Why gCC invested in VEGA protocol

Arrington Capital and Cumberland DRW led a $5M round recently covered in Techcrunch this morning. This strategic round consists of active trading firms who will be market participants on the VEGA protocol. This round’s investors join those in the previous round including gCC that was led by Pantera Capital.

Ninos Mansor from Arrington XRP Capital posted this:

Crypto desperately needs credibly neutral derivatives. A year from this PTSD-inducing moment of market history and not much has changed. Put aside the fact that we still don’t know what happened on that day — the majority of derivatives volume is still executed off-chain in the opaque land of the centralized exchange. 

From “Toward Credibly Neutral Derivatives: Announcing Our Investment Into Vega” by Arrington XRP Capital’s Ninos Mansor

http://arringtonxrpcapital.com/2021/03/18/toward-credibly-neutral-derivatives-announcing-our-investment-into-vega/

gCC VEGA Thesis: Evolution of a Novel Exchange Infrastructure

The untold story of VEGA is that they have developed a fundamental new technology for digital asset exchange that has to do with a principle that even a child can understand: fairness. In a fight between siblings, you might hear one of them shout “Alice hit me first.” Fairness is often tied to the sequence and ordering of events.

https://medium.com/vegaprotocol/new-paper-fairness-and-front-running-an-invitation-for-feedback-cbb39a1a3eb?source=———0———————–

Klaus Kursawe, from VEGA published the white paper, Wendy the good little fairness widget. This is truly the heart of what we got excited about when we met VEGA and later understood the implications of it.

As you know, the only currently viable decentralized exchange is the AMM or Automated Market Maker style of exchange. There have been historically so-called “DEX” exchanges like EtherDelta and IDEX that feature CLOB style central limit order books. But the Order Book is more notably the beating heart of exchanges like Binance and Coinbase, exchanges that match “Alice” and “Bob” in real time. These participants are called “active liquidity” and are contrasted with the passive liquidity providers in traditional DEX AMM.

VEGA changes all that. Using the VEGA system, even in a decentralized and distributed computing framework, the fair order sequence is preserved. This effectively eliminates front-running which is a large source of miner extractable value (MEV) in blockchain based exchanges.

This enables a fundamentally new form of decentralized exchange (DEX).

Why Derivatives Need VEGA?

We know the derivatives market is “huge”, so what is the problem here.

The problem with the traditional derivatives is that because of the diversity of products there is a hugely fragmented market. So for any given derivative asset the total liquidity in that submarket may be insufficient because there so many different subproducts. In a low liquidity market, market makers charge exorbitant spreads.

In the traditional model, liquidity is provisioned by intermediaries that extract value through spreads. In the VEGA model, liquidity is provided peer-to-peer directly by the counterparty and is incentivized by fee-sharing to generate margins more fairly and efficiently. Because of the fair sequencing of orders VEGA enables a new and more intrinsically fair, lower cost, dynamically liquid and higher capacity derivatives market.

Market makers are still a key part of the VEGA ecosystem, but they act more as counterparties instead of intermediaries. The market prices the risk which is calcluated by the protocol which increases fairness and helps regulate conditions of lower liquidity better for all parties. This new market structure is the result of the deep experience of the team in traditional derivatives markets.

How did we meet VEGA?

We first met VEGA through a cold inbound via our partner Ray Zhang in October 2018 and they pitched us in our San Francisco offices. Their design was very early and we told them so. We definitely were hugely impressed by the team and we wanted to find a way to work with them.

In June of 2019 we were reconnected with VEGA through Rockaway ventures and Pantera, firms with whom gCC frequently works with.

Miko Matsumura remembers the final moments of conviction this way:

“I met up with Barney and Ramsey at the Coupa Cafe in Palo Alto and we ended up walking all over and all the way down onto the Stanford campus. The discussions were extremely wide ranging and intellectually diverse, but the incontrovertible conviction that arose from those discussions was that this was a team with incredibly deep domain expertise and an unstoppable passion for the domain. Although Tamlyn Rudolph and Klaus Kursawe were not at the meeting, their ideas were clearly present and conviction was attained.”

Miko Matsumura recalling a long walk in Palo Alto with the VEGA founders.

The rest, as they say, is history.

The future of Derivatives

As you know with traditional financial markets the derivatives market is 100x or more larger. We feel that the crypto derivatives market is destined to also be huge.

Our perspective on derivatives has been informed by conversations with industry leaders on DeFi derivatives.

Kain Warwick of Synthetix (SNX) noted about the complex tradeoffs required to operate a decentralized finance derivatievs exchange in the follow quote from the MikoBits show:

“…my very strong view is that these decentralized protocols that we’re seeing emerge, are unequivocally better than the centralized, you know, equivalence. Like they just are, right? They’re more transparent. But there are trade offs. And one of the trade offs right now is scalability.”

Kain Warwick, founder of Synthetix (SNX)

Currently, Kain is solving his own scalability problem using layer 2 rollups with Optimism. But we also believe that a new form of derivatives exchange such as proposed by VEGA will do a lot to advance the size, liquidity and fairness in crypto derivatives.

Miko relates another discussion about these trade offs with FTX / Alameda founder Sam Bankman Fried who took the position that Miner Extractable Value was simply solved by increasing transactional throughput. While faster transaction (in his case supplied by Solana/Serum) decreases MEV, we feel that this is a less fundamental solution than that provided by VEGA.

gCC also invested in Delta Exchange which is a centralized crypto derivatives exchange. Here is a MikoBits show episode featuring a conversation between Miko and Pankaj Balani the CEO and founder of Delta Exchange. Pankaj has deep expertise on traditional derivatives markets (as do the VEGA team) and gives us a great perspective here.

In this interview, Pankaj points out the importance of the economic role that derivatives play, which includes the reduction of volatility in markets and the ability for professional investors to more precisely model and invest in complex risk assets.

“…there was a day in crypto Twitter when everybody was talking about free yield and free. There’s no free lunch. Somebody is paying for it. Yeah. So if nobody’s paying for it, then whatever tokens you are getting is not worth. Right. So either it creates economic value for someone, if it is not creating economic value for you, anyone, then you are taking unnecessary risks for no return. So it’s an it’s a net zero activity. In that regard. I mean, somebody has to pay for the yield. Otherwise, there’s a problem.

Pankaj Balani, CEO and founder of Delta Exchange

We also interviewed Andrey Belaykov who is also an expert from traditional derivatives markets.

Andrey explains the structure of the Opium protocol

So opium protocols a little bit the same philosophy (as the Bloomberg terminal). So we built a professional ecosystem, with a matching layer off-chain, by the way on 0x (protocol) type relayers. with settlements on chain, secondary markets, like super fast order books…

Andrey Belaykov, founder and CEO of Opium Protocol

Andrey solves the tradeoff problem using off chain superfast order books, not unlike the Solana/Serum approach.

VEGA solves these tradeoff problems through fundamentally reconstructing both the fabric layer of the exchange as well as by constructing a fair exchange application on top. We feel very excited about the future of crypto derivatives and the future of VEGA protocol.

Author: Miko