Introduction:

Here's a recap of the insightful dialogue from Klein Labs' recent space event on the topic "A New Era in DeFi: The Intersection of On-Chain Derivatives and Layer 2", held on Oct. 26th 1:00 p.m. UTC.

In a dynamic online discussion featuring Promethium Finance, Substance Exchange, ACX, and GAVE, Klein Labs facilitated a deep dive into the synergies between on-chain derivatives and Layer 2 technologies in the DeFi sector.

The session brought to light the pivotal enhancements Layer 2 solutions like Arbitrum are introducing to the DeFi space, as articulated by the innovative approaches of the participating projects. Promethium Finance's automated liquidity rebalancer and Substance Exchange's decentralized derivatives platform exemplify the transformative impact of Layer 2 on transaction efficiency and cost-effectiveness. ACX's digitalized derivatives exchange and GAVE's blockchain project connecting US Treasury bonds to crypto markets through NFT tokenization further underscore the breadth of innovation at the intersection of DeFi and Layer 2.

Recap:

1. Guest Self-Introduction and Project Overview

Promethium Finance: Building an automated liquidity rebalancer product on Arbitrum that rebalances users' funds across lending protocols to achieve maximum yields from lending investments.

Substance Exchange: A decentralized derivatives exchange built on Arbitrum, aiming to bring the products and services of centralized exchanges to decentralized infrastructure.

ACX: A one-stop digitalized derivatives exchange providing various derivatives products with up to 50x leverage. Developing various derivatives based on new L2 trends.

GAVE: An innovative new PoS public blockchain project that aims to connect US short-term Treasury bonds to the crypto market via asset digitization and NFT tokenization, providing investors opportunities for high liquidity, transparency and stable returns.

2. Projects Q&A Session

• Host: What are your thoughts on this trend? How should DeFi projects strategize their positioning within Layer 2?

GAVE: These are big changes happening in blockchain technology. Modular blockchains allow people to build in smaller parts that work together making everything quicker and more flexible for DeFi projects. This is really big and important these days as everyone is looking for a unicorn in this field for the next bull run. DeFi projects should think about how to fit into Layer 2 to take advantage of the faster speeds and better performance.

Promethium Finance: Layer 2 solutions like Arbitrum and Optimism dramatically reduce transaction fees and speed up settlement, which directly impacts the efficiency of DeFi protocols. For example, Uniswap's deployment on Optimism reduced fees and improved speed. Layer 2 enables new great products like Permission Finance's rebalancing strategy to be maximally efficient due to low gas fees and fast transaction execution.

Substance Exchange: Not all Layer 2 solutions need to prioritize speed - they can focus on other advantages like security. The various Layer 2s don't all need to compete for the same users and market. For example, ZK rollups may be ideal for collateralized lending while Arbitrum is suited for derivatives. Most Layer 2s competing just for the derivatives market and absolute speed may not be best for the overall blockchain ecosystem progress.

• Host: How do you perceive the role of Layer 2 in the future ecosystem of DeFi? What unique development opportunities and challenges does L2 present for on-chain derivatives?

Substance Exchange: In the future, Layer 2 will be crucial for DeFi to scale while maintaining decentralization and security. The low fees and fast speed of Layer 2s like Arbitrum make many new on-chain derivative products possible. However, educating users about Layer 2 and ensuring a good UX presents a challenge. Adoption can't just be about attracting traders with speed and low fees - the fundamentals like security and decentralization matter.

GAVE: Layer 2 solutions will be a key part of DeFi's future success. Arbitrum provides many advantages for on-chain derivatives like low gas fees, fast transactions, and scalability. The main challenges are around managing collateral/assets across multiple chains and ensuring a seamless UX. Education on Layer 2 will be important.

ACX: Layer 2 scaling solutions will support higher demand and volume for on-chain derivatives trading. Faster speeds and lower costs of Layer 2 benefit complex derivatives products. Main challenges are around bridging assets between Layer 1 and 2, and providing fiat on-ramps. Need to ensure trading experience is easy and intuitive for users.

• Host: What is the current state of the on-chain derivatives market in the DeFi space? Are there any specific on-chain derivatives or L2 technologies or projects that have caught your attention?

GAVE: The current DeFi market is very active with lots of builders and fast growth. Among the DeFi derivatives, Gabi catches attention by connecting crypto to real-world assets like commodities, US bonds, real estate. Gabi digitizes US Treasury bonds into tokenized assets tradable on their platform and DeFi.

ACX: Dydx has been a leader for on-chain derivatives exchange and maintains high trading volume. Their innovation of providing liquidity pools as counterparties and using off-chain oracles is noteworthy. Xisx is building similar features to attract users.

Promethium Finance: His colleague's project creating a CFD derivatives platform on Clayton shows the potential. It allows two peers to create derivative contracts that lock their collateral in smart contracts and earn yield. This works efficiently on L2s for low cost and speed. Products like Permission Finance's balancer can also generate yield on collateral/liquidity locked in smart contracts.

• Host: What is the current state of the on-chain derivatives market in the DeFi space? Are there any specific on-chain derivatives or L2 technologies or projects that have caught your attention?

Substance Exchange: When evaluating on-chain derivatives projects to invest in, the top considerations are the team credentials, technical architecture, product-market fit, tokenomics, and ecosystem partnerships. Ultimately, investing requires evaluating if the fundamentals are strong, the team can deliver, and the product fills a market need.

ACX: Main factors when selecting on-chain derivatives projects include the team expertise, innovative product offering, technical robustness, user experience, integrations with DeFi, and tokenomics. The best projects have unique value propositions, solve real problems for traders, and continually improve the platform.

• Host: With the converging trend of on-chain derivatives and L2, how should market makers and investors adjust their investment and operational strategies to adapt and thrive?

Promethium Finance: Market makers and investors should focus on protocols built specifically for L2 to benefit from speed and cost savings. Evaluating team competency in building for L2 is important. Consider diversifying across multiple L2s instead of concentrating in one. Be selective and avoid spreading too thin.

Substance Exchange: Investors should analyze if projects truly benefit from being on L2 versus L1 - don't assume L2 is automatically better. Assess if the tech stack and roadmap are optimized for L2. Market makers should provide liquidity on both L1 and L2 to access a wider user base. Utilize bridges to move capital between chains. Overall be open-minded about new L2 derivative opportunities.

3. Summary
The dialogue centered on the pivotal role of Layer 2 technologies in advancing the DeFi spyace, particularly for on-chain derivatives. It highlighted the advantages of L2 in reducing costs and increasing transaction speeds, while also pointing out the challenges in user education and seamless asset management. The discussions concluded that for DeFi to thrive, especially in the derivatives market, both market makers and investors must adapt to the nuances of L2, focusing on the technical strengths and market fit of emerging projects.

About Klein Labs

Klein Labs is a pioneering community-oriented Web3 accelerator and research-driven venture capital firm. It was founded by a passionate team of engineers, data specialists, crypto enthusiasts, and investors hailing from prestigious institutions like Stanford University, CMU, Cornell University, Google, and Microsoft. We boast a strong culture of collaboration, an ardor for crypto-economics, and an optimistic view of the future of the internet and AI.

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