An Analysis of Domination Finance: A New Tool for Hedging Cryptocurrency Market Cycles

Source: Rhythm Research Institute

Many well-known investment institutions and practitioners believe that the derivatives track will be an important direction for the next round of innovation in the Crypto industry. The recent vigorous development of dYdX further proves that as long as there are excellent products and convenient trading mechanisms, users' demand for on-chain derivatives trading is as strong as their demand for spot trading.

However, the current innovations in on-chain derivatives are still mainly focused on replicating the categories of derivatives that already exist on centralized trading platforms. For example, dYdX primarily focuses on perpetual contracts, and the trading range covered by its products is almost entirely existing risk exposures.

The greatest advantage of blockchain technology is that it provides developers with a platform that requires no admission, allowing them to build derivative products that include any exposure, providing users with new risk management tools that cannot be obtained in traditional financial markets. Therefore, compared to perpetual contracts, synthetic assets that can more conveniently combine various risk exposures are likely to become the next innovation focus in the derivatives track.

On-chain synthetic assets have many advantages over traditional centralized financial markets. The representation range of synthetic assets is no longer limited to mature assets such as stocks and bonds, but can represent various risk exposures such as BTC market share, ETH volatility index, and even weather conditions or COVID-19 infection numbers.

People's real lives are filled with various uncertainties, and synthetic assets provide users with a great means to manage these uncertainties. However, building a variety of rich synthetic assets requires a simple and powerful underlying development platform for support. The UMA protocol, built on blockchain technology, meets this need perfectly. Domination Finance, which will be introduced in this article, is also built on the UMA foundational protocol. Therefore, it is necessary to briefly introduce the operation principle of UMA to the readers.

Basic Mechanism of UMA

UMA provides an excellent underlying technology platform for all project teams that want to issue synthetic assets.

As UMA founder Hart Lambur introduced in an article, there are two key components for building a brand new synthetic asset: sufficient and stable collateral, and a payout function built on a reliable oracle.

The assets used for collateral can directly use mainstream assets in the current market, such as BTC, ETH, or Stable Coin. The most important factor to ensure the accurate operation of the payout function is the oracle. To enable synthetic assets to accurately and efficiently obtain off-chain information, UMA has constructed an Optimistic Oracle mechanism based on optimistic assumptions.

In simple terms, UMA's oracle mechanism differs from the more familiar Chainlink. The caller of the oracle price does not need to perform on-chain transaction verification each time data is called but directly accepts the information provided by the proposer, only verifying through the DVM (Data Verification Mechanism) when disputes arise. By introducing a game-theoretic mechanism, nodes providing incorrect information are punished, ensuring the smooth operation of the oracle.

This mechanism, akin to Optimistic Rollup, significantly reduces the cost of calling UMA oracles, greatly increases speed, and allows synthetic asset protocols to call more types of data beyond price information, thus giving rise to a richer variety of synthetic asset categories.

UMA has built a complete synthetic asset issuance platform based on these underlying technologies. On this platform, developers can create various alternative synthetic assets, such as volatility index tokens, BTC market share tokens, or tokens representing ETH gas prices.

Domination Finance fully utilizes UMA's mechanism to transform one of the most commonly used indicators in the industry, BTC market share, into a brand new synthetic asset category.

Index Tokens for Hedging Crypto Cycles

Investors with long-term Crypto trading experience surely know that BTC market share is often used to assess the specific stage of the Crypto market's large cycle, a pattern closely related to the mindset of crypto market participants.

Whenever the Crypto market enters a new bull market, early investors reap substantial financial returns, and this wealth effect continuously attracts new investors. However, new entrants often do not directly purchase mainstream assets like BTC; first, the price of BTC has often surged after the bull market begins, making it risky to chase high prices, and second, the price of BTC is too high for many to afford even one. As a result, many altcoins that seem to have not yet completed "value discovery" become popular investment targets for newcomers. Thus, after the bull market begins, the market share of Altcoins (tokens other than BTC) often rises significantly.

Conversely, when the market as a whole enters a bear market phase, investor sentiment gradually cools, and many projects once seen as the next Bitcoin or the next Ethereum are debunked, with prices approaching zero. Various funds increase their allocation to core assets like Bitcoin for hedging. This leads to a significant drop in many Altcoin prices and a rebound in Bitcoin's market share.

From the above chart, it is clear that this pattern was perfectly demonstrated in the last four-year cycle. Therefore, understanding this key indicator, BTC market share, can help investors better assess the specific position of the market in this cycle.

Just like the Nasdaq index in the stock market, this indicator, which reflects overall market sentiment and cycle stages, may seem simple, but it is an indispensable financial tool for both speculators and institutions that need to manage risk.

Thus, creating a financial derivative product that allows for easy trading of this market cycle index has become an urgent issue in the crypto market. Domination Finance meets this market demand by utilizing the infrastructure provided by UMA, allowing users to mint tokens representing BTC market share (BTCDOM) by staking Stable Coin USDC.

How to Use Domination Finance

Domination Finance is a decentralized synthetic asset minting and trading protocol built using blockchain technology. All trading rules on the platform are deployed on-chain via smart contracts, and the code has undergone strict audits to ensure the safety of user assets.

Therefore, unlike trading derivatives on centralized trading platforms, users of Domination Finance do not need to worry about fund custody and deposit/withdrawal risks. While participating in trading, all user assets are kept in their own wallets. This technical architecture adheres to the open and admission-free spirit of blockchain technology, allowing any user to freely participate in trading. This is particularly valuable in the current environment where regulations on centralized trading platforms are tightening in various countries.

The usage of Domination Finance is also very simple. Although it is an ecosystem project based on UMA, Domination Finance has developed its own independent front-end trading interface. This interface supports interaction with various ETH ecosystem crypto wallets. Users only need to open the webpage, connect their daily-use Web3 wallet (such as MetaMask), and they can start using it directly.

Below the BTC market share chart, there are four clearly distinguishable buttons in different colors.

First, for users who anticipate that BTC's market share will rise, they only need to click the green LONG button to directly buy BTCDOM at the current market price. Currently, the system supports users to trade BTCDOM directly using USDC and ETH, and the entire user experience is completely consistent with other AMM-based trading platforms, making it very user-friendly for first-time users.

Similarly, if users are bearish on BTC's market share, they can also conduct reverse trading. Domination Finance offers a reverse BTC market share token called invBTCDOM, whose price movement trend reflects the market share of Altcoins (1-BTC market share). Therefore, for investors with a more optimistic outlook on the crypto market, they can purchase invBTCDOM to profit from the increase in Altcoin market share.

In addition to going long and short, the yellow button on the trading interface provides users with the option to mint BTCDOM tokens and to provide liquidity to the liquidity pool using these tokens.

Similar to becoming a liquidity provider on Uniswap, when users obtain BTCDOM through minting or purchasing, they can inject corresponding funds into the liquidity pool along with USDC to provide liquidity and earn fees from other traders as income.

The mint option is equivalent to the primary market for BTCDOM. Users can stake USDC while minting an equal amount of BTCDOM and invBTCDOM. After receiving the two opposing tokens, users can sell one of the tokens based on their prediction of future market trends while keeping the other token, thus obtaining a one-sided risk exposure.

In addition, Domination Finance provides trading tools for ETH market share and USDT market share, representing the proportion of the market holding Stable Coins, in addition to BTC market share. The trading methods for these are completely the same as those for BTC market share, facilitating users to conduct more detailed risk management operations.

Currently, the Domination Finance project has been deployed on the ETH mainnet and Polygon, and is open for user use. Do you think BTC's market share will rise or fall in the future? Cast your vote through Domination Finance.