DYDX’s challengers: Scanning the track of decentralized perpetual contract trading platforms
Research institution: Mint Ventures
Researcher: Li Yuxuan
Data update time: 2021–09–22 1 a.m.
1. About #track scanning
This research report belongs to the #track scan series of Mint Ventures. Compared with the #in-depth research report series with comprehensive analysis of individual projects, the focus of the #track scan series is to pay attention to the development trend of the track and find representative projects for horizontal comparison, thus grasping the dynamics and potential projects of each track in the crypto business.
This is also our new attempt. Welcome to leave your feedback in the comment area.
This issue of #track scan focuses on the track of the decentralized perpetual contract trading platforms.
2. Track value
Perpetuals are a type of derivatives. According to the TokenInsight report (https://tokeninsight.com/report/2835), the transaction volume of derivatives has surpassed that of spot as a whole since Q4 2020, and maintained a more rapid growth in Q2 2021.
For derivatives, Perpetuals (or Perpetual Futures) occupy an absolute advantage. From the below monthly derivatives transaction chart with the breakout of subcategory, we can see that the single transaction volume of perpetuals has already exceeded spot trading, and the proportion is still growing (in June, the transaction volume of perpetuals was more than 1.5 times that of spot trading!). During April to June in 2021, the total transaction volume of perpetuals exceeded US $18.8572 trillion, equivalent to more than US $200 billion per day.
Of course, these transaction volumes are mainly located on centralized exchanges (CEX).
Decentralized spot exchanges have grown vigorously in the summer of DeFi in 2020. At present, UNI, CAKE, SUSHI and other project tokens have entered the top 60 in the circulating market capitalization of cryptocurrencies, and UNI was once in the top 10. However, now the project tokens of decentralized perpetual contract trading platforms have not yet entered the top 100 cryptocurrency market capitalization. And we can see that at the regulatory level, the regulation of derivatives exchanges is stronger than that of spot exchanges. In this context, the significance of decentralization is more prominent.
Therefore, the track space of decentralized perpetual contract trading platforms is very broad, whether compared with centralized exchanges or decentralized spot exchanges.
3. Market overview
In 2021, the track of decentralized perpetual contract trading platforms has developed rapidly. With the rise of high-speed and low-cost side chains, Perpetual Protocol became a decentralized trading platform of perpetuals, with a single-day transaction volume of more than 100 million in February. With the progress of ETH Layer 2, the average daily transaction volume of DYDX successfully exceeded 1 billion at the end of August.
New projects are also emerging in endlessly. At present, the projects that have issued tokens and whose products include decentralized perpetuals are as follows:
In addition, there are quite a number of unissued tokens, such as Synfutures, dTrade, etc., which are not included in our research for the time being.
In this article, we select projects for evaluation according to the following 2 principles:
i. They have issued tokens;
ii. The circulating market capitalization of their tokens exceeds US $50 million or they have actual trading products launched (at least on the testnet) with the average daily transaction volume exceeding US $100,000.
The final selected protocols include: DYDX, Perpetual Protocol, GMX, MCDEX, Cap Finance, and Deri Finance.
The reasons why some protocols shown above were not selected include:
· Injective Protocol, Mango markets, LeverJ and DYDX all use the order book model, and the transaction volumes are far less than that of DYDX. The order book model is not very different in the core product mechanism. Thus, when DYDX already has such a first-mover advantage, other products that adopt the order book model may have little chance to break through.
· Bonfida’s leveraged trading products use a vAMM model similar to Perpetual Protocol V1.
· Although DerivaDEX has started small-scale testing on Kovan, their trading products have not publicly disclosed documents about its mechanism.
· Futureswap announced that it will directly launch the v4 version in September, but there is currently neither testnet to try nor complete product documentation.
· Vega Protocol trading products are not yet launched.
We will briefly introduce the above projects in descending order of circulating market capitalization, and then compare their core mechanisms.
3.1. DYDX
3.1.1 Product introduction
It provides services on Layer 2 starkware of Ethereum and uses the order book model for transactions. It also adopts the funding rate mechanism to balance the naked position (naked position refers to the net position held by the exchange as a whole. If it is too high, it will increase the systemic risk. This will be introduced in detail below). Its core mechanism is almost exactly the same as CEX’s perpetuals, and because of the StarkEx engine, users only need to send transactions on the Ethereum main network when funds are transferred to and from the margin account. There is no need for wallet confirmation (the data is not on the chain), so its transaction experience is almost identical to CEX.
DYDX also has a full range of features, including limit orders, depth charts, and funding rate trends, which are comparable to CEX.
