What are structured products?

Now that we have reached $100m TVL, I figure there are enough Ribbon apes who love the vault APY’s but are secretly scratching their heads wondering: what exactly is a structured product? I will answer that question here, and then discuss what it means for Defi.

NOT FINANCIAL ADVICE.

What are structured products?

Structured products were first offered in the 90’s, born out of retail / institutional demand for simple and risk-averse ways to gain exposure to equities.

Today, banks will bundle different financial instruments into one comprehensive product with a specific goal, put it into a nice box, tie a ribbon ($RBN) over it, and offer it to you. Consider it as a make-your-own pizza store. You describe on a high level how you want your custom pizza, and the likes of Goldman / Morgan Stanley will knead the dough, put the toppings on, and put it in the oven. Simple for the buyer.

The traditional finance “structured products” market is $7tn.

Some common structured products:

1. Capital protected products (Principal Protected Note). Under the hood, its a zero-coupon bond + call option. You have $1000 and buy a note. $700 is used for zero-coupon bond purchase which has a face value of $1000. $300 is used for S&P 500 call option purchase. At maturity, the zero-coupon bond is $1000. So you have exposure to S&P 500, but in the case that the S&P 500 call option is not ITM you still get back the original investment $1000. Hence “principal protected”. No harm no foul.
2. Yield enhancement products. Let’s say I can give you the following payoff on Apple stock: If Apple returns < 0% you lose one-for-one. It drops 3% you lose 3%. If Apple returns > 0% and < 7.5% I give you double the return. It appreciates 3% you get 6% return. If Apple returns > 7.5% you get 7.5% capped. It appreciates 15% you get 7.5% return.
3. Lookback product. The returns of the instrument is the average returns of the underlying asset over a time range instead of at the very end. If I just buy Apple stock at t0, my returns at t5 will be (Apple price at t5 — price at t0) * # shares bought. If I buy a lookback product, my returns will be smoothed out through a time range (avg of price at t0, t1, t2, t3, etc.).

There are other structured products. They all have the same thing in common: easy to buy but are more complicated under the hood.

Market Makers pay in the underlying for calls

Now I want to address the cognitive dissonance some of you might have. Given the above definitions, the Ribbon theta vaults might not look like a structured product because after all it just sells OTM puts/calls. It does not combine different financial instruments. But if you look closely it does. Since the premiums for the call vaults are paid in the underlying (eth, wbtc) you are actually implicitly buying the underlying asset with the premiums, which is a type of levered structured product :)

What does this mean for Defi?

In case you haven’t noticed, structured products is tradfi’s way of screaming COMPOSABILITY.

Combining different legos (fixed income, options, futures, swaps, etc) into a single lego piece and offering it to users. Many of you are probably sick hearing that analogy :) Principal Protected Notes just sounds like depositing into a vault that buys a ZCB on 88mph and also an at-the-money call option on hegic.

I am bullish on structured products “vaults” in defi for two reasons (there are other reasons):

1. composable. Tradfi is confined when it comes to the composability tenet. In defi, it is quicker to iterate over and build new simple, clean structured products — new primitives entirely. I just described a principal protected note in defi terms two seconds ago. The meat is probably ~100 lines of code.
2. accessibility. All these primitives (compound, uniswap, etc.) are accessible to all kinds of folks and institutions across the world by design. Simple, one button click “deposit and forget” vaults that do more complicated investments for you under the hood are important.

I wouldn’t be honest if I didn’t mention that there are issues with structured products such as liquidity, capital lockup, etc. But this was intended as a primer. I will address these issues and how defi partially solves them in future articles.

A good paired reading from a while back: https://ribbonfinance.medium.com/yield-hacking-for-fun-and-profit-b50cf47fca35

If you have any feedback, please dm me on twitter.