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What is Quanto?
"Quanto" is a term used in finance to describe a type of derivative in which the underlying security is denominated in one currency, but the derivative itself is settled in another currency at a fixed exchange rate. These derivatives are particularly useful for hedging and managing currency risk.
The key feature of a quanto derivative is that it removes the foreign exchange risk from the contract. This means that no matter how the foreign exchange rate changes, the derivative will always be settled in the fixed currency at the specified exchange rate. Here's an intuitive video about the mechanics of quanto options:
There are several types of quanto derivatives, including:
- 1.Quanto Futures Contract: A futures contract where the investor is exposed to price movements on an index or commodity, but without any currency risk.
- 2.Quanto Options: Similar to a futures contract, a quanto option allows an investor to take a position on an asset without exposure to currency risk.
- 3.Quanto Swaps: This is an interest rate swap where one party pays a foreign interest rate to the other, but the notional amount is in domestic currency.
In the context of decentralized finance (DeFi), a quanto feature allows users to take positions in assets that are not native to the blockchain on which the DeFi project operates. For example, a DeFi user might take a position in Bitcoin (BTC) on an Ethereum-based DeFi platform, and their gains or losses would be denominated and settled in Ether (ETH) or other native ERC20 tokens.