3.1.2 Business data
DYDX’s trading layer will generate an average daily trading volume of US $1 billion in the week from the end of August to the beginning of September. This will be the highest among all decentralized perpetual contract trading platforms, far higher than other competitors. .
Of course, this has a lot to do with the platform’s well-designed combination incentives of trading mining -market-making mining — staking mining, and the price of DYDX (before August, the experience of DYDX is exactly the same as it is now. The average weekly transaction volume is around US $200 million). In terms of financing, DYDX has included professional market makers in both the B and C rounds of financing, so as to bind the interests of professional market makers with DYDX. In addition to daily market-making benefits, professional market makers can also obtain token incentives from DYDX platform by making market on DYDX. On the other hand, the increase in transaction depth and transaction data is also conducive to the valuation of DYDX itself, thereby potentially increasing the investment returns of market makers.
3.1.3 Token model
The total number of tokens issued by DYDX is 1 billion, and it will be distributed to all DYDX ecosystem participants within five years, including community users, investors and DYDX team. After five years, the community can vote to determine the inflation rate of DYDX tokens for additional issuance. The current maximum inflation rate is 2% per year.
· 50% (500,000,000 DYDX) is allocated to the community, as follows:
o 25% (250,000,000 DYDX) is allocated to users of transaction mining
o 7.5% (75,000,000 DYDX) are allocated to retrospective mining users
o 7.5% (75,000,000 DYDX) is allocated to market makers who make markets and mines
o 5% (50,000,000 DYDX) is allocated to community reserve funds
o 2.5% (25,000,000 DYDX) is allocated to users participating in the liquidity staking pool
o 2.5% (25,000,000 DYDX) is allocated to users participating in DYDX staking (insurance pool)
· 27.73% (277,295,070 DYDX) is allocated to past investors
· 15.27% (152,704,930 DYDX) is allocated to current members of DYDX Trading or DYDX Foundation
· 7.00% (70,000,000 DYDX) is allocated to future members of DYDX Trading or DYDX Foundation
At present, in addition to the governance function, DYDX can obtain a deduction for transaction fees. It is worth noting that DYDX holders cannot obtain the transaction fee of the platform, which are currently obtained by the DYDX project party (but there is the possibility of modifying the fee distribution through governance).
3.1.4 Summary
DYDX’s transaction data is not uploaded to the chain, which means that the core transaction data is not immutable. From this perspective, it seems that the degree of decentralization is indeed doubtful. But if we agree that DYDX is a “decentralized perpetual contract trading platform”, then DYDX is currently the undisputed king in this track, in terms of transaction volume, or the fully circulating market capitalization, or the market attention to the entire track. However, at the core transaction mechanism level, DYDX almost completely copied CEX. This can make CEX user experience migrate seamlessly, with low mistake risk; on the other hand, it also leaves a lot of room for latecomers to replace the current position of DYDX by combining more innovative mechanisms and DeFi. Next, let’s take a look at those potential competitors who do not use the order book mechanism in the decentralized derivatives exchange track.
3.2 Perpetual Protocol
3.2.1 Product introduction
The V1 version is currently running, whose transactions are executed on the xDai network.
Users can trade after depositing USDC as a margin. The virtual AMM mechanism is used for pricing during the transaction. The virtual AMM refers to AMM’s x * y = k model. Let’s take the ETH perpetuals as an example: where x represents the number of ETH in the virtual pool and y means the number of USDC. Under the premise of the k value given by the protocol, if a user holds long, the y value will become higher (the USDC of the user’s corresponding position is transferred into the virtual AMM pool), and the x value will become lower accordingly. So, the price of ETH in the virtual pool (namely y/x) correspondingly becomes higher, so as to realize the simulation of price changes.
The advantage of virtual AMM is that it can achieve single currency liquidity, so it can avoid the problem of impermanence loss. In addition, the transaction process does not need to rely on oracles. However, the disadvantage is that it is difficult to determine the k value. If the k value is too small, the transaction slippage will be large; if the k value is too large, the price change in Perpetual’s virtual AMM will be too slow, resulting in obvious arbitrage space. In Perpetual Protocol V1, the k value is manually maintained by the project party according to the liquidity of the corresponding Uniswap pool. It has also been attacked because of the k value setting problem. In fact, Perpetual Protocol also abandoned the virtual AMM in V2 and uses Uniswap V3’s real AMM instead, which explains the problems of the virtual AMM mechanism.
