Float: A capital-efficient way to trade derivatives with leverage

Leverage is a way for degen traders to double down on their trades.

Essentially, a standard trade, like buying ETH, means getting 100% long exposure to the price of ETH. ETH goes up 10%, and your position goes up 10%.

But with leveraged trading, you can get more exposure to the price. If your position is 2x leveraged, and the price goes up 10%, your position could go up by about 20%. If you were 3x leveraged, the gain could be around 30%.

This is risky. If the price moves against you, your loss will be as great as your gains. It’s also been hard to get leverage on-chain in the past. Most commonly, traders would open an over-collateralized loan at risk of liquidation.

With a novel Float protocol, you can trade leverage, long and short, without those extra barriers.

To understand why that’s a big deal, let’s dig into how big those problems are.

Over-collateralization

A lender lends assets to a borrower and charges a premium on repayments, so the full amount repaid will be greater than the amount lent.

To protect the lender’s capital, the borrower will deposit their own assets to guarantee repayment of the loan. These assets are called collateral. Think of it as the borrower asking for insurance on their loan.

Mortgages for houses, personal loans, credit cards, and other traditional financial instruments are all under-collateralized loans. That means the value of the collateral supplied is less than the value of the loan. Banks can issue under-collateralized loans because they know who you are and where you live and can take legal action to reclaim their funds.

Blockchain lenders like Aave, Compound, and Maker DAO can’t do this. They just have your wallet address, not your home address. They require greater security. To achieve this, they ask for over-collateralized loans – where the value of the collateral is greater than the loan's value. This method of borrowing isn’t very capital efficient, but it’s commonly used by traders to get leverage on crypto assets.

How much can be borrowed from each lender will be based on a collateralization ratio – essentially the percentage of the collateral that can be borrowed.

Leverage Through Borrowing

Over-collateralized loans are a risky but popular way of getting leverage.

Say a user has some ETH and believes the price will go up. They could go to Maker DAO and deposit their ETH into a borrowing vault. They can then borrow a percentage of their collateral as DAI, head over to a DEX, like Uniswap, and swap their DAI for ETH.

They have now leveraged their exposure to ETH above 100%. They can repeat this process by depositing their new ETH into Maker, borrowing more DAI, and swapping for more ETH. This process can be looped again and again until the costs of the borrow and swap transactions are greater than the additional gains that could be captured.

This process can be time consuming and hard to manage and opens the user up to a great risk: liquidation.

Liquidations

Getting liquidated means that some or all of your collateral gets taken by the lending protocol to cover your loan. There are generally two ways this can happen:

When the collateral backing drops too low. The lending protocol will charge an interest rate on loan, deducted at regular intervals from the collateral. The loan will have a liquidation threshold or liquidation ratio – a point at which the collateral backing drops too low and the borrower’s collateral is liquidated.

In some protocols, liquidations occur based on price movements. In Maker DAO, in particular, since loans are based on DAI – a dollar-based stablecoin, liquidations are based on the dollar value of the collateral. Users borrowing DAI from Maker will get a liquidation price based on how much they borrowed against their collateral and the type of collateral deposited. If the collateral asset's price drops below that, it’ll be liquidated.

Leveraged traders have been getting liquidated this way for years. In 2022 alone, there were some notable liquidations when the markets plummeted, and even massive crypto funds were caught.

That’s why Float is working on resolving this issue.

Introducing Float

Float is a leveraged derivatives trading platform that builds ways for users to trade, with leverage, without risk of liquidation or the added complexity of managing over-collateralized loans or collateralized debt positions.

Float lets users, in a single transaction, deposit stablecoins to enter a market on the long or short side and mint ERC-20 tokens representing their position.

A novel floating exposure mechanism enables the risk of liquidations and the requirement for over-collateralization. Under floating exposure, long and short positions offset each other based on the balance of capital on each side of the market. When less capital is going, for example, short on an asset, that side of the market is underbalanced.

To counter this, floating exposure sees the exposure of the overbalanced side, in this case long, drop under 100%. The drop in exposure scales linearly with the imbalance – so if capital is perfectly balanced, both sides have 100% exposure, but if one side has twice as much capital as the other, that side will get 50% exposure.

Inline with the market imbalance, the protocol has a set of incentives that scale up to keep markets balanced. This consists of a funding rate, which scales up to 200%, or even 600% APY, depending on the market. This also includes yield enhancement – where users on the underbalanced side earn a share of the yield on all the capital in the market.

In the Float Alpha, users can earn alphaFLT tokens as an additional incentive for balancing the markets. The FLT token is not live and will not be launched until the protocol is self-sustaining without requiring a token. When FLT is launched, holders of alphaFLT can redeem their tokens for FLT. Trading in the Float Alpha is the only way to earn alphaFLT tokens.

The Future of Derivatives

The Float team has the mandate to build innovative financial primitives. Floating exposure is just the start. The team is hard at work building Float Arctic – the successor to Float Alpha.

The team keeps details of Float Arctic tightly controlled but claims it will include several world-first features for a tokenized derivatives trading protocol.

The one known feature of Float Arctic is called Smart Markets. Each Float market in the Arctic will be deployed as a standalone smart contract – giving the team immense power to innovate and test out new markets with novel use cases. That could include launching markets with rare and exotic assets, non-stablecoin payment tokens, and even novel innovations beyond floating exposure that enable new ways to trade, hedge, and farm.

Wrapping Up!

Float allows users to effortlessly turn their crypto into assets of their choice without the need for over-collateralization or liquidation. It is a peer-to-peer, yield-enhanced, floating asset exposure mechanism. It is a novel protocol, creating an efficient magic internet asset marketplace governed entirely by code, allowing anyone worldwide to get involved.

Hit their website to know more about them. You can also explore their blogs or read the whitepaper to dive deeper. For any questions, Float is active on Discord on Twitter.