The entire DeFi vertical has been reeling from the widespread collapse of yields across the board. With this in mind, a very interesting trend is starting to emerge – risk mitigating DeFi protocols.
Risk mitigating protocols help investors and traders hedge their exposure to a crypto asset. For example, options help mitigate risk because an investor with long exposure to ETH can buy put options and reduce their downside risk.
As this theme of risk mitigating protocol furthers, several players are gearing up to launch. But this week, an existing financial primitive that’s finally made its way to DeFi caught my attention.
Barnbridge is a new project bringing collateralized debt obligations (CDOs) to DeFi. For those who’ve watched The Big Short or followed the 2008 GFC, you probably think CDOs are financial products from hell. In reality, they’re insanely useful to minimize risk when used correctly.
What they do is effectively cut up exposure to financial instruments into siloed baskets, called a “tranche”. The senior most tranche carries low risk and low returns; the junior most tranche has high risk and high returns. Say we divide exposure to ETH into three tranches: junior (high risk;high return), mezzanine (medium risk;medium return), and senior (low risk;low return).