In terms of naked position management, Perpetual Protocol takes a lesson from CEX’s perpetual futures funding rate and adopts a funding rate mechanism to balance long and short positions. Its mechanism also uses the difference between the marked prices (i.e., prices in the virtual AMM) and index prices (obtained from the oracles) to calculate the funding rate. This will encourage arbitrage users to hedge one-way excessively high positions for funding rates, thereby making the system more stable.
Regarding to the liquidation mechanism, 20% of the user’s liquidation margin is obtained by the liquidator, and the rest go into the risk margin account. The risk margin account also needs to bear the responsibility of making payments to the profitable traders. This is to say, the traders’ overall account and their risk margin accounts are negative-sum game (due to the existence of transaction fees and liquidators). If the traders make a profit, the risk margin account will lose; if they loose the account will make a profit.
The product UI is simple to use, but Perpetual Protocol does not support limit orders and stop-loss orders under the virtual AMM mechanism.
3.2.2 Business data
Perpetual Protocol is the perpetual contract protocol with the largest trading volume before DYDX. It once set a record of US $550 million in single day trading volume on May 19, when the market fluctuated violently.
3.2.3 Token model
Perpetual Protocol’s native token PERP was officially released at the end of August 2020, with a total supply of 150,000,000 tokens. Among them:
· 7,500,000 PERP tokens (5%) are used in Balancer LBP (Liquidity Bootstrapping Pool), which was completed between September 9th and September 12th, 2020, at a price between 1.05 USDC ~ 2.3 USDC.
· 31,500,000 PERP tokens (21%) are allocated to the team and advisors. This part will be released 6 months after the launch of the mainnet (June 15, 2021), and will be released quarterly for the subsequent 30 months, with each release of 2.1% of the total amount.
· 6,250,000 PERP tokens (4.17%) are allocated to the seed round investor — Binance Lab. One fifth of these tokens will be released after the launch of the mainnet (December 15, 2020), and one fifth of them will be released in each subsequent quarter. Currently four fifths have been released and the rest will be released completely in December 2021.
· 22,500,000 PERP tokens (15%) are allocated to strategic investors. One fifth of these tokens will be released after the launch of the mainnet (December 15, 2020), and one fifth of them will be released in each subsequent quarter. Currently four fifths have been released and the rest will be released completely in December 2021.
· The remaining 82,250,000 PERP tokens (54.83%) are allocated to the ecosystem and rewards, including liquidity mining.
The token release rules except the reward part of the ecosystem are shown in the following figure:
In the V1 version, in addition to governance function, PERP tokens can also obtain yields from transaction fees. To obtain fee yields, users need to stake PERP tokens, the staked PERP will be used as a supplementary treasury for risk deposits in case for redemption under extreme circumstances.
3.2.4 Changes to Perpetual Protocol V2 (not yet released)
It serves on Ethereum’s Layer 2 Arbitrum. Different from the game between long and short traders in V1, LP is introduced into V2, forming a three-way game between LP, long and short sides. Its virtual AMM mechanism is also integrated with Uniswap v3, but it has become a real AMM in essence, which means that users need to face the risk of impermanent loss. In addition, Perpetual Protocol also plans to implement functions such as market creation without review and cross margin. In terms of token economy, the system will assign more handling fees to PERP. The detailed implementation will not be known until the V2 version is released.
3.3 GMX
3.3.1 Product introduction
GMX provides services on Arbitrum, and its products have been officially launched on September 1. It also offers services on BSC. The previous project name was Gambit, and the token was called GMT. This article mainly discusses the services provided by GMX on Arbitrum. The core mechanism is as follows:
Different from DYDX and Perpetual Protocol, the transaction process of GMX is a three-party game of long side, short side and LP (liquidity provider, and it is called GLP in the GMX system).
Trading users can start trading after depositing USDC, ETH (WETH) or WBTC as a margin. Currently, it supports leveraged trading of up to 30 times for BTC and ETH. The transaction is executed in real time at the prices of oracles, and the proceeds can be withdrawn in real time.
The counterparty of all transactions is the GLP pool. The GLP token is a special token composed of BTC, ETH, and USDC in proportion. Users can start market making by depositing a single GLP token into the GLP pool. Because it is a single currency liquidity, there is no trouble of impermanence loss. Since the counterparty of all transactions is LP, there is also a zero-sum game between LP and traders: the margin that traders loose will be directly allocated to GLP (reflected in the rise of GLP price), and the profit earned by traders is also directly from GLP (reflected in the decline of GLP price).
In addition to the incentives of the platform token GMX, GLP holders can also get 50% of transaction fees.
GMX currently has no a handling mechanism for naked positions, so GLP holders need to hedge their own risks.
