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Decentralized futures derivatives are mainly divided into three genres: AMM, order book, and synthetic assets. At present, they are further exploring in terms of performance, price acquisition, risk control, cost and liquidity, capital efficiency and anonymity, and have achieved certain results. .
Original title: “Can Decentralized Derivatives Shake the Position of Centralized Exchanges?” 》
Written by: Hippy, Sandra
In the traditional financial world, financial derivatives are divided into the following categories according to the form of the product: forward contracts (Forward), futures contracts (Future), option contracts (Option) and swap contracts (Swap). The corresponding native assets are divided into stocks, interest rates, currencies and commodities. The nominal value of the overall derivatives market in 2020 is roughly US$840 trillion, while the size of the stock market is US$56 trillion and the bond market is US$119 trillion. The size of the derivatives market is 4-5 times its original assets. .
We correspond to it in the world of digital currency. Most of the transactions of existing digital currency derivatives take place in exchanges, in the form of delivery contracts, perpetual contracts, and options. Perpetual contracts are also an alternative. Of swap products. According to Coingecko’s statistics, the world’s top seven contract exchanges are Binance, OKEX, Huobi, Bybit, FTX, Bitget, and BitMEX. Among them, Binance’s spot trading volume in the past 24 hours is 23 billion U.S. dollars, while futures trading volume For DEX, the total 24-hour trading volume of Uniswap V2 and V3 is 1.25 billion US dollars, and the 24-hour trading volume of the decentralized contract exchange represented by Perpetual Protocol is 3.37 times that of the spot. At 96 million US dollars, the futures trading volume in a decentralized world is only one-fourteenth of the spot trading volume.
Source of the top seven crypto derivatives exchanges: coingecko
Comparison of derivatives and spot sizes in various markets Source: Foresight Ventures
If you apply the trading volume of a centralized exchange, the trading volume of a decentralized contract exchange should also be 4 times that of a spot exchange. On the surface, the trading volume of futures contract exchanges still has room for growth of several tens of times. . However, based on current data, the business development of decentralized derivatives trading platforms is obviously not satisfactory.
Decentralized exchange transaction volume data
Advantages and pain points of decentralized derivatives
First of all, we define the derivatives in the current decentralized field, which are mainly divided into four major categories, namely futures (perpetual contracts). Currently, there are Perpetual Protocol, dYdX, Futureswap, Injective Protocol, MCDEX, DerivaDEX, etc.; options include Opyn, Hegic, Charm, Opium, etc.; synthetic assets include Synthetix, UMA, Mirror, Duet, etc.; prediction markets include Augur, Polymarket, etc.; interest rate swaps include Horizon, Yield, Barnbridge, etc. This article mainly analyzes decentralized derivatives from the perspective of futures and synthetic assets.
Compared with centralized institutions in the digital currency field, decentralized derivatives have the following advantages:
1. Asset custody: The assets of decentralized derivatives projects are hosted on the chain, which is transparent and traceable, which can avoid the illegal operations and default risks of centralized institutions;
2. Fairness: The transaction rules are formulated in advance by the smart contract, which is difficult to tamper with through the background, which is more fair for both parties to the transaction;
3. Autonomy: The charging model, currency types, and development policies of the decentralized derivatives platform can all be determined through community autonomy, and participants can share the benefits of project development.
At the same time, the decentralized derivatives platform faces many problems that need to be resolved:
1. Performance: Derivatives transactions require extremely high timeliness, and it is difficult for on-chain solutions to satisfy real-time transactions;
2. Price acquisition: Derivatives transactions are extremely sensitive to prices, and the definition of marked prices and transaction prices need to be resolved by means of oracles;
3. Risk control: The clearing mechanism is a major problem faced by both decentralized exchanges and centralized exchanges. Decentralized platforms also need to involve on-chain congestion caused by sharp price fluctuations. How to conduct clearing in a reasonable and timely manner? An important condition to ensure the continued existence of the derivatives platform;
4. Cost and liquidity: high-leverage margin trading has a high demand for the liquidity of the transaction target, so the platform needs to avoid the shock cost of the transaction and formulate a reasonable fee standard;
5. Capital efficiency: The core requirement for traders to participate in derivatives transactions is to allow margin trading and additional leverage, but the over-collateralization mechanism introduced by some synthetic asset projects once again restricts the efficient use of funds;
6. Anonymity: The two sides of decentralized projects. The data on the chain is clear and checkable, but large-scale institutional traders have the need to hide their positions and contract addresses.
