UMA is an open source protocol that allows two counterparties to create their own financial contracts and synthetic assets, backed by economic incentives that make them self-enforcing. UMA, short for Universal Market Access, is a decentralized platform for financial contracts that aims to allow precisely what the name suggests: universal market access.
The project has experienced steady traction in recent times and the expectation of new collaborations to improve the protocol is fostering good expectations for 2021.
Financial contracts and derivatives represent the core of the existing financial system. The emergence of the DeFi world and the development of a financial system that wants to become more ethical and open, thanks to permissionless systems such as blockchain, does not exclude the importance of derivatives and synthetic assets in its adoption.
In traditional finance, derivatives and other financial contracts are generally applied through two mechanisms
- margining, in which counterparties post value guarantees as the contract varies
- legal recourse, in which a counterparty can sue the other party if the contract is not fulfilled.
Legal recourse is often limited to those who are larger and more powerful, limiting access and use of this tool, moreover in traditional systems moving money and margining a contract takes time.
The blockchain allows financial contracts to be margined continuously and on a near-real basis, thus enabling contracts with no legal recourse, no trust and entirely secured by economic incentives.
With significant advantages:
- elimination of barriers that limit access to financial markets;
- users in countries with weak financial structures could bypass local infrastructure limitations;
- universally programmable risk, smart contracts open up financial markets of all types, opening up great opportunities for decentralized financial products.
A truly global financial market.
How does UMA work
UMA consists of a decentralized, open source infrastructure for self-enforcing financial contracts on Ethereum.
Specifically, it consists of two elements
- Self-enforcing financial contract templates;
- Data Verification Mechanism (DVM), i.e. a “demonstrably honest” oracle used to evaluate and marginalize such contracts.
Combined, these two technologies enable the creation of synthetic, fast and secure derivatives on the Ethereum blockchain.
UMA financial contracts are contracts that do not require an on-chain price feed to function, thus reducing the use of oracles through incentives that tend to make counterparties commit to securing their positions without requiring any off-chain price feeds.
The incentive mechanism specifically allows counterparties to be rewarded for identifying inadequately secured positions, if a position is not liquidated it is assumed to be solvent (adequately secured).
Oracles are only used when liquidation is disputed.
UMA thus defines an open source protocol for creating and verifying financial contracts without trust, allowing anyone, anywhere, to design and create universally accepted financial contracts on Ethereum.
The Data Verification Mechanism (DVM) is the name given to the service performed by the UMA oracle. It does not provide on-chain price feeds, but is used exclusively to resolve settlement disputes and to resolve synthetic token contracts on expiry.
In the event of a dispute, a price request is sent to the DVM which proposes a vote among the UMA token holders in order to price the asset at a specific timestamp. The pricing is done via off-chain price feeds recorded via UMA’s Voter dApp service.
The DVM will aggregate the votes of the token holders and determine the final price of the asset at a given timestamp. The premise on which the DVM service is based is that any oracle on a public blockchain can be corrupted. For this reason, UMA is based on a system of economic incentives, so that any attempt at corruption is not profitable.
The goal is to build a mechanism whereby the Cost of Corrupting (CoC) is always greater than the profit that would be made from corrupting the Profit from Corruption (PfC) system, a formula where CoC>PfC, thus allowing for a “demonstrably honest” oracle.
This process takes place in three steps:
- Measuring the Cost of Corruption (CoC)
- Measuring Profit from Corruption (PfC)
- Maintaining CoC>PfC
If you want to learn more about these three processes, please refer to the UMA whitepaper.
UMA Synthetic Tokens
With UMA it is possible to launch synthetic assets that reference an underlying benchmark index, rather than relying on on-chain data via price oracles.
A trustless tokenization system that uses contracts to create ERC-20 tokens for synthetic cryptocurrency or real-world asset exposure.
UMA allows users to tokenize the price of anything in an open and decentralized way, global investors can get exposure to any existing asset or better use creativity to tokenize assets not yet conceived in traditional finance.
At the heart of the protocol is the native UMA token, holders are empowered to contribute to important decisions, whether it be protocol parameters, types of assets supported, or whether to intervene in disputes over price requests, through the UMA protocol’s data verification mechanism.