Decentralized Perpetual Exchanges: A Dive into Technology, Market Analysis, and Upcoming Predictions

TL;DR

1) Order Book

2) Liquidity Pool

6. The competition in the derivative DEX is fierce, and the breakthrough path consists of four points:

1. Industry Overview

1.1 History

DeFi was born in 2018 and reached unprecedented heights during the DeFi Summer of 2020. As spot DEX continued to evolve and mature, derivatives DEX flourished. Today, three years after DeFi Summer, the derivatives DEX track led by dYdX, GMX, and SNX has broken through a market value of 2 billion US dollars, accounting for approximately 7.9% of the total DeFi market value.

If DeFi Summer can be seen as the Big Bang of derivative DEX, from complete silence, with a “bang,” everything was born, dazzling and breathtaking. Then, the bankruptcy filing of FTX can be considered the supernova explosion in the development of derivatives DEX. The explosion’s radiation lit up the entire cryptocurrency market, and the matter and energy it left behind also triggered the formation of new stars. The fall of FTX made people doubt centralized exchanges as never before, and at this moment, the era of decentralized derivatives exchanges has arrived.

1.2 DeFi Perpetuals Market Overview

From 2022 to 2023, we’ve observed a significant dip in the DeFi market value, which currently sits at $17.9 billion, marking a steep decline of 72.9%. Sectors like lending and yield aggregators experienced massive drops of 80.5% and 85.3%, respectively. However, the derivatives sector has demonstrated resilience. Despite a year-on-year decrease of 65%, the sector’s market share has risen to 7.9%, surpassing that of the aggregator sector. This growth can be largely attributed to the significant expansion of decentralized perpetual exchanges like GMX and Gains Network. In January 2023, the trading volume of crypto derivatives increased by 76.1% compared to December 2022, reaching $2.04 trillion.

As of this writing, the trading volume of derivatives represents 68.77% of 24H global trading volume. Furthermore, statistics from The Block show that the two major mainstream crypto assets, Ethereum and Bitcoin, have spot-to-derivatives trading volume ratios of 0.13 and 0.23, respectively, with derivatives significantly outpacing spot trading.

Upon closer inspection, we found that, in terms of total derivatives trading volume, DEX accounts for a mere 1.3%, whereas, in the spot market, this ratio is closer to 6%. In addition, Binance, the largest centralized exchange, holds only a 16.95% market share, which is half of its market share in the derivatives market. This indicates that perpetual DEXs are less developed than spot DEXs and have substantial room for growth.

Further analysis reveals that only 3% of all derivatives volume is traded on DEX currently, while the remaining 97% is executed on CEX. dYdX is the only perpetual DEX with trading volume comparable to CEX, indicating the dominance of CEX and the nascent state of perpetual DEX.

Despite being far behind CEXs, perpetual DEXs are expected to close the gap in the coming years. Starting from 2022, CeFi’s disastrous events, CEX’s opaque custodianship, and the increasing regulatory pressure have been pushing users toward DEX. Moreover, the upcoming Cancun Upgrade, which will reduce Layer 2 gas fees, could further increase the adoption of perpetual DEXs.

1.3 Growth Obstacles

1) Strong competition from centralized exchanges.

While the FTX event has indeed shaken user confidence in CEXs and raised awareness about the risks associated with centralized entities’ custodianship, DEXs still lag behind in several respects. These include higher trading fees, barriers to use, limited trading functions, and the risk of losing funds. As such, DEXs still have a long way to go in terms of achieving mass adoption.

2) Constraints of on-chain order book

Although the order book model excels in certain areas such as liquidity depth and price discovery. Notably, dYdX, the foremost Perpetual DEX utilizing an order book, boasts the highest trading volume. However, implementing a fully on-chain order book system can be challenging due to technical constraints. As a result, dYdX conducts its order book system’s matching off-chain, utilizing Amazon Web Services to facilitate these operations.

Moreover, the order book model faces potential regulatory risks. Given that this model requires deep liquidity depth, it relies heavily on market makers for smooth operation. In the United States, market-making entities are strictly regulated by financial authorities. They must comply stringently with the regulatory requirements of entities like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), and adhere to securities laws and regulations. Market-making entities also need to comply with anti-money laundering requirements. The FTX incident further exposed the risks that market makers face, and these risks could directly impact the stability of order book exchanges like dYdX.