Schools of decentralized futures products
Decentralized futures derivatives are the derivatives track with the most types of projects and the most diverse solutions on the market. The product model is based on perpetual contracts. Currently, it is mainly divided into three genres: AMM, order book, and synthetic assets ;
AMM genre represented by Perpetual Protocol
The AMM genre mainly transforms the AMM model in Uniswap (such as vAMM, sAMM, etc.) to form a capital pool or virtual capital pool model. Traders can go long or short by interacting with the assets in the pool.
Mainstream decentralized derivatives platform GMV Data source: Token terminal
This genre is represented by Perpetual Protocol. According to Messari’s statistics, Perpetual Protocol has a market share of 76% in the perpetual contract track, and its July revenue ranks seventh among all Defi projects, second only to Sushiswap. However, because the transaction mining started in February this year, the contribution of the scalping behavior is more difficult to calculate, and its transaction volume and income cannot accurately reflect its true market share.
The model adopted by Perpetual Protocol is to build a virtual liquidity pool vAMM. Its essence is to simulate pricing based on the formula of X*Y=K. Traders provide margin USDC to inject into the Vault without requiring external liquidity. By. This method is also a casting path of synthetic assets, and does not produce actual token exchange between two currencies, because there is only USDC in the fund pool, and the amount and income of funds in and out are based on the transaction pair when entering and exiting the market. The price of is calculated by mathematical formulas.
Here we quote the documents of the project party as an example:
X*Y=K , the price of ETH and USDC is Y/X=100 ;
There are 10000USDC in the Vault pool, X=100 , K=100*10000 , Alice uses 100U to inject twice as much ETH;
Since Alice injected 100U and opened more than twice, the pool counted the position in Y to become 10000+100*2=10200U , and the exchange rate between ETH and USDC became 100*10000/10200=98.04 ; Alice’s actual ETH position became 100- 98.04=1.96 ;
Subsequently, Bob continued to inject 100U and opened long with a leverage of 2 times. By the same method as above, his actual long position was 98.03-96.15=1.89; (note that the price of ETH here has risen because of Alice’s opening of the position. Therefore, Bob’s average holding cost is higher than Alice)
When Bob opened the position, the ETH exchange rate price rose again, and Alice closed the position, realizing a profit of 7.84U=10400-96.15*10400/(96.15+1.96)-200
Then Bob closes the position, and there is a loss after closing: -7.84 U=10192.15-98.11 * 10192.15 / (98.11 + 1.88) -200.
Through the above example, it can be found that for the participants in the same pool, the profit of one trader is equal to the loss of the other. All traders in the pool act as counterparties to each other, and calculate each person through the virtual AMM model. The income situation. The characteristics of the model are as follows:
1. The AMM model does not require an external oracle machine to obtain prices. The price is realized by arbitrageurs inside and outside the market. Although the risk of the oracle machine is avoided, the price of assets on the market is lack of arbitrageurs. It may cause a great deviation from the off-market , which will prompt margin traders to liquidate their positions;
2. The K value is floating. In the Perpetual project, the K value is set by the team. If the K value is too small, it will affect the depth of the pool. If the K value is too large, the on-market price fluctuation is too small to match the off-market price; Therefore , the setting of the K value will greatly affect the operation of the AMM mode ;
3. In the AMM model, large orders have a greater impact on the cost of the capital pool , especially for price-sensitive contract traders, the size and order of their orders have a great impact on the income situation;
In response to the above problems, Perpetual Protocol once again proposed the V2 version of Curie, and its main changes are reflected in:
1. Place the original vAMM liquidity pool into Uniswap V3, and create a liquidity pool in the form of v-token (such as vETH/vUSDC). When the trader deposits in USDC, Leverage LP will transfer the v-token to the v-token. The pool is generated and injected with funds equal to the open position, which is essentially a casting path of synthetic assets, but the original method of calculation by formula is transformed into a path of liquidity pool composed of actual tokens .
