What is UMA?
in UMA (UMA)
Decentralized finance, or Defi, is creating an entirely new financial system on top of the blockchain. That can include features like,
- Interest earning bank accounts
- Collateralized and uncollateralized loans
- Futures and options contracts
- Exotic derivatives
- Commodity and currency exchanges
The list goes on but in this article, we’ll focus on UMA, which stands for Universal Market Access. UMA’s goal is to bring derivatives to Ethereum so that anyone, regardless of where they live, can trade the financial instruments they want to.In this article:
What is a Derivative?
A derivatives is a contract between two or more parties about an asset’s price movements. The attraction about derivatives is that it gives investors exposure to an asset without actually having to hold the asset. Examples of derivative products are options, futures, collateralized loans and prediction markets, which let investors interact with assets such as bonds, stocks and currencies, without having to actually own or exchange any of them directly.
Currently, the traditional derivatives market is estimated to be in excess of $500 trillion, so if UMA can even bring just 1% of that to Ethereum it will be an incredible windfall.
How UMA Enables Derivatives Trading
The technology which enables UMA to function, the nuts and bolts of the protocol, is fairly complex and outside the purview of this post. We’ll be focusing on the bigger picture instead. However, for those who want to get deep into the technicalities and learn how UMA works, there is an excellent article here, explaining the project. UMA’s whitepaper is also available on GitHub.
One of the key problems with the derivatives market is accessibility. As with just about everything else in the existing financial system, there are limits to who can participate. These limits come in several forms.
- The accredited investor rule, whereby certain financial products are only available to those who have $1 million or more
- Identity rules, whereby if you can’t verify your identity you can’t sign up for trading. It’s estimated that 1 billion people don’t have an ID card
The goal of UMA is to make derivatives trading open to anyone.
All that you need to trade a derivative on UMA is a person who wants to take the other side of the trade. Thanks to the trustless nature of UMA, all positions are collateralized in advance so that neither party can default without paying a high fee. This is what makes decentralized finance so special.
In the traditional world of finance, contracts are backstopped by the courts. If one party reneges on a contract, the other party can sue. However, this creates problems if the two parties are in different jurisdictions, or if one party doesn’t have adequate legal resources to initiate a lawsuit. It very much favors the large players with deep pockets.
With its smart contracts and collateralized positions, UMA is totally different. The derivative contract is governed by code and the court system is never involved since a default on that contract is not possible (at least, not possible without a large financial loss). The advantage is that,
- Any two people or organizations can trade with each other from anywhere in the world. USA to China, Canadan to Zimbabwe, etc. It doesn’t matter since the courts are not involved
- Everyone is equal. A large trader with lots of money and teams of lawyers has no inherent advantage over a twenty-something day trader living in Kansas City
- Contracts are settled instantly. Since the funds are already being held in the smart contract, they can be paid out instantly as soon as the contract ends
The following are a few examples of the types of products that can be traded on UMA
- US & Global Equities
- Cryptocurrency Dominance
- DeFi Total Value Locked
- DEX Market Share
- Perpetual Swaps
- Tokenized Yield Curves
- Private Pension Plans
- Insurance and Annuity Products
UMA Tokens Can Track the Price of Anything
In addition to derivatives trading, UMA has a second interesting feature: it allows users to create a synthetic token that can track the price of anything. An obvious example might be a token which tracks the price of the S&P 500, however, the possibilities are endless.
- A Chinese Yuan CNY stablecoin
- Tokens that track the interest rate of anything
- Soybean prices
- US 30 year treasury bond prices
If it has a price, it can be tokenized. Again, we won’t get into the technical details but a full explainer of the technology is available here.
One feature that is worth pointing out: these tokens don’t require an oracle. They maintain their value without a price feed, which removes a major attack vector. Oracles are often considered one of the weakest points in the DeFi ecosystem.
Similar to other DeFi tokens, UMA is a governance token that can be used to vote on decisions for the project. According to DeFi Rate, UMA is used to, “challenge reference indexes and vote on protocol decisions.” UMA holders can use their tokens to vote via the Voting Dashboard.
UMA is another piece of the DeFi money lego system, another decentralized financial product that doesn’t rely on a centralized company or financial institution to clear transactions. UMA connects buyers and sellers from anywhere on the planet and thanks to its clever smart contracts, all positions are pre-funded so that neither party can back out of the deal.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.