Dialogue between Synthetix and Perpetual: DeFi structured derivatives or future trends


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Dorothy, head of Synthetix Greater China, and Nigel, head of Perpetual Protocol China, shared the main obstacles to the development of decentralized derivatives and the design of AMM mechanism.

Original title: “Dialogue between Synthetix and Perpetual: Structured and aggregated products may be the future of the derivatives track”
Finishing: Chain Catcher

Recently, the 23rd issue of the Catcher Academy hosted by Chain Catcher invited Dorothy, the head of Synthetix Greater China, and Nigel, the head of Perpetual Protocol China, to conduct “Why Derivatives Will Be the Most Potential DeFi Track This Year” Topic sharing.

During the period, Dorothy and Nigel shared with the community users the main obstacles to the development of decentralized derivatives, the problems and solutions of AMM mechanism design, and the risks that ordinary people need to pay attention to when participating in DeFi derivatives mining, etc. Dry goods, the full text is now organized as follows, hoping to inspire readers.

Chain catcher: Please briefly introduce the positioning of Synthetix and Perpetual, and the specific exploration and advantages in the DeFi field.

Dorothy: Synthetix is ​​a decentralized synthetic asset (Synths) protocol built on Ethereum. Users can stake our token SNX to mint the stable currency sUSD, or directly purchase sUSD to perform digital transactions on our platform. Trading of synthetic assets such as currency, foreign exchange, stocks, commodities, indices and reverse assets.

In the world of blockchain, we do not have an effective way to directly trade traditional assets such as stocks. Therefore, we need to synthesize virtual assets on the chain for trading by anchoring the price of traditional assets.

To put it simply, synthetic assets are mirrored simulations of target assets, such as sUSD against USD price, sGold against gold price, sTSLA against Tesla stock price, and sDeFi against DeFi index. By mapping real-world assets, everything is Can be traded on the chain.

Synthetix was established in 2017. It is the first project in the industry to try a decentralized synthetic asset issuance and transaction mechanism. It has the advantages of no slippage, unlimited liquidity, and a rich asset portfolio. It is one of the top projects in the DeFi world.

Next, we will deploy the protocol on Optimism’s Layer 2 network and launch V3 upgrades, including futures functions.

Nigel: Perptual Protocol, as its name suggests, is a vAMM-based derivative agreement on the chain. The current main product is a perpetual contract.

We are the first project to sell token LBP on Balancer. After more than half a year, it has now become a more mainstream IDO method. In addition, our mechanism is vAMM, which is also the first protocol to introduce AMM to derivatives trading. This innovation has also made many DeFi enthusiasts pay close attention to us.

In terms of advantages, I think it is a little preemptive, because the market wants to find a low-cost and relatively large number of user transactions on the chain perpetual contract trading platform except Perpetual. In addition, we have developed on xDai, so the cost is relatively low, and the user experience is much better than that of the first-level network.

Chain catcher: The popularity of DeFi has lasted for almost a year, and the products in all sectors have matured, especially the derivatives track. Many investment institutions are in the layout. As an early participant, do you think the current DeFi derivatives track is right? At what stage of development?

Dorothy: First share the definition of the concept of derivatives. A derivative is a financial contract whose value depends on one or more underlying assets or indexes, including forwards, futures, and swaps. And options (Option) and other forms, can be standardized or non-standard, the main purpose is hedging, speculation and arbitrage.

In the field of digital assets, futures are linear contracts with relatively simple products that have achieved explosive growth in the previous year; while options are very complex derivatives with high thresholds. It was not until last year that more institutions entered the market. Exponential growth.

The early leading centralized futures exchanges include BitMEX and OKEx. Recently, Binance, Huobi and FTX have caught up in trading volume and become the new leader. For traditional compliance agencies, CME is the only one. The choice; in the more immature options track, deribit has long thrived.

On the decentralized track, Synthetix is ​​the leader in synthetic assets. We support spot trading of synthetic assets and reverse synthetic assets, as well as binary options trading, and will also support futures trading after Layer 2 is launched.

Among the decentralized exchanges that specialize in futures, dYdX is the oldest project, Perpetual Protocol, Ddx, Injective, and Mcdex are all rising stars that emerged last year, and Hegic and Opyn are emerging projects in the options track.

The derivatives track is still at a fairly early stage, and the trading volume is still very small compared to centralized exchanges. There are more entrepreneurial projects on the futures track, but there is not a clear head project that has run out. The options track is more difficult to promote and popularize because of the complexity of the options themselves.

