a specific pair of crypto assets, negotiating the exchange rate bilaterally before execution
Define Constant function market maker (CFFM)
smart contract liquidity pool that holds at least two cryptoassets in reserve and allows users to trade between two cryptoassets, with the exchange rate determined by a constant product model
In a CFFM, what is the relationship between two tokens
Model of two token reserves is constantI
In CFFM, what is the token reserve curve
Convex
In CFFM, what’s the relationship between price of token and supply
Low supply = expensive token
What is the 0x crypto ecosystem?
- open sourced
- decentralised exchange infra
- low friction peer to peer exchange of tokenised assets on multiple ETH block chains
The three steps of trading process of the 0x ecosystem
- Makers submit pre-signed orders to relayer to be included in the relayers’ off chain order book
- Potential takers query the order book and select one of the orders
- Takers sign and submit to the smart contract, triggering atomic exchange
In collateralised debt market, difference between P2P matching and pooled loans
- Pooled: Variable interest rates determined by supply and demand
- In P2P matching, parties agree on fixed rate and time period for loan repayment
Advantages and disadvantages of a centralised exchange
ADV: efficiency
DISADV:
- exposed to potential cyber attack
- loss due to dishonest operator
What is the DeFi stack?
Settlement - block chain and native asset protocol which ensures network stores ownership info securely
Asset
Protocol
App
Aggregation
Advantages of smart contracts
- secure
- run of DeFi blockchain (no need for intermediary)
- executed automatically based on a set of criteria
What is a price oracle
- mechanism that provides asset prices to a blockchain
- blockchains are isolated ecosystems, no direct way of querying external data
- API to fetch asset prices from centralised exchanges
key risks of DeFi ecosystem
- operational security
- dependencies
- external data
- illicit activity / bad actors
- scalability / use of energy
- smart contract execution
What is a collateralised debt position and the key steps involved to creating a CDP and how a CDP is closed
- cryptocurrency asset is leveraged to create stable coin (e.g. DAI in MakerDAO)
- issues new token without the need for a counterparty
- to create the tokens, user deposits crypto assets in mart contract as collateral (at min. ratio)
Advantages and Disadvantages of “on-chain” collateral
ADV: transparency
DISADV: depend on the state of the blockchain for validity, e.g. Maker DAI and can be volatile
e.g. algo stablecoins are not fully backed by collateral but using reserves in on-chain assets and issues/redeems stable coins to match demand
How does MakerDAO address the issue of high volatility of ETH
DAI requires overcollateralisation of ETH upon issuance
If the value of ETH falls below min. threshold 150% of DAI, smart contract will auction off ETH to cancel the debt in DAI
What is the role of price relayers
Maintain order book that providers taker information needed to find orders they want to match
Benefits of decentralised exchanges compared to centralised exchanges
Decentralised exchanges mitigate CP risk by allowing users to remain in control of assets until transaction is executed
Trades exec atomically via smart contract; indivisible transaction
What is an inverse token
- inverse of the performance of reference asset
- used to obtain short exposure
opportunities in DeFi
- Composability: apps and protocols being combined to create new services, flexibility for financial engineering
- Accessibility
- Transparency
- Efficiency
Difference between asset based and event based derivatives tokens
Asset based: references performance of an asset
Event based: depends on any observable variable
What is the blockchain trilemma
Scalability
Security
Decentralisation
Describe operational security risk in DeFi
Protocols and applications use admin keys which permit a pre-defined group of individuals to upgrade contracts and perform emergency shutdowns
If they are malicious / pursue own financial interests, then place user assets at risk of loss
Three backing models used for promise-based tokens
- no collateral
- off-chain collateral
- on-chain collateral
name a protocol for a decentralised exchange that uses off-chain order books
0x
Difference between collateralised debt position (CDP) and collateralised debt markets
CDP: create new token
Market: using existing token to borrow crypto form another party
Drawbacks of Bitcoin DeFi
- only simple currency-based transactions can be carried out
- expensive/slow
- not interoperable between blockchains
2 countries that have approved Bitcoin ETF applications
Brazil and Canada
What are Automated Market Makers
- Smart contracts that provide liquidity
- Each AMM holds pool of 2 assets and enables users to swap between them at exchange rate set by formula
Term for decentralised machine learning
Federated machine learning
Process of Federated Machine Learning and ensuring data security
- training models at the edge (not in central location) using distributed data set
- privacy preserving data infra is used
Why did SEC deny applications for bitcoin etc filing?
- concerns on security
- concerns on manipulation
- due to market fragmentation
- whether regulated bitcoin market of significant size exists
cheapest way of gaining exposure to bitcoin
CME bitcoin futures
steps for systematic trading
- data access / cleaning
- data analysis
- trading signal generation
- trade execution
- post trade analysis
ICO vs STO vs IPO
STO is subject to securities regulations thus safer than ICO
STO provide significant efficiencies and cost savings compared to OPO
Benefits of tokenised investing
- cheaper for company to fund raise, greater liquidity
- for investor: lower risk, faster settlement, better risk management
What is a utility token?