The front page of GMX is relatively simple, and currently it does not support functions such as limit orders and stop-loss orders.
3.3.2 Business data
Since the launch on Arbitrum on September 1, GMX‘s data are as follows:
The total trading volume has reached to US $400 million in just 20 days, and the average daily trading volume is close to US $20 million. Data performance is excellent.
3.3.3 Token model
The total number of GMX is 13.25 million, of which 6,490,428 are currently in circulation. The token distribution is as follows:
· 6 million tokens (most of which are currently in circulation) are from the XVIX and Gambit migration (the project before GMX)
· 1 million GMX and ETH form LP on Uniswap v3 as initial liquidity
· 1 million GMX provides additional liquidity after the GMX price exceeds US $20.00
· 1 million GMX is used for market-making rewards of GLP
· 1 million GMX is used for GMX staking rewards
· 2 million GMX is assigned to the reserve price fund (the reserve price fund is used to support the GMX price)
· 1 million GMX for marketing, cooperation and community developers
· 250,000 GMX tokens will be linearly distributed to the team within 2 years
In addition to the governance function, GMX can also be staked to obtain 30% of the platform transaction fee, additional GMX rewards, and “multiplying points” (a tool used to incentivize users to hold GMX for a long time, rules of which have not yet been released).
3.4 MCDEX
3.4.1 Product introduction
The latest version of MCDEX, V3, provides services on Ethereum’s Layer 2 Arbitrum. Its products have been officially tested on September 1. MCDEX’s products have actually been released in 2020, but the V3 launched in September will completely replace the previous version, so we only analyze the v3 of MCDEX.
Similar to GMX, the transaction process of MCDEX is also a three-party game of long side, short side, and LP (liquidity providers). The core mechanism is as follows: First of all, the counterparty of all transactions is LP, which provides USDC’s single currency liquidity, so there is no trouble of impermanence loss. At the same time, since the counterparty of all transactions is LP, there is also a zero-sum game between LP and all traders: if traders lose, LP gains, or if traders gain, LP loses.
In terms of the determination of transaction prices, MCDEX adopts a “complex AMM” mechanism: at any time a user initiates a transaction, the transaction price will be determined based on the total depth of the LP, the oracle price, and the net position of all trading users: when the net position of all trading users is long, the transaction price determined under the complex AMM mechanism will be higher than the price of the oracle, thus encouraging users to open short positions to reduce the overall net position of the trading users; when the net positions of all trading users are short, the transaction price determined under the complex AMM mechanism will be lower than the price of the oracle, encouraging users to open long.
We can see that MCDEX’s price determination mechanism actually includes the management of naked positions. Compared with the traditional funding rate method, MCDEX’s naked position management will be more direct, directly reflected in the underlying price.
As a counterpart, in addition to the transaction fee of traders, under the complex AMM LP can also obtain the price difference between users’ transaction prices and oracle prices, the capital cost paid by traders when the long and short are not balanced, the penalties for forced liquidation, and the MCB incentives of additional issuance.
On the product page, in order to better display the depth, MCDEX displays the liquidity of the AMM mechanism in the form of an order book, and also supports limit orders and stop-loss orders. In general, its product has complete functions and excellent experience.
3.4.2 Business data
At present, the trading volume of MCDEX mainly comes from the officially certified trading pool. The pool uses USDC as a margin to support the trading of ETH and BTC perpetuals. Since its launch on September 1, its cumulative trading volume has exceeded US $130 million, and its trading volume has increased significantly. Meanwhile, the thickness of LP has also exceeded US $8 million, showing a good development trend.
In addition, since the inherent risks and yields of LP are not certain, MCDEX also discloses the “net asset value” in each pool in order to avoid the trouble of LP before making the market, which represents the change in the net value of each USDC deposited in the LP pool. In fact, it also shows the historical profit and loss of market making from the side. We can find that, although the release time is not long, overall the share value of LP is still rising. That is to say, LP’s overall yield is positive then the overall yield of traders is negative, which is also consistent with our intuition.
3.4.3 Token model
MCDEX’s native token is MCB. The MCB’s token model has undergone a major change in early 2021, by changing its total amount from 100 million to 10 million. At present, a total of 2.3 million are in circulation, of which 1 million belong to the team, advisors and investors:
· The development team received 484,000 tokens
· Advisors received 75,000 tokens
· Angel investors received 109,000 tokens
· Private placement funds received 332,000 tokens
MCDEX DAO is responsible for new release of the remaining part, 75% of which will go to community incentives, and 25% going to developers.