Nigel: Comparing the ten-fold difference between derivatives and spot transactions on a centralized system, I think the explosion of DeFi derivatives is far from coming. Perpetual agreements are considered derivatives that are running out of scale, but every day The transaction volume of Uniswap is only 50-60 million, and Uniswap’s recent transaction volume is more than 1 billion U.S. dollars.

Over and over, the transaction magnitude of on-chain derivatives is at least a hundred times different from that of centralized derivatives. So we can’t even name the current stage with a name that can be found. I made up a name myself called the cocoon period. In this period, the whole track is added together to try and make mistakes, fail, and waste. Don’t be afraid to trap yourself, you need encouragement for a while.

Chain catcher: In the traditional financial sector, the volume of derivatives is much higher than the spot volume, but in the DeFi sector, the volume of derivatives trading still accounts for a very low proportion of the entire trading volume of crypto assets. Under the benchmark, many practitioners believe that decentralized derivatives still have a lot of room for development. What do you think is the potential market space for decentralized derivatives? What are the main obstacles to development at present?

Nigel: I think it is at least a hundred times more space. The current obstacles mainly come from the following points:

There are still too few DeFi users. Most of the currently educated DeFi retail users come to participate in mining to earn profits, or because of the better liquidity and depth of DEX to trade on the chain, they do not have the habit of using derivatives.

The solution to the previous problem is that the project needs to keep attracting users. However, users who are attracted find that the network is expensive and slow, and more importantly, the depth of derivatives on the chain is not good. Therefore, the second obstacle is insufficient infrastructure and insufficient product strength.

Dorothy: We can look at a set of data. In the traditional financial market, the total market value of stocks is 70 trillion U.S. dollars, the bond market has a larger market value of 130 trillion U.S. dollars, and the market value of the derivatives market is more than all of them combined. It has reached 1,000 trillion U.S. dollars. It can be seen that the derivatives market is not an order of magnitude worse than the underlying market of underlying assets.

In contrast, on the centralized exchanges of our industry, the trading volume of digital asset derivatives is only three times that of the spot market. We can expect that in two to three years, the derivatives market will grow further, leaving the spot market far behind. Reached 10 times the size of the spot market.

While the centralized market has yet to break through, the decentralized derivatives market is still in a very early stage, and it is more for DeFi “farmers” and experts who entered the market early, and cannot accommodate large financial institutions for transactions.

I think the current main obstacles come from three aspects. The first is the problem of market education. Many derivatives users are used to trading on centralized exchanges and are not familiar with or even trust DeFi products. Especially under extreme market conditions, the top centralized transactions such as Binance have stronger solvency, while decentralized exchanges can only rely on the cash retained by insurance funds and foundations, and the solvency is doubtful.

The second is the issue of transaction costs. Derivatives exchanges themselves are much more complicated in smart contract design than Uniswap and other spot exchanges. In addition, derivatives traders trade more frequently and are more sensitive to execution prices and transaction fees. , The overall experience will be affected. At present, many products on Ethereum are restricted by the Ethereum network, and face the problems of high network handling fees, delayed oracle price feeds, high costs, and serious transaction price slippage.

The last and most critical issue of liquidity. Centralized exchanges complete the matching through the order book, and users and users are rivals. If there is no market maker, it is difficult to efficiently match orders based on the liquidity provided by the users’ own fragmented trading needs. On the decentralized exchange, the efficiency of the chain is low, and it is difficult for market makers to control transaction costs and cannot effectively provide liquidity, and it is difficult for users to complete transactions at ideal prices.

In order to solve the liquidity problem, Synthetix created a debt pool method, through which users pledged funds to generate a debt pool as counterparty, to achieve no slippage and unlimited liquidity transactions, and Perpetual Protocol’s vAMM (automated market making curve) mechanism It seems to quote a similar concept of pledge pool.

Chain Catcher: What do you think is required for decentralized derivatives on DeFi to reach the volume of the derivatives market on CEX? And what’s the tipping point?

Nigel: The first is the infrastructure, including network performance, network costs, etc., and the second is that the frequency of people’s behavior on the chain needs to be increased by an order of magnitude during the development stage of the industry. Of course, this depends on the above conditions. The third is the layering of products. Outstanding is not a spring. A hundred schools of thought are contending for DeFi. Someone must target big whales, some serve retail users, some target long-term agreements, some target perpetual contracts, and there are enough in each category. People and teams try and make mistakes.