3) Lack of viable models.

For the AMM model, although there are many innovative designs and improvements to the flaws, such as Virtual Automated Market Makers (vAMM), Hybrid AMM, MEV Capture AMM, etc., a lot of trial and error and continuous product iterations are still necessary. Moreover, most of the current derivative protocols are inspired by the Uniswap V2 spot market model, meaning these protocols have an uncapped liquidity pool and an automated market maker model. However, without an effective liquidity provider (LP) risk management system or LP incentives, considering the higher risk, LPs have no incentive to provide liquidity for derivatives.

1.4 Industry Drivers

1) Urgent need for mechanism innovation and user experience enhancement: The success of the GMX model has led many teams to imitate it, and many GMX imitators have appeared in the market, such as Vela Exchange, Mummy Finance, Level Finance, etc. However, due to the similarity in mechanism and implementation, it is difficult for them to surpass the imitators in terms of trading volume and commission income. In terms of user experience, it is also difficult to surpass centralized exchanges with 7*24H customer service and perfect fund recovery mechanisms.

2) Demand for derivative trading exceeds spot trading: Following the development rules of things, cryptocurrency will be like traditional finance, with the trading volume of derivatives far exceeding spot trading, showing great potential for derivatives. In addition, for decentralized exchanges, the trading volumes of Uniswap and Pancakeswap are less than 10 times different from those of centralized exchanges at peak times, but the trading volume of decentralized derivatives is still several orders of magnitude lower than that of centralized derivatives (Binance’s daily derivatives trading volume has already exceeded $50 billion, while the combined daily trading volume of all decentralized derivatives exchanges is still around $100 million).

3) Low penetration of DEX in derivatives market: In the derivatives market, centralized exchanges like Binance, OKX, and Bybit occupy most of the market share. The leading protocol in perpetual futures, dYdX, only accounts for 0.86% of the trade volume in the derivatives market, but it has a market share of 89.67% in the perpetual futures sub-market. Therefore, it’s clear that the penetration of DEX in the derivatives market is extremely low, indicating tremendous room for growth for DEX.

4) Market Cycle: Turbulent markets are more suitable for derivatives trading. Not only can the severe volatility increase protocol fee income, but it also provides more opportunities for derivatives. In bear markets, derivatives are often more popular, as they not only offer the ability to profit from short selling, but also allow for hedging and risk mitigation. Additionally, market turbulence tends to shake user confidence, causing them to be more concerned about the risks associated with centralized exchanges, making them more inclined to trade on DEX for derivatives. On the contrary, if the market goes through a long period of stability, users may not be as concerned about potential centralized risks and would prefer the convenience and efficiency of CEX.

5) Regulation and Compliance: The biggest competition for DEX derivatives is not among each other, but the absolute dominance of CEX giants like Binance, Bybit, and OKX, any of which alone has a derivative trading volume far exceeding the total trading volume of DEX. The key for DEX derivatives is how to take a share of the pie from centralized exchanges. Fortunately, increasingly stringent regulatory policies have given DEX a brief respite. Incidents like the FTX’s meltdown and SEC’s investigations into Binance and Coinbase have raised users’ concerns about whether they should look for other trading opportunities if regulators were to crack down on centralized exchanges. This will bring more short-term demand for DEX. But in the long run, how DEX can reduce trading costs and improve user experience is key to retaining users.

1.5 Competitive Landscape

Breakdown by Chain：

Derivatives trading primarily occurs on Layer 2, where Optimism dominates half of the market with a monthly on-chain trading volume of $9.01B. Arbitrum accounts for 35% with $6.3B, and BSC’s on-chain trading volume is $1.33B, accounting for 8%. The remaining public chains share 10% of the market share. Worth mentioning is that, in the past month, the on-chain derivatives trading volume on zkSync Era has increased tenfold, with a total trading volume of $39.4M in July, four times that of Solana. Importantly, many leading derivatives protocols on Layer 1 and other public chains are gradually expanding to Layer 2. For example, Level Finance, which originated on BSC, has recently arrived on Arbitrum. Futureswap, native to Avalanche, is deploying its V3 version on Arbitrum. With its superior performance and low fees, Layer 2 is not only nurturing new protocols but also attracting the deployment of established ones.