The main use case of MCB is governance. There is currently no design for token buyback and burn or dividends.
3.5 Cap Finance
3.5.1 Product introduction
Cap Finance provides services on Ethereum’s Layer 2 Arbitrum, and its product has been released with the opening of Arbitrum’s testing on September 1.
The product logic of Cap Finance is very simple. Currently, the margin and LP it supports are both ETH. After trading users select the corresponding object and leverage multiples, they can open a position and deposit the corresponding amount of ETH. The price will be traded in real time according to the oracle price, with the need for AMM, and a simple game logic is used in the transaction process: if a trader makes a profit, he can directly withdraw the ETH stored in the LP’s Vault; on the contrary, if the trader loses money, the margin of his loss will also be attributed to the LP’s Vault.
LP can currently earn transaction fees.
Regarding to naked positions, the system currently does not have a hedging plan. In the official document, Cap Finance recommends LP users to hedge by themselves.
The front page of the product is minimalist in style without K-chart, and it does not support stop-loss orders or limit orders.
3.5.2 Business data
In terms of data, Cap Finance also uses a consistent minimalist style. It is disclosed on its official website that the total transaction volume since its launch has exceeded US $85 million (more than 29,100 ETH), which is equivalent to US $4 million per day.
The current capacity of LP is 24 ETH, but the current balance of LP has reached 54 ETH, with significant gains of LP (which means that traders have suffered heavy losses).
3.5.3 Token model
The native token of Cap Finance is CAP, and there is little disclosure about the token model from the project side. At present, we know that CAP is a project issued in 2020. The original total amount of CAP was 10 million, but the total amount was reduced to 100,000.
According to the document on its official website, CAP can not only govern the protocol, but also stake to obtain transaction fees. However, currently there is no staking entry on its front page.
In general, the current products of Cap Finance are not mature yet. However, with the concise logic and Arbitrum’s strong trend, its monthly transaction volume is likely to exceed US $100 million, which has been quite successful as a cold start.
3.6 Deri Finance
3.6.1 Product introduction
Deri Finance provides services on four chains, including BSC, ETH, POLYGON, and HECO. Its trading products were launched at the beginning of this year. In addition to perpetual contracts, Deri also has a business of perpetual options. We take BSC chain as an example to introduce Deri’s perpetual contract transaction process.
Deri’s logic is similar to GMX and Cap, in that trading users can directly trade various objects at the price of the oracle. Trading users can start trading after depositing BUSD, WBNB or CAKE as a margin. The transaction is executed in real time at the price of the oracle, and the profit can be withdrawn in real time.
The counterparty of all transactions is the LP pool. Users deposit BUSD, WBNB or CAKE to become LP and start market making. Because it is a single currency liquidity, there is no trouble of impermanence loss. The counterparty of all transactions is LP, so there is also a zero-sum game between LP and traders: the margin of traders’ losses will be directly allocated to LP (reflected by the rise of LP share value), and traders’ profit is also directly obtained from LP (reflected in the decline of LP share value).
Deri’s perpetuals are currently divided into main zone, innovation zone and open zone. The main zone mainly supports mainstream assets, and the transaction object supports BTC, ETH and BNB, sharing the same LP pool. The innovation zone supports the trading of new assets such as AXS, MBOX and AGLD, sharing the same LP pool too. The open zone supports users to build pools without permission, thus users can customize basic assets and underlying assets.
Deri balances naked positions through the funding rate mechanism. In addition to long and short sides, LP will also assume the role of the counterparty, so the funding rate will also be allocated to LP.
As the counterparty of the transaction, LP can not only obtain the additional Deri rewards issued by the system, can also receive 80% of the transaction fees, part of the funding fee, and 50% of the liquidation yields.
The Deri trading page is shown in the figure above, which currently does not support limit orders and stop-loss orders.
3.6.2 Business data
Deri Finance currently does not have a disclosure panel for trading data. From its monthly report, we know that the monthly trading volume of Deri Perpetual Futures has exceeded US $10 million in the past three months.
3.6.3 Token model
The native token DERI has an upper limit of 1 billion, of which 400 million are allocated to the team, investors, and Treasuary, and 600 million are produced by mining. The current circulation is about 111 million. The team recently announced that some tokens attributed to the team will be allocated to Treasuary, and the specific rules are waiting for the team to disclose.
In addition to governance functions, DERI tokens can also capture 20% of transaction users’ handling fees (through regular buyback and burn). In addition, the team also plans to give DERI liquidation qualifications and use cases for fee deduction in the document.
After understanding the basic logic of the above projects, we will conduct a comparative study of their mechanisms.