The tipping point is that I think the market for Fomo is relatively easy, and the hot spots take turns. After Layer 2 comes out, everyone takes it for granted that there may be no problem, and then stirs up a wave. But I think the real detonation is to make a thing become accustomed, such as Uniswap, Synthetix, including the head DeFi protocol. Therefore, although the perpetual agreement is a member of this track, I am not optimistic that derivatives will be detonated in the short term.

Dorothy: I think Ethereum L2 (Layer 2 network) will be an important explosion opportunity for derivative DEX, both in terms of currency price and practicality. For example, dYdX has chosen to cooperate with StarkWare, which supports ZkRollup technology, and has launched the L2 version.

Together with Uniswap and Chainlink, Synthetix is ​​an early support project of the Optimism network. It is expected that the L2 trading function will be launched this month. Network fees are now a major issue that restricts all ecological projects in Ethereum. On the second-tier network, transactions can reduce network fees by at least 90%, meet faster transaction times, and effectively reduce slippage problems.

But I don’t think that the trading volume of DEX derivatives can catch up with CEX in the short term. Even on the second-tier network, decentralized exchanges still have a gap with centralized trading in terms of user experience and transaction fees. Of course, the relative success of decentralized exchanges can force centralized exchanges to improve problems such as pin insertion, downtime, and position penetration. Centralized exchanges can further educate the market and expand user groups, which can bring more fresh blood to decentralized exchanges.

Chain catcher: Judging from the experience of traditional finance and even centralized exchanges, derivatives are still a problem in terms of customer acquisition. What do you think is the key to on-chain derivatives exchanges to attract users? What risks should ordinary people pay attention to when participating in DeFi derivatives mining?

Dorothy: Centralized exchanges generally attract market makers to provide liquidity through commission rebates, and provide ordinary users with discounts on transaction fees through the VIP level system. The most common way for decentralized exchanges is to provide Liquidity mining.

Synthetix uses a form of pledged mining. In order to encourage users to use our platform for pledges and transactions, we launched an inflationary monetary policy in April 2019. The policy stipulates that within 5 years, a certain percentage of SNX tokens will be issued each year, year by year. Decreasing, the initial inflation rate was 75%, and this year’s inflation rate is roughly 29%.

Users can stake our token SNX to mint stablecoin sUSD. The pledge rate on the Ethereum Layer1 network needs to be maintained at 500%, which is equivalent to 5 USD worth of SNX minting 1 USD worth of sUSD; when the pledge rate is less than 500 %, the user needs to burn the sUSD held to increase the pledge rate and restore it to the level of 500%.

On the deployed Layer 2 network (currently only supports pledge casting and receiving pledge reward functions), the pledge rate for maintaining positions is 600%.

When the staking rate drops to 200%, users will have 3 days to cover up their positions, and increase the staking rate by burning sUSD. If the user fails to complete the cover up within the 3-day validity period, then the staking rate is less than 500% (the second layer network is 600%) will be liquidated, returning the pledge rate to 500%. Such a mechanism gives users a sufficient buffer period to avoid the risk of forced liquidation on the chain and protect their positions.

There are also platforms that adopt a transaction mining model, just like MCDEX. Because perpetual contracts are directional transactions, the platform provides users with automatic hedging tools, and users need to rebalance (rebalance) regularly.

In general, to participate in derivatives DeFi mining, you need to check in advance the security of the platform’s smart contracts (such as whether the security audit is passed, whether there is a back door) and the reliability of the platform’s qualifications (such as team background, institutional endorsement). Most mining operations have impermanent losses or liquidation risks. Users must study the operating rules of the platform and put risk management in the first place.

Nigel: I think the most important thing is the maturity of the product. The reason why OK can occupy the leading position in the delivery of futures contracts is that the product is strong enough. In the same 18 years, the sudden emergence of BitMex also carried forward the perpetual contract. Under the conditions of maturity of all infrastructures, use innovative awareness and endure the time that no one pays attention to to polish on-chain derivatives that are truly product-powerful.

I think that the security risk should be paid attention to in DeFi derivatives mining. After all, the opportunity is not a scarce product, but the principal is. Most of the mining itself is the project party’s demand for liquidity, thus using token benefits to drive users to inject liquidity. I think the profit-seeking is naturally correct. After all, no one can avoid being vulgar in the market, but if everyone is willing to spend a little time thinking about the value of the agreement and the value provided by liquidity, think about it before doing it, and it may be boring to make money. Get a little spiritual satisfaction outside.

