CompliFi Protocol

CompliFi is a decentralized derivatives protocol built on Ethereum. First conceived in January 2020 to prove that it's possible to design an AMM that serves the needs of fee revenue-focused market makers better than Uniswap's original constant product design. After a year in development, the protocol went live on April 2, 2021, allowing anyone to trade derivatives without counterparty risk while eliminating margin calls, liquidations and defaults for on-chain derivatives.

CompliFi addresses the problem of unbounded potential payoffs, which cannot be fully collateralized upfront. It solves it by modifying all derivative payoffs to fit within a fixed collateral pool. Once this feature is baked into the payoff function, every instrument can be fully collateralized upfront and will never default.

Why create derivatives that don't default?

The risk arises because most regular derivatives have unbounded potential payoffs, which cannot be fully collateralized upfront. For instance, suppose you buy a synthetic leveraged token. If the underlying asset's price keeps on rising, so does your payoff, and someone has to fund it. For that someone, there is no finite amount of collateral that could be posted upfront to guarantee coverage of their liabilities in every market scenario.

A derivative involves multilateral promises of a payment contingent on the future state of the world. Making sure the losing side delivers on their promise is hard. In conventional finance, this job is done together by regulators, central counterparties, internal risk management departments and the judicial system. Associated costs run into hundreds of billions per year, yet we still get epic failures like the 2008 subprime crisis.

Derivative protocols before CompliFi

Derivative protocols tend to manage counterparty risk but adopt a single technique from conventional finance – they ask users to post collateral that partially covers their potential downside, and, if the downside starts to materialize, they ask users to post more. If users refuse, derivative positions are liquidated and proceeds are used to cover the liabilities.

When markets move slowly, and there is plenty of block space to get collateral top-up transactions mined in time, the system tends to work. Problems begin when these conditions no longer hold:

• If the market moves too far too fast, topping up collateral may no longer make sense – users will abandon their positions to be liquidated. Except, the collateral that is already there may not be enough to get everyone paid in full. The "winners" on the other side of the trade will not be able to collect.
• When users do want to meet their collateral calls but can't due to block capacity constraints, their positions also go into liquidation. Then, the same capacity constraint can prevent the liquidation process from yielding fair value. When a significant portion of potential bidders is excluded, the underlying collateral could be sold too cheaply. The final outcome is again the failure of winners to collect their payoff.

How does CompliFi eliminate counterparty risk?

The risk arises from the fact that most regular derivatives have unbounded potential payoffs, which cannot be fully collateralized upfront. For instance, suppose you buy a synthetic leveraged token. If the price of the underlying asset keeps on rising, so does your payoff, and someone has to fund it. For that someone, there is no finite amount of collateral that could be posted upfront to guarantee coverage of their liabilities in every market scenario.

CompliFi addresses this problem by modifying all derivative payoffs to fit within a fixed pool of collateral, effectively "cutting off" the unbounded bits that cause all the trouble. What you get as a result are derivatives that look very much like their conventional counterparts, but have a pre-determined floor and ceiling for how much the holder can gain/lose. Once this feature is baked into the payoff function, every instrument can be fully collateralized upfront and will never default.

CompliFi AMM Leveraging the Uniswap Invariant

Automated market makers often serve a dual purpose in decentralized finance – to generate trading fees for liquidity providers and to rebalance their asset portfolios towards a predetermined target composition. CompliFi proves that it is possible to design an AMM that serves the needs of fee revenue-focused market makers better than Uniswap's original constant product design by decoupling terms of trade from market markers' inventory.

Even in the most popular AMM pools, only a tiny fraction of assets is ever traded, while the rest lie idle and do not generate trading fees. For the market maker, that is an inefficient use of capital. CompliFi Protocol designed its own AMM that removes excess reserves from its pool, allowing it to affect its trading dynamics significantly.

Current State of COMFI Token Implementation

First announced on April 6, 2021, COMFI has a total supply of 10,000,000 tokens. As of the time of writing, COMFI has been deployed on Ethereum mainnet, but has not been connected to the protocol. As a result, COMFI does not currently allow its holders to directly participate in the governance of CompliFi, or to benefit from revenue generated by the protocol. The upcoming CompliFi V2 is about to lay the foundation for the introduction of governance & revenue-generated mechanics.