4. Mechanism comparison
We believe that, the core factors that determine the experience for any exchange are as follows: the depth of the transaction, the availability of the object (whether it supports permissionless listings), and the yields of liquidity providers (LP).
· The importance of trading depth is self-evident. Especially for margin trading, better trading depth not only means lower slippage, but also means less chance of margin call.
· The availability of the object is also easy to understand. Everyone should have had such an experience more or less, that is, you want to long or short a currency through leveraged trading for speculation or hedging, but you haven’t found a suitable trading place.
· For most protocols that do not adopt the order book model, the liquidity provider (LP) is the counterparty of transaction users. For the exchange, transaction users are their true service object, and the LP is their incentive object. CEX has already started to provide different rates for makers and takers, and even some exchanges have negative rates for makers, or even the “maker mining”. All of these aim to encourage users to become makers, because makers are the liquidity providers of taker transactions, that is, the counterparty. And what happened in the DEX is also very clear to us: the competition between each DEX for TVL (i.e. LP) is very fierce.
In fact, if we review the explosion of DEX represented by Uniswap in 2020 from the above perspective, we can see that in addition to benefiting from the booming development and composability of DeFi itself, they motivated ordinary users to become LP in a simple and effective way, making DEX comparable to CEX for the first time in terms of trading depth. On the other hand, any user can simply list any currency on Uniswap without permission, thus providing rich availability of objects. The improvement direction of Uniswap V3 is the yields of LP (capital efficiency).
Of course, in addition to the factors mentioned above, transaction speed, complete functionality (such as whether to support limit orders or stop-loss orders), transaction fees and other factors are also very concerned by trading users. In terms of transaction speed, the above-mentioned derivatives exchanges are generally built on public chains or Layer 2 with higher TPS, so there is no significant difference in terms of the speed of pure transaction execution. As for the DEX project, which is still in the exploratory stage of perpetuals, it is far from the stage where we need to rely on transaction rates and complete functions to snatch users. In addition, we believe that, although the above-mentioned issues are important, they can all be solved. So, we will not cover these factors in the following analysis.
In addition, we also pay attention to the protocol’s handling of naked positions (too high naked positions will not only cause potential losses to LP, but also affect the security of the entire protocol), as well as the performance of the protocol in composability.
4.1 Transaction depth
For any exchange, transaction depth is the core competitiveness of its products. In the above-mentioned projects, the design of transaction depth can be roughly divided into three categories:
The first category is order book design, represented by DYDX. The transaction depth of the order book model depends on the counterparty.
The second type is the XYK model, in which the K parameter determines the transaction depth. This is divided into two sub-categories, Perpetual V2 that uses AMM, and Perpetual V1 as well as MCDEX V3 that use virtual AMM. The transaction depth of this type of model depends on the K value, that is, for the AMM model, it depends on the depth of the corresponding LP, and for the virtual AMM, it depends on the setting of the K value.
The third type adopts the “global shared liquidity” mechanism, which is characterized by transactions directly traded at the oracle price, including GMX, Cap Finance and Deri Finance.
From the perspective of design, the third category performs best in terms of transaction depth. Because the transaction depth of this design is theoretically infinite (no matter the transaction is 1 ETH or 10000 ETH, the transaction price will be exactly the same). This is mainly because the transaction itself does not require any liquidity. The transaction depth of the order book model depends on the counterparty, the depth of the XYK model depends on the K value, and the transaction depth of the third type model will only have a soft upper limit, that is, the amount of money in the LP pool. This is because LP bears the responsibility for cashing traders. When the transaction amount is close to the LP balance, the payment ability of the entire system may have some concerns.
The first and second categories pay more attention to how the project side encourages the transaction depth. For example, it is relatively difficult to incentivize the transaction depth of the order book model. However, by using the combination of sophisticated transaction mining — market making mining — staking mining and deep binding with stakeholders, DYDX became the first derivatives protocol to obtain a daily trading volume of more than US $1 billion, with good performance in transaction depth. Although the mechanism of virtual AMM is also abandoned by Perpetual Protocol, Perpetual Protocol did use this mechanism to become the first perpetual futures protocol with a daily trading volume of more than US $100 million.
In addition, the transaction depth of the order book model and the XYK model cannot be shared under normal circumstances, that is to say, the depth of BTC’s perpetuals has nothing to do with the depth of ETH’s perpetuals. Under the premise that the depth cannot be shared, expanding more trading pairs needs to incentivize more liquidity. MCDEX’s current USDC pool supports both ETH and BTC transactions, which is equivalent to aggregating the liquidity of these two pools, thus providing users with better transaction depth.