Chain catcher: We all know that the emergence of AMM is very important to the development of DeFi, but in the past period of time about AMM’s impermanent loss and capital utilization rate has been the industry’s attention. Can you start from these two issues and analyze derivative products? Problems in the design of the AMM mechanism and possible solutions?

Dorothy: The traditional AMM mechanism uses the formula of xy=k. This constant product formula has the disadvantages of low capital efficiency and high transaction slippage. Market makers who provide liquidity to the trading pool often suffer impermanence losses due to this.

As far as I know, most futures exchanges on the market still adopt the order book model. For example, dydx and ddx apply the model of off-chain matching and on-chain settlement. The disadvantage of this model is the high degree of centralization. The core parameters of perpetual contracts rely on off-chain facilities. When the order book fails, the on-chain funding rate cannot be updated. In addition, other smart contracts cannot interact with the off-chain order book to build other structured products.

Synthetix plans to launch futures products with 10 times leverage after Layer 2 is officially launched, following the debt pool model of spot trading.

First, explain the concept of fund rate. When the futures contract (Futures) of the traditional financial market is delivered on the expiry date, the price will naturally converge with the spot price. It was invented by BitMEX and used by most exchanges. Perpetual swap) does not have a delivery date, so we need to adjust the price through the capital rate, and the dominant party (in the opposite direction) will subsidize the other party to achieve the purpose of returning the contract price to the spot price.

On Synthetix, the price of our synthetic assets is directly generated by the Chainlink oracle machine, and there is no decoupling of the contract price and the spot price. On the contrary, we have to adjust the funding rate to affect the market slope and reduce the risk of the debt pool.

On other trading platforms, every buy order must be completed by the corresponding sell order. In fact, the market will never tilt, and the number of contracts traded between long and short sides will always be balanced.

But in Synthetix, every contract transaction does not require a counterparty, but a sUSD debt pool generated by pledging SNX tokens for users. Here we need to explain the concept of floating debt pools.

All SNX holders will generate a “debt” when they mortgage. At the beginning, the debt is the amount of sUSD they initially minted. After that, the debt will fluctuate with the income of other synthetic asset holders on the platform.

When someone buys other synthetic assets such as sBTC with minted sUSD, and sBTC increases in value, then that person will outperform the market, the debt pool of the entire market will increase, and this person’s income will be added to all participating pledges in proportion Debts of SNX holders. Each holder must repay all sUSD debts in order to unlock and retrieve the pledged SNX (in this case, the final debts of other debtors are higher than the amount of sUSD at the initial minting).

When a user exchanges sUSD for sBTC, sBTC is essentially generated out of thin air, and no one sells it. After the transaction is completed, the system will automatically destroy sUSD and create sBTC for users. The total amount of sBTC in the entire market increases, and the total debt of all SNX holders also increases. It is this zero-sum game mechanism that provides unlimited liquidity for the market.

Now we look at the application of debt pools in the futures market.

Assuming that in the unilateral market, 90% of trading users are bullish, and then the spot price does rise, then the users participating in the pledge must repay higher debts, so the bulls have to pay a higher funding rate than other platforms. To attract more empty orders and reduce the risk of staking users.

Assuming that the total value of long orders on the entire platform is $100,000 and the total value of short orders is $10,000, then in this case, the short will receive a funding fee of $10,000, and the additional funding of $90,000 will be paid to Pledge users. The purpose of this design is to keep the market from leaning toward long or short positions, and to maintain neutrality, so as to reduce the debt risk faced by pledged users. In summary, it is to use the funds provided by the pledge user to act as the counterparty of the transaction user.

Nigel: I have observed that there are several ways to eliminate impermanent losses with AMM Based products:

The first type, ThorChain, the conscience project party, centralizes to help users solve the impermanence loss of Cover and Rune-related trading pairs.

The second is to innovate the AMM mechanism, such as DODO’s PMM, or simply like us, Perpetual Protocol has no real liquidity, and virtual liquidity in the AMM pool. After users deposit assets, they do not essentially enter the liquidity pool, but are individually sealed up for clearing and settlement. According to the user-set leverage multiple mint, the corresponding amount of vUSDC enters the virtual liquidity pool. The advantage is that users can get good transaction depth without anyone providing liquidity.

The third is our future solution. This solution is not for our own AMM, but minimizes the integration of Perpetual Protocol into the AMM Based DEX, which is convenient for users to hedge against the impermanent losses caused by liquidity with one-click.