2. Introducing the role of market maker to provide liquidity management for Uni V3’s liquidity pool, which will improve the state of liquidity provision to a certain extent, but the size of the pool’s liquidity depends on the market maker’s capital and market-making ability .
3. In addition to the function of guaranteeing the settlement of abnormal compensation, the insurance fund will join the pool as a counterparty when the long and short positions are unbalanced, and at the same time supplement the liquidity of the pool.
On the whole, the AMM solution used by Perpetual V1 seems to provide unlimited liquidity, but once the amount of funds becomes larger, although the position can be opened, the actual impact cost is still unavoidable; the V2 model will also be subject to Specialized market-making agencies provide services. After applying Uni V3’s active market-making strategy, liquidity providers will also incur corresponding gratuitous losses. Although the use of the AMM model solves the long-tail problem of the derivatives market, the impact cost of the AMM model is still high for traders with large capital volumes and higher price sensitivity.
Order thin genre represented by dYdX
Source of dYdX lock-up volume and profit statistics: Token terminal
As the earliest trading platform for decentralized derivatives, dYdX launched the first BTC-USDC perpetual contract in May of last year. In April this year, it cooperated with StarkWare to build a full-storage margin perpetual contract Layer 2 agreement on the StarkEX engine. , Recently, there has been a relatively large increase in transaction volume due to currency issuance and airdrops. In addition to perpetual contract trading, dYdX also provides lending, spot and margin trading functions. Its contract part currently accounts for 12% of the decentralized perpetual contract trading market, ranking second.
dYdX adopts an order book model, with Wintermute as the main market maker providing liquidity, using offline matching + online settlement. Therefore, its trading model is basically the same as that of a centralized exchange. The price of the current contract is determined by the market price, and the price of the market contract is set by the market maker. According to the data disclosed by Wintermute, more than 95% of the current transactions on dYdX are quoted by market makers. Therefore, market makers have become an important core of the order book genre trading platform. This is also the degree of centralization of dYdX by most critics. Excessive criticism .
Secondly, the order book transaction mode has extremely high requirements for matching and transaction performance. dYdX’s Layer 2 adopts the ZK-Rollup expansion plan. Traders need to deposit funds into the dYdX contract to conduct transactions. The funds adopt a self-custodial model, and users always have the right to control the funds. The general running path is as follows: StarkEX obtains a sequence from dYdX, runs them internally, and ensures that everything is checked out and meaningful. Then, it moves the transaction to the Cairo program. The Cairo compiler will compile the Cairo program, and then the prover will convert it to STARK proof. Subsequently, the proof on this chain is sent to the verifier for verification. If the verifier accepts the proof, the proof is legal. This is reflected on dYdX that everyone can view the balances of all users on Layer1, but transaction data does not occur on the chain, which ensures the privacy of transaction strategies and reduces transaction costs . At the same time, the Gas fee on Layer 2 is borne by the dYdX team, and users only need to pay transaction fees.
With the gradual improvement of Layer 2 and various expansion plans, the trading experience of the order book transaction model will be close to that of a centralized exchange. dYdX has also launched a variety of advanced order types (such as market price, limit price, stop profit and stop loss, and Good-Till-Date, Fill Or Kill or Post-Only order options), for traders, its contract function is gradually moving closer to centralized exchanges. For a contract exchange, different stages have different priorities. A single market maker is a necessity for its early development to ensure liquidity. When professional investors gradually enter the market, the entire trading ecosystem will also improve. The degree of centralization will also decrease.