The advantage of the protocols adopting the third type of model is that they can theoretically share the depth of all trading pairs. This will bring a better experience to trading users (more objects for transactions without slippage), on the other hand, it will also increase the yields of LP.
4.2 Availability of the objects (permissionless listing)
At the object availability level, we mainly examine whether the above-mentioned projects support permissionless listing of trading objects, and the dependent conditions of this listing process.
DYDX: Similar to CEX, it adopts a centralized method to decide the listing of objects.
Perpetual Protocol: In the v1 version, it is still centralized to decide the listing of objects (because the K value needs to be manually set), and in the V2 version, it plans to realize the permissionless listing of trading objects, without details about the implementation at present.
GMX: No information about permissionless listing of objects has not found. GMX currently supports all 7 cryptocurrencies (BTC, ETH, LINK, AAVE, YFI, SUSHI, UNI) for which Chainlink offers quotations on Arbitrum.
MCDEX: Any user can list an object without permission (that is, create a trading pool), and the creator of the pool (operator) can also get a certain percentage of transaction fees. However, due to the complicated mechanism of MCDEX, there are many parameters that need to be filled in the process of building the pool. Besides the number of LPs deposited by the user, the parameter setting will directly impact the transaction depth of the pool, and the operation is complicated on the whole. There are already some pools created by users, but with little liquidity.
Cap Finance: No information about permissionless listing of objects has been found. Cap has also supported all 7 cryptocurrencies that Chainlink offers quotations on Arbitrum.
Deri Finance: It supports permissionless listing of objects. Compared with MCDEX, its operation is much easier. There are currently 3 pools created by users, with small liquidity.
In fact, due to the heavy dependence of perpetual contract projects on oracles, it still needs the support of oracles at this stage although it is permissionless. Except for MCDEX supporting Uni v3’s TWAMM as its oracle, other projects generally use Chainlink as their oracle. Thus, at this stage, the ultimate determinant of which trading pairs are supported by the perpetual contract exchanges is the quotations of which currencies are supported by Chainlink on the chain.
Therefore, compared with Uniswap which builds its own pool completely independent of any external data, the independent pool building of decentralized perpetual contracts is more limited.
However, with the continuous development of oracle project itself, in the future, the characteristics of permissionless and convenient to list trading products of perpetual contracts will become more and more important in the future.
4.3 The yields of LP
The capital efficiency of LP will determine the yield. Of course, the most important factor in determining capital efficiency is the trading volume of the platform.
In the projects of GMX, MCDEX, Cap Finance and Deri Finance, the yields that LP can obtain include the following categories:
· Transaction Fees
· Rewards for additional issuance of platform tokens
· Loss of trading users (the breakdown can be divided into realized loss and liquidation margin)
The main potential losses are:
· Profit of trading users
The profit and loss of trading users cannot be predicted, so we mainly compare the distribution of transaction fees and additional issuance of tokens on the platform.
· GMX: LP obtains 50% of the transaction fee, and it can also obtain additional issuance of tokens.
· MCDEX: LP obtains 68.75% of the transaction fee (official pool), and it can also obtain additional issuance of tokens.
· Cap: LP obtains all transaction fees, without additional issuance of tokens.
· Deri: LP obtains 80% of the transaction fee, and it can obtain additional issuance of tokens.
In addition, it should also be mentioned that, for GMX, Cap Finance and Deri Finance that adopt a global shared liquidity plan, LP only bears the responsibility of redemption and will not directly act as the counterparty of the transaction, so they have the motivation to aggregate all LPs. Because greater liquidity means better payment guarantee (unless the project party consider deliberate isolation due to risks, such as Deri divides into the main zone, innovation zone and open zone), and LP is also happy to see this. Supporting more trading pairs means that it can capture more yields of handling fees.
As for MCDEX, which adopts a complex AMM mechanism, the current USDC trading pair also supports the transaction of BTC and ETH at the same time, improving capital efficiency for LP and bringing higher yields.
4.4 Naked position management
For the entire exchange, if the net position held by the trading user in a certain direction is too high, and the market fluctuates sharply, systemic risk may occur. Because the margin of the losing party is limited while the theoretical profit amount of the profiting party is infinite.
For perpetual contract exchanges that adopt the order book model (including CEX and DYDX), the difference between the market price and the marked price shows the naked position held by users as a whole, so the order book model exchange adopts the difference between the market price and the marked price to charge the funding rate to reduce the overall naked position of users.