Trading Volume:

Comparing 24-hour trading volumes, order book-based DEXs significantly outperform liquidity pool-based DEXs. Among the order book DEXs, dYdX holds a dominant position, being the largest and most widely used perpetual futures platform in the market, with a daily trading volume reaching $873.94M, which is 1.5 times the total trading volume of all liquidity pool derivative DEXs. Among liquidity pool DEXs, Kwenta, GMX, and Vertex all have daily trading volumes exceeding $100M, each accounting for 20% of the total trading volume, while gTrade accounts for 12%, reaching $68M.

Market Cap、TVL：

In terms of market cap, dYdX continues to lead, with $339M accounting for one-third of the total market capitalization of derivative DEXs. GMX and gTrade rank second and third with $258M and $131M respectively. In terms of Total Value Locked (TVL), GMX, with a total asset value of $560M, surpasses the total value of all other protocols’ locked assets. GMX’s trading volume is lower than dYdX, but its TVL significantly exceeds dYdX, as dYdX operates on an order book mechanism with liquidity provided by market makers, thereby not requiring a large number of LPs. (As Kwenta’s liquidity is backed by Synthetix, it is not included in the statistics). Notably, MUX has a market cap of only $40M, but its TVL surpasses gTrade to reach $58M. This is due to its unique profit distribution mechanism — holding $MCB and $MUX does not directly yield profits, but staking $veMUX allows for sharing of platform profits. The staking ratio is weighted according to the staking period.

Fees：

In terms of fees, GMX leads the way, with a cumulative income of $26.6M over the past 90 days, maintaining a good trend since last year and performing impressively during the bear market. However, since GMX has to use 70% of its fee income to incentivize GLP, its income space is relatively small, with income over the past 90 days only reaching $8M. While dYdX’s trading fees are not as impressive as GMX’s, totaling only $16.2M, all of its fees are owned by the protocol. Moreover, in the face of intense competition, dYdX used $16M for token incentives, with an average profit level. Currently, dYdX has not fully decentralized, and will distribute fees to users in the V4 version. Level fees rank third, reaching $12.1M, but 45% is used to incentivize liquidity and 20% to reward stake, with $12.2M used for token incentives in the past 90 days, resulting in a protocol loss of $5.6M. gTrade charges fees on both the open and close of trades, and 40% of market order fees and 15% of limit order fees are distributed to $GNS stakers. Even though the service fee of $4.4M is less than that of GMX, the final profit exceeds GMX, reaching $3.7M. In summary, GMX and dYdX have high fee income and strong protocol fee capture capabilities, but gTrade has stronger profitability.

Source: Token Terminal (as of August 2, 2023)

Source: Token Terminal (as of August 2, 2023)

1.6 Implementation Mechanisms and Features

The mechanisms of the five perpetual futures /leverage trading protocols (dYdX, GMX, Gains Network, Kwenta, Perpetual Protocol) are different and can be divided into two main categories: Order Book mode and Liquidity Pool mode. The latter can be further divided into four types: single asset as LP, basket of assets as LP, synthetic assets, and vAMM (Virtual Automated Market Maker) mode.

1.6.1 Order Book

Also known as Peer-to-Peer (P2P), the protocol provides liquidity through market makers, where users and market makers act as counter-parties. Essentially, it is a matching mechanism that matches buy and sell orders. Representative project: dYdX.

Features：

1.6.2 Liquidity Pool

Also known as Peer-to-Pool, the protocol typically attracts Liquidity Providers (LPs) to form a pool, where users trade against the pool as the counterparty. The price is provided by an oracle.

1）Single Asset as LP

In this model, liquidity providers deposit a single type of asset (often a stablecoin, such as DAI) into the vault to form a liquidity pool. Users trade through the protocol, and the liquidity providers act as the counterparty. The liquidity providers earn profits from the traders’ losses. Representative project: gTrade.

