Programmable Derivatives: a Vision for Variational's Future

06 May 2025

If you asked me to describe the end goal for Variational, I would say: programmable derivatives. A longer explanation: providing infrastructure to power the world’s derivatives markets, allowing for permissionless creation of arbitrary derivatives and support for the full trade lifecycle, from matching orders to clearing to settlement.

If that sounds like a lofty goal, that’s because we’re not even close to achieving our final form. Yet we’ve achieved a big milestone – hundreds of millions of dollars have been traded on various crypto perpetual futures markets, all powered using the Variational Protocol.

Our long-term vision is a future where anyone can create derivatives markets on any data source. This includes standard markets like perpetual futures, options, and forwards for crypto, stocks, bonds, and commodities. It also unlocks possibilities for alternative markets, such as prediction markets for elections. Even private data, like the price of carrots in a local store, could power hyperlocal markets.

Building blocks of a derivatives market

Conceptually, a derivatives market is pretty simple and has only a few building blocks:

• A contract definition detailing the payoff function, expiration date, settlement rules, the contract size, etc.
• An oracle – a data feed that streams the mark price of the underlying asset.
• A market maker (also known as a liquidity provider) provides quotes: bid and ask prices at which they would buy and sell the derivative.
• Takers – traders willing to buy and sell the derivative.
• A “settlement pool” – a combined pool of capital that warehouses collateral from both the market maker and the counterparty.
  • If collateral falls under the minimum maintenance requirement, then liquidation occurs, and the position is closed
  • The mark price moving will shift realized or unrealized pnl from one counterparty to the other
  • The pool could be bilateral, with only two counterparties, or it could be multilateral, with traders’ collateral commingled in one pool. Either way, every pool is completely segregated from others.

Variational Protocol provides infrastructure that automates most of the pieces above:

• It provides a liquidity matching system known as RFQ (request for quote)
• It provides a smart contract that escrows collateral, and accounting systems to track trades, transfers, realized pnl, interest payments, etc.
• It provides a liquidation engine that closes positions according to predefined rules
• It provides a settlement engine that handles derivatives expirations at mark prices

Using crypto rails, both counterparties could connect their wallet and be ready to trade in under a minute!

Permissionless financial networks

In the future, I imagine we’ll have many segregated financial networks. You can think of each network as its own OTC desk, providing liquidity to a subset of derivatives markets. We have an in-house one called Omni, which you can think of as a Robinhood-like experience for trading crypto perpetual futures. The market maker providing liquidity is a community owned vault called Omni Liquidity Provider.

But let’s say you wanted to create your own OTC desk, one that provides liquidity for prediction markets on local soccer matches. What would that look like?

1. You would generate a settlement pool, and define rules for collateral and liquidation. Let’s say you allow 5x leverage, so the collateral requirement will be 20% of the notional contract size, and liquidation occurs at 10%.
2. You would need to provide an oracle that conforms to our API requirements. For example, let’s say you had a Websocket stream that defines the mark price for the derivative as the win probability:

1. You would need to provide quotes, bids and asks that reflect commitments to buy and sell the derivative at a specified price.

After that, you’re off to the races! Anyone you allow can join the pool and begin trading. We imagine specialized market makers will create many networks that cover their own use cases, for example:

• Access to perpetual futures on stocks and other traditional asset classes
• Prediction markets for elections, sports, and other events
• Options markets for various crypto tokens

We deliberately designed settlement pools to be segregated – money is isolated on pools, and is airgapped from other pools. This gives each pool maximum flexibility to customize the mini financial ecosystem according to its needs. As repeated financial crises have shown, there is always the possibility of a pool going bankrupt due to poor risk controls or excessive leverage. The segregation of pools is designed to prevent financial contagion.

Use cases unlocked

In this new world, we can view the protocol as “Shopify for derivatives”. Users choose the settlement pools (subnetworks) that they wish to participate in.

Use case	Why peer-to-peer wins
Crypto perpetual futures, altcoin options	Enables profit sharing mechanisms (zero fees, loss refunds, vaults) between makers and takers, many of which will be implemented on Omni. If someone manages to lose a trillion dollars, this causes bad debt in one settlement pool but does not crash the financial system, e.g., unlike FTX
OTC structured products, for example, yield generation on locked tokens	Allows flexibility in designing the structured product. For example, selling covered calls using a SAFT as collateral. This is all based on mutual trust between the counterparties.
Equities perpetual futures	Allows specialized mms to setup for each local region, for example, US listed stocks vs HK listed stocks Each settlement pool can have customized collateral in the local currency
Prediction markets for elections, sports, and other events	Needs specialized oracle providers and data feeds, this again allows for specialized providers for each subset of the market (basketball vs presidential elections vs F1).

But why though?

Crypto excels at permissionless money transfer, enabling instant global fund exchange without intermediaries. Why not extend this to allow the permissionless creation of new derivatives markets? Beyond speculation, derivatives are crucial for modern economic functions like mortgages and insurance. While crypto rails have largely been absent from mainstream financial markets, programmable derivatives offer the potential for limitless innovation and the development of new markets to address real-world challenges.