Synthetic asset genre represented by Synthetix
Synthetix’s lock-up volume and profit statistics source: Token terminal
As the largest and earliest synthetic asset platform, most people have known the development status of Synthetix, so I won’t repeat it here. The transaction mode is that the user generates sUSD by staking SNX at a staking rate of 500%, and then exchanges the sUSD into any synthetic asset in the system by trading sUSD. You can use sToken to go long and iToken to short, and the type of asset to be traded is not limited Digital currencies also include foreign exchange, stocks, and commodities. Here we discuss synthetic assets as a genre of decentralized derivatives, because they are essentially contract transactions in the form of collateral or margin.
SNX’s trading model is quite novel, introducing a concept called dynamic debt pool . The debts of the user and the system change in real time. When the user mortgages SNX to cast sUSD, sUSD is the debt generated by the system. When it is converted into sToken, the debt of the system will also change with the value of sToken . The debt is shared proportionally by all users who pledge SNX . Here we quote an example:
Assuming that there are only two people in the system, A and B, they each minted 100sUSD.
In the end, both the debts of A and B have become 150 sUSD, but the value of A’s assets is 200 sUSD, and the value of B’s assets is still 100 sUSD. At this time, A sells sBTC to get 200 sUSD, and only needs 150 sUSD to redeem SNX, and B also needs to buy 50 sUSD to redeem the mortgaged SNX.
For SNX’s staker, Synthetix’s debt pool model is actually a dynamic zero-sum game (the fee is also proportionally distributed to the staker): the profit may come from the increase in the price of its own assets, or it may be in the process of falling Among them, asset prices have fallen even less; vice versa. In other words, for users who participate in the pledge of Synthetix, they are essentially doing more “own investment ability / investment ability of other participants”. Holding sUSD without moving is of course an option, but at the same time it exposes myself to the risk of “others have too strong investment ability, so I lose money”. According to Taleb’s point of view, when users pledge SNX to generate sUSD, they are already “sink in the game”. This is a very bold design. Everyone is taking risks, so that all talents are truly “stakeholders”. “.
Source: Mint Ventures https://www.chainnews.com/articles/894865830615.htm
This design of SNX is quite bold and innovative. It is essentially similar to the zero-sum game constructed in the AMM model. At the same time, for vAMM, the virtual assets injected according to the open position are also similar to the casting process of synthetic assets. However, unlike AMM, the price of synthetic assets is directly fed by the oracle, so there is no slippage and liquidity issues, thus realizing unlimited liquidity.
Solution to the problem of decentralized derivatives
After understanding the operation mode of decentralized derivatives, we return to the questions at the beginning of the article. Can the above-mentioned projects effectively solve these problems? Where is the future direction of decentralized derivatives?
The current performance problem has been initially solved. Each decentralized derivative platform has adopted different expansion solutions: Perpetual Protocol uses the side chain solution xDai; dYdX adopts ZK-rollup’s Layer 2 solution for off-chain matching and on-chain recording. Account; SNX uses Optimisitc’s Layer 2 solution for capacity expansion. These expansion plans basically ensure the real-time performance of transactions and also solve the front-run problem of transaction execution.
The price acquisition path of the AMM genre is mainly defined by the asset situation in the pool and the formula of x y = k. The transaction price does not require an external oracle, and the index price for the fund rate uses the oracle Chainlink, Perpetual V2 After the introduction of Uni V3’s liquidity pool function, Uniswap’s oracle will also be combined. Therefore, for the AMM mode, the impact of the oracle failure is relatively small. *
And dYdX has three kinds of prices: index price, oracle price and mid-market price. The index price is maintained by the dYdX team and determined by referring to the prices of six to seven spot exchanges to trigger functions such as conditional orders; predictions The price of the machine is provided by Chainlink and MakerDao to calculate margin requirements and funding rate; the middle market price is the price generated by the order book and is also used to calculate the funding rate; dYdX’s price acquisition mode is similar to that of a centralized exchange. The actual transaction price of the contract is based on the order book, and the liquidation price is determined by the oracle. On the whole, market makers and arbitrageurs have become the dominant players in dYdX prices, and the oracle risk will affect the liquidation price to a certain extent .