Features:

2）Basket of Assets as LP

In this model, a pool of assets with varying proportions is used as a liquidity provider (LP). Users interact with the protocol, which adjusts the minting and burning fees of LP tokens and transaction costs to balance the weights of various assets. Representative project: GMX.

Source: GMX (as of August 2, 2023)

Features:

3）Synthetic Assets

Synthetic assets are mirror simulations of target assets. For example, sUSD is used to represent the price of the US dollar, and sGold represents the price of gold. Essentially, they are derivative tokens anchored to the prices of other assets by oracle feed, with liquidity coming from a shared debt pool. A DeFi protocol is needed to help users issue these tokens, and they exist in a standardized token form on the blockchain. Representative project: Synthetix — Kwenta.

The synthetic asset model consists of two parts: minting and trading.

Firstly, the minter over-collateralized a certain asset in the protocol to mint a stable synthetic asset. At this point, the minter can share the transaction fee according to the asset ratio, while also proportionally bearing the global variable debt.

Secondly, traders can obtain synthetic assets through minting or off-exchange trading, and trade synthetic assets to go long or short.

For instance, Ellie collateralized $500 worth of $SNX in Synthetix and minted $100 sUSD. Suppose the total debt pool is worth $200, all in sUSD. At this point, Ellie in Synthetix: assets $500 $SNX, liabilities $100 sUSD, collateralization ratio 500%, debt ratio 50%.

Situation 1: Ellie is bullish on BTC, so she exchanges all $100 sUSD for sBTC (another synthetic asset). After a week, the price of BTC rises by 50%, and the value of the total debt pool is $250 ($150 sBTC and $100 sUSD). As Ellie bears 50% of the global debt, at this point, Ellie in Synthetix: assets $500 $SNX, liabilities $125 sUSD, collateralization ratio 400%, profit $150 sBTC — $125 sUSD = $25. At the same time, she needs to replenish collateral or repay sUSD to increase the collateralization ratio.

Situation 2: Ellie chooses to hold $100 sUSD. After a week, the price of BTC rises by 50%, the total debt rises to $250. Like in situation 1, Ellie also bears 50% of the debt, which is $125, so she loses $125 sUSD — $100 sUSD = $25. At this point, the profiters are users who hold sBTC.

Through the above examples, it can be seen that the features of this model are:

5) vAMM

This is an innovation based on the AMM model, known as a Virtual Automated Market Maker (vAMM). It stores the liquidity provider’s funds in a smart contract vault, with users only trading in the virtual asset pool. This separates funds from trading and effectively isolates risk. Representative project: Perpetual Protocol.

AMM Trading Platform = AMM Automated Quoting Algorithm + Liquidity Providers (LP)

vAMM Trading Platform = AMM Automated Quoting Algorithm

The basic model for vAMM is: x*y=K, but vAMM itself does not store a real asset pool (K). The value of K is manually set by the vAMM operator at startup and can be increased or decreased at any time according to the latest market conditions. The actual assets are stored in a smart contract vault, which manages all the collateral for vAMM, and operators have no authority to move the collateral.

Taking Perpetual Protocol as an example, its V2 uses Uniswap V3 as the execution layer and uses aggregate liquidity for market making. Users need to use USDC as collateral, which is stored in the vault. The protocol updates vAMM according to the vault data, and vAMM provides the quote.

Source: Perpetual Protocol

In summary, vAMM acts merely as a quoting mechanism and does not provide liquidity itself; its LP depends on other protocols.

2. Main Protocol

2.1 Order Book

2.1.1 dYdX

dYdX is a non-custodial, decentralized perpetual contract trading platform offering exposure to over 35 assets with leverage up to 20x. The core team is composed of software engineers from well-known cryptocurrency companies such as Coinbase.