Among the projects we studied above, Perpetual Protocol, MCDEX, and Deri Finance all have management mechanisms for naked positions. Perpetual also uses the difference between the v-AMM price and the marked price to balance naked positions, with a similar mechanism to CEX and DYDX.
As for MCDEX and Deri, due to the existence of LP, LP is always passive as the counterparty of the transaction. The naked position held by the trading user is the opposite position held by the LP as a whole (for example, if trading users has a total net holding of 50 ETH long orders, it is equivalent to 50 ETH short orders held by the LP in total). Therefore, in order to hedge against this risk of LP, in addition to incentivizing trading users to open positions in the opposite direction, both MCDEX and Deri also pay a portion of the fees charged for net long positions to LP.
GMX and Cap Finance, which are relatively new projects, currently have no plans to deal with naked positions. They all recommend users to hedge by themselves.
4.5 Composability
The development of DeFi benefits from the composability, which mainly lies in two aspects: whether the products of other protocols can be used, and whether the products of its own protocol can be used by other protocols.
For decentralized perpetual contract protocols, the core of “using the products of other protocols” is whether the assets generated by other protocols can be used as collateral. In this regard, we can see that Deri supports the use of AAVE’s USDC deposit certificate amUSDC as the basic token on Polygon (which can be used as either margin or LP’s market-making). This can provide users the opportunity to participate in the perpetual contract transactions without losing the yields of AAVE deposits, which is also a significant application of composability now.
“The products of its own protocol can be used by other protocols” may be more difficult for decentralized perpetual contract protocols, because it depends on the understanding and cognition of other protocols on decentralized perpetual contract protocols. The products of decentralized perpetual contract protocols have only two types. One is the position of trading users, and the other is the staking certificate of the LP. Whether these two types of products can interact with other protocols in some way to improve the capital efficiency of users at the cross-protocol level, is the next issue to be considered by each decentralized perpetual contract protocol.
On the whole, the exploration of the composability for decentralized perpetual contract protocols is still in the early stage, which is also related to the fact that the current development of the entire track is in the early stage too. When the influence of decentralized perpetual contract protocols increases, we also look forward to the continuous development of protocol composability in the perception of users and the market.
4.6 Brief summary
The author believes that, in the future competition of decentralized perpetual contract trading platforms, the design of core transaction structure is vital. Moreover, the success of the AMM mechanism in decentralized spot exchanges is not necessarily applicable to decentralized derivatives exchanges.
GMX, Cap Finance and Deri Finance have all transformed the approach of “transactions are executed at the price of the oracle machine and all LPs are jointly responsible for the payment”, created by Synthetix, a leading synthetic asset firm (It is also worth mentioning that, Synthetix’s synthetic futures, which will soon start testing on the testnet, can also be classified as perpetual contracts. For more information about Synthetix, please refer to https://mp.weixin.qq.com/s/q1zM3yYKgCdMoZgsO1EvRg). This transformation has achieved good results so far. The author believes that, compared to the AMM mechanism, decentralized derivatives projects that adopt the approach of “transactions are executed at the price of the oracle machine and all LPs are jointly responsible for redemption” are more likely to succeed. Because this mechanism naturally has:
· Nearly infinite and shareable liquidity
· The simplest listing process of a new object (except for the oracle, it hardly depends on any other external conditions, so it is easier to achieve permissionless listing)
· Higher capital efficiency for LP
5. Summary
This article introduces several perpetual contract protocols that currently have released actual products from the perspective of product mechanism. It also compares these protocols from multiple and more-valued perspectives, including transaction depth, the availability of the object (permissionless listing), LP income, naked position management, and composability.
This article does not involve quantitative valuation analysis, because for the decentralized perpetual contract track where the development of the entire track is still in the early stage, the current transaction volume is still too small compared to the future development space.
Compared with those projects applying the core mechanism of CEX or spot DEX, the author is more looking forward that a team can deeply understand the product essence of perpetual contracts and combine the incentive approaches of DeFi, so as to produce a paradigm innovation similar to AMM for spot exchanges: a new model, the cornerstone of open finance, and a market space with ten-billion.
Statement: All the above content is not considered as financial advice. If you find that there are errors in facts and data in this research report, please leave a message or send a message to us, and we will make a revision to the report.
Reference
https://docs.google.com/spreadsheets/d/1An5qiN09QqpZ_0uaW1_TDgizda2octg4ee8Hw1iMMhk/edit#gid=0
https://www.chainnews.com/articles/578853748247.htm
https://tokeninsight.com/report/2835
https://gmxio.gitbook.io/gmx/trading
https://docs.mcdex.io/mai-protocol-v3
