Inverse vs Linear
Delta Money employs both inverse and linear perpetual contracts to manage its derivatives positions, ensuring the stability of DUSD. These contracts are vital tools for risk management, capital efficiency, and maintaining the protocol’s risk-adjusted returns.
Linear Contracts
A linear contract directly correlates with the price of the underlying asset.
Example: In a linear contract such as ETHUSDT, the contract’s price is quoted in Tether (USDT), and both margin and profit/loss (PNL) are denominated in USDT.
This allows Delta Money to take long positions in assets like ETH, BTC, and others — capturing upside while ensuring proportional risk mitigation in line with the underlying asset’s price movement.
Inverse Contracts
An inverse contract behaves differently, where the contract’s value is inversely related to the price of the underlying asset.
Example: ETHUSD is quoted as ETH/USD, but its value is 1 / ETH/USD.
This structure allows the contract to pay out in USD per contract while adjusting according to the inverse of ETH’s price. This design is essential for hedging USD-denominated risk, directly supporting Delta Money’s primary goal of maintaining DUSD’s peg to the U.S. Dollar.
Convexity Implications and Risk Management
Convexity, also known as Gamma, describes the non-linear nature of price movements, particularly in inverse contracts. This non-linear relationship significantly affects Delta Money’s ability to hedge effectively.
Linear Contracts
The payout for a linear contract is straightforward:
Calculated by multiplying the contract multiplier by the difference between entry and exit price.
The risk/reward profile is linear, meaning profits or losses move in direct proportion to the price movement of the underlying asset.
Inverse Contracts
Inverse contracts introduce convexity, meaning the payout is non-linear. The profit or loss is determined by:
This means that for inverse contracts, the profit or loss is more sensitive to large price movements, with changes in price having a disproportionate effect on the outcome.
Example of Inverse Contract Convexity
Let’s consider a more realistic example, based on current market conditions.
Initial Position: Delta Money shorts 50,000 ETHUSD contracts at a price of $1,800 (realistic value based on current market prices).
Price Movement: Over the course of several days, the price of ETH increases from $1,800 to $1,900.
The profit or loss for an inverse contract is calculated as:
Conversely, if the price had dropped to $1,700, the calculation would be:
In this example, the non-linear behavior of the inverse contract results in a higher loss when the price decreases and a more limited gain when the price increases. The convexity effect highlights how inverse contracts provide higher exposure to downside risk, but also offer increased protection against market volatility.
Strategic Use of Inverse and Linear Contracts
Delta Money strategically combines inverse and linear perpetual contracts to manage risk and optimize capital efficiency, ensuring that DUSD maintains its peg to the U.S. Dollar.
Linear Contracts
These are employed when the market is showing upward momentum. They provide stability and allow Delta Money to capture market gains with limited risk exposure. Linear contracts are ideal for periods when Delta expects continued growth in the value of assets like ETH or BTC.
Inverse Contracts
These are primarily used as a hedging mechanism, protecting Delta Money from adverse market conditions or downturns. The protocol uses inverse contracts to mitigate the risk of falling asset prices, ensuring that the reserves backing DUSD remain protected from large losses.
During periods of high volatility or downward market movement, inverse contracts provide an effective way to hedge against downside risks.
By balancing the use of both contract types, Delta Money maintains a delta-neutral portfolio, meaning the protocol is shielded from large price movements in any single asset. This minimizes systemic risk, ensuring that DUSD remains stable while allowing Delta Money to take advantage of favorable market conditions when they arise.
Delta Money continually optimizes its positions across both linear and inverse contracts, adjusting as market conditions change. This dual strategy allows the protocol to:
Safeguard the reserves supporting DUSD
Minimize exposure to both upward and downward price movements
Maintain peg stability and long-term solvency, even in volatile market conditions
Conclusion
Delta Money’s use of both inverse and linear contracts creates a robust risk management strategy, balancing capital efficiency with risk mitigation to safeguard the stability of DUSD and ensure its reliable performance over time.
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