Having said that, I want to extend this topic, that is, derivatives need loyalty that does not depend on liquidity. The loyalty of liquidity is very low. They are profit-seeking. For derivatives, which is currently not so profitable, how to avoid the loyalty risk of liquidity.

I think Synthetix is ​​a very good way of synthesizing assets, a token that produces two, three, and all things. The transaction objects and assets on the platform come from the origin of SNX. The mechanism is very good, including the MIR that performed well in the past six months. Another way to avoid the risk of liquidity loyalty is to use virtual liquidity to provide services to users. The pressure on users and project parties will be less, and there is no need to rely on liquidity providers. You can keep liquidity while pleasing users.

Chain catcher: As a well-known synthetic asset protocol on the Ethereum platform, Synthetix plays a very important role in the field of DeFi derivatives. PERP also adopts the new mechanism of vAMM. Can you talk about the problems in traditional financial derivatives? A better solution through decentralized derivatives? What are the more anticipated application extensions in the future?

Nigel: I think from the user’s point of view, it is permissionless. Traditional derivatives have strict requirements on investors due to their high leverage ratio and high volatility. In other words, it is the strict review, market fragmentation, and the limitation of the distance between time and physical space. On the chain, in the decentralized world, it may not exist anymore, 24×7 hours trading, no KYC, the experience is wonderful.

I still hope that the Lego attributes of DeFi can be presented in derivatives, so that our lone derivatives can have better composability and empower the DeFi world.

Dorothy: In the traditional financial market, the markets of different countries and different types of assets are often fragmented, and the market access barriers are also high. The Synthetix platform can provide users around the world with no identity restrictions, no thresholds, no review, and one stop. The 24-hour trading of spot, futures and binary options of digital currencies, foreign exchange, stocks, commodities, indices, and reverse assets provides great convenience for users to conduct cross-asset, cross-market, and cross-position transaction management. . For example, one day crude oil plummets and the U.S. dollar is depreciating again, then you can exchange your assets for Bitcoin as a hedge.

Another major advantage of decentralized protocols is community autonomy. Users can vote for the types of assets they want to trade on the platform, adjust the currency composition in the index, and make other important decisions, which is unimaginable in the traditional market.

Non-custodial, no threshold, and anti-censorship are the biggest advantages of decentralized protocols. The DeFi agreement can subvert the existing financial system and become a true “digital bank”, providing an inclusive financial portal for billions of people around the world, especially the new generation of digital natives.

Chain catcher: Derivatives track products are relatively diversified, including options, futures, prediction markets, synthetic assets, etc. Once the problem of Ethereum’s expansion is solved, how will these subdivisions be combined? At the same time, what kind of competitive landscape will give birth to the DeFi track?

Nigel: Once the expansion schemes are excellent, users and agreements are concentrated on one or two expansion schemes, and the limitation of infrastructure performance on the product is lifted. I think that in the end, there may be a relatively large platform that will cover all the agreements on the various product categories of the derivatives track.

There are two possibilities. One is to add functions to the protocol with platform potential, and to integrate each company’s strengths into a platform with protocol matrix interoperability.

The second possibility is that in the future, there will be a relatively macro-oriented middleware platform that encapsulates the necessary infrastructure, attracts various types of derivatives, and eventually becomes an ecological platform. This is what I think is the future combination. Simply put, the agreement will not be isolated. Based on this platform, the composability just mentioned with the current mainstream DeFi protocol will also be easier to implement because of the convenience of mutual calls.

Dorothy: The largest transaction volume in the current DeFi market still comes from native digital assets, but the volume of the traditional asset market is a thousand or ten thousand times that of the entire digital asset market. Therefore, on-chain synthetic assets that mirror real-world assets will become digital assets in the future. There will be huge room for growth in the mainstreaming wave.

What we are currently doing is to combine synthetic assets with various derivatives such as futures and options to provide users with a variety of trading tools.

In addition, I am also very optimistic about structured products that take advantage of the composability of smart contracts. In fact, in the DeFi world, it is not users who use a certain smart contract agreement most, but other smart contracts. At present, the structure of derivatives on the chain is relatively simple, and most of the income of aggregators like YFI comes from mining on Curve. As the industry’s infrastructure matures, more teams will take advantage of the composability of financial Lego and combine different options and futures contracts to launch an on-chain structured structure with higher returns and richer types than existing agreements such as YFI. product.

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