For SNX, the price acquisition is completely dependent on Chianlink’s oracle price. The price of the oracle will directly determine the transaction price of all assets, system liabilities and liquidation prices.
At present, the liquidation of the current derivatives exchanges relies on the oracle quotation. When the margin is lower than a certain level, the liquidation is carried out and the insurance fund is used to compensate. First of all, most projects rely on Chainlink’s quotation, so when there is an oracle attack, it cannot be avoided. Secondly, the problem of on-chain liquidation congestion caused by sharp price fluctuations cannot be solved temporarily. In the future, a number of expansion plans may alleviate the congestion problem to a certain extent.
Cost and liquidity
For traders with a small amount of funds, Gas costs are higher, while for traders with a large amount of funds, the shock cost due to liquidity is higher. The former has been initially solved through the Layer2 solution, and the latter is unavoidable in the AMM genre. The order-thin genre mainly depends on the market maker’s market-making ability and capital size, while the synthetic asset genre, if the overall amount of funds in the agreement is large enough In this case, the impact cost of a single trader will also be smoothed out.
In addition, handling fees are also a major issue for derivatives traders with relatively high turnover rates. From the current data, the transaction fee of decentralized derivatives contract exchanges is much higher than that of centralized exchanges. Among them, Perpetual transaction fee is 0.1%, and the transaction fee rate for general users of dYdX is 0.05% for pending orders. Single 0.2%, while the transaction cost of centralized exchanges is only 0.02%-0.04%. Although these projects have enabled the transaction mining function to subsidize transaction fees, the transaction costs of decentralized exchanges are still expensive after the release of transaction mining is completed.
At present, the fund utilization rate of derivatives exchanges of the AMM and order book genres is not much different from that of centralized exchanges. Among them, Perpetual’s maintenance margin rate is 6.25%, and dYdX’s is 7.5%. However, derivatives exchanges of the synthetic asset genre like SNX require over-collateralization, and their liquidation line reaches 200%. Although SNX can achieve unlimited liquidity, for contract traders, the way of over-collateralization greatly limits the efficiency of the use of funds and loses the meaning of contract transactions.
At present, the expansion plan adopted by various exchanges transfers most of the transaction data to the off-chain. dYdX adopts zero-knowledge proof to protect the privacy of traders. Therefore, when the privacy plan related to Layer 2 is gradually improved, the anonymity of contract transactions will be guaranteed.
Through the comparison of the above-mentioned decentralized derivatives exchanges, it can be found that the order book genre represented by dYdX can better solve the main pain points of current decentralized derivatives projects, and the transaction mode and transaction functions of the order book are also more consistent. The habits and needs of derivatives traders. Although dYdX has some shortcomings of insufficient decentralization, this is actually a problem of survival and development. The first purpose of a decentralized project is to meet the basic functional needs of users, and then through the introduction of more cooperative institutions and multiple Type participants complete the user ecology and gradually realize their goal of decentralization.
For the exchange, the derivatives track is like the fresh food e-commerce in the e-commerce field. Due to various restrictions on products, technologies and channels, it is the most difficult fortress to break. Therefore, it is difficult for decentralized derivatives to shake the position of centralized exchanges in the short and medium term. With the development of Layer 2 and various expansion solutions, the performance, risk control, transaction costs and transaction anonymity of decentralized derivatives projects The problem will be partially resolved, and the decentralized derivatives exchange will also become the biggest beneficiary of the development of Layer2. In the long run, the derivatives track is still one of the tracks with great development potential and high ceiling in the Defi field.
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