Provides stakeholders access to a specific digital application of service in blockchain
Properties of Distributed Ledger
Distributed
Immutable - cannot be changed, validated records on distributed ledger or irreversible
Programmable
Secure
Anonymous
Time-stamped
Unanimous
Define a smart contract
A computer program
stored on bitcoin platform
automatically execute agreement
once a condition is met
What are the two main types of regulated futures markets for digital assets?
Physical and cash settled
Main advantage of using cash settled rather than physical settled
Cash settled: traded on same platform as futures, regulated by CFTC. No concern about custody
Explain how block chain is tamper resistant
- each block is cryptographically secured and connected to each blockchain
- change block without detection all blocks would have to be changed
Capital efficiency of physical bitcoin exposure
- physical bitcoin used as collateral to access liquidity
- liquidity, borderless, fast and final settlement, real time price discovery
How to create risk neutral position in BTC
Long spot BTC, short long dated futures
How is blockchain security maintained?
Consensus mechanism
cryptography
incentive structures
How can data integrity be accessed?
- data governance policy
- ethics policy on data use
- cost-benefit framework for judging the value of additional data. Is it mission critical
In “Assessing Long Term Investor Performance: Principles, Policies and Metrics”, what are the golden rules in designing effective performance metrics?
- consistent across the organisation
- based on function and goal
- transparent and parsimonious
- mutually exclusive and collectively exhaustive (MECE)
- adaptive to market risk
Does fund specialisation increase likelihood of successful action item implementation?
Yes, funds benefit from economies of specialisation. Likelihood of action point being successfully implemented is greater if the other deals pursue related action items
e.g. governance engineering, operational improvement
Difference between CEX and Automated Market Maker
In a traditional exchange, buyers’ and sellers’ asset price orders are matched with each other based on the exchange’s central limit order book.
With AMMs, users place trades directly with each other (no intermediary) using a liquidity pool of tokens supplied by AMM users.
What are the three consensus mechanisms?
- Proof of Work
- Proof of Stake
- Delegated proof of stake
Four key production inputs according to “Assessing Long Term Performance”
- Capital
- People
- People
- Information
Three environmental enablers
- Governance
- Culture
- Tech
Long term performance of an investment organisation is the product of:
- Environmental Enablers
- Production Inputs
- Mobilises the commitment of investment professionals
- by ensuring alignment of interests
- sharing of info
- consistent with comp adv
- org goals
Why is looking at quarterly returns a flawed measure of long term success?
- performance metrics tend to overlook risks taken to generate returns + liabilities that the strategies are meant to cover
- no meaningful comparisons since each investor have different traits
- different time horizons
Metric for commitment = above how many years is considered long?
4 or 5
What are the two metrics of final performance?
- Portfolio health: discount rate of expected return target. Funding status / discount rate = higher the number, healthier the fund
- Cost efficiency:
According to Clark and Monk: What do the intermediate outputs of an investment organization represent?
- Journey to Long Term goal
- Key outputs by combining production inputs and environmental enablers
Other than illiquidity premium, explain two other factors why PE may generate more return
Small cap bias
Higher beta, thus higher equity risk
What are the three key findings in “Expected Returns of PE”
- Leveraged small cap may be better benchmark for PE, IRR may be misleading compared to time weighted return
- Smoothed returns understate true economic risk + lack of MTM
- Rich valuations = smaller oupeformance over equity
Why has PE returns dropped
- Rich valuations in PE
- Decline in PE leverage
From 1986 to 2017, did PE exceed small cap value stock returns?
NoS
State an issue with IRR and what is the preferred performance metric?
IRR is misleading and can be gamed
Preferred metric: Public Market Equiv. Compare capital generated by PE to that by public market index over fund life
What is the most appropriate benchmark for PE?
Leveraged Small Cap equity index
What are some of the top VCPs
- Financial Engineering
- Topline growth
- operational improvement
For minority stake holders, what type of strategies perform the best
homogenous strategy
Private equity firms implement value creation plans more frequently for which type of private equity deal, fund ownership, and growth strategy?
Buyout
Majority owned
Inorganic growth
most popular VCP strategies (descending)
- Top-line growth
- Financial engineering
- Cash mgmt
Which VCP combinations predict highest returns?
HIGHEST:
- topline growth
- governance engineering
- financial engineering
LOWEST:
- operational improvements
- governance engineering
Most popular action items
- buying/upgrading assets
- charging product and service mix
- pursuing M&A
regional PE funds are more likely to implement which VCPs
- topline growth and governance engineering
- likely to consolidate across counreis and use wider networks of managers and board members
Name some liqudity management strategies
- MM/T-Bills
- PME
- Tiering based on average call rates
- Conservative application of tiering - highest 10th percentile of call rates each year
How many % uncalled by PE investors after 5 years
20%
private debt: 10%
Define Gap Risk
In CPPI, floor is violated if value of risky asset declines by more than 1/m
Define Time invariant Portfolio Protection Strategy
TIPP is a variant of the CPPI, and differences:
- floor = % of portfolio’s
previous high water mark
- does not require timr horizon