Despite being a decentralized exchange, like most centralized exchanges, dYdX uses an off-chain order book and on-chain settlement method. It is one of the few DeFi protocols that has been operational for several years and yet has not issued a governance token.

dYdX incorporates three functionalities: lending, leveraged trading, and perpetual contracts. Leveraged trading includes an automatic lending feature; users’ deposited funds form a pool, and if insufficient funds are available for a transaction, funds are automatically borrowed and interest is paid. Note that currently, dYdX’s leveraged trading is only user-friendly for large transactions. If a single order is less than 20 ETH, the option is to take the order and pay a higher small-order fee to offset the Gas cost.

dYdX’s perpetual contracts run simultaneously on Layer 1 and Layer 2, with Layer 2 utilizing StarkWare’s second-layer solution. Currently, the public testnet for dYdX V4 went live on July 5, 2023. It plans to break away from Ethereum and develop an independent blockchain in the Cosmos ecosystem for greater scalability.

Since its launch in 2017, dYdX has grown rapidly and maintains a leading position in derivative DEXes, with trading volumes far exceeding competitors. As of August 4th, it has 101,288 unique users, with USDC deposits amounting to $4.7M, having spiked to a high of $142.7M in September 2021. The annual cumulative trading volume reached $275.46B, an increase of 26%. The annual accumulated fees were $66.99M. Due to spending $96.5M on token incentives, the protocol was in a net loss state over the last 365 days, with a net income of -$15.8M.

Source: Dune Analytics (@impossible_finance) as of August 4, 2023

Source: Token Terminal (as of August 4, 2023)

2.2 Single Asset (DAI) as LP

2.2.1 gTrade（Gains Network)

gTrade is a decentralized leveraged trading platform on the Polygon and Arbitrum chain, with gTrade as the trading protocol on Gains Network. Its liquidity is provided through a DAI vault, and it offers a variety of trading pairs, including cryptocurrencies, commodities, and forex.

The core advantage of Gains Network lies in its intricate risk control mechanisms. Gains Network uses a three-pronged approach to risk management on the trading side, through Price Impact, Rollover Fee, and Funding Fee.

Gains Network’s performance was mediocre since its launch until January 1, 2023. After expanding to the Arbitrum network, gTrade’s trading volume surged. Currently, gTrade holds a market share of around 12–15%, with 15,959 independent users, and a total trading volume of $39.51B.

Source: Dune Analytics (@Shogun) as of August 4, 2023

2.3 Basket of Assets as LP

2.3.1 GMX

GMX is a perpetual contract trading DEX, originally deployed on BSC. It launched a public version on Arbitrum in 2021 and integrated the Avalanche network in 2022.

Zero Slippage: GMX abandons the automatic market maker model (AMM) and adopts oracle-based pricing. Users can complete a perpetual contract transaction by injecting funds into the pool and relying on oracle quotes. The protocol will exchange according to the real price of the oracle. There is no slippage loss during the exchange process, and it avoids the need for the trading engine to match orders off-chain. It provides spot and margin trading with zero slippage.

GLP Pool: Unlike dYdX and centralized exchanges, GMX does not use AMM and order book mechanisms, instead, it adopts the GLP pool to meet users’ short or long needs. The GLP pool is a multi-asset pool that contains mainstream tokens such as BTC/ETC/AVAX/USDC, which support users’ short or long contract requirements. When users go long on Bitcoin, it is equivalent to “renting” Bitcoin from the pool. Conversely, when users short Bitcoin, it is equivalent to “renting” stable coins from the pool. This allows the GLP pool to earn LP fees for the protocol, and all profits will be distributed to the stakers of GMX and GLP.

Fully Decentralized: All data for the GMX exchange is on-chain and does not require KYC. All assets are held by smart contracts. The smart contracts are open-source, and all operational data is public and transparent.

Unique product innovations and expectations of Arbitrum airdrops have led to rapid growth for GMX. As of August 4, 2023, GMX’s annual cumulative trading volume reached $34.63B. Over the past three months, GMX’s market share in the liquidity pool derivative DEX category has declined, peaking in April 2023 at 50%. It has 117,097 unique users. The total commission income for the past 180 days is $81.8M, ranking 8th among all protocols, even surpassing veteran protocols like Pancakeswap and dYdX.

Source: Token Terminal (as of August 4, 2023)

Source: Dune Analytics (@shogun) as of August 4, 2023

2.4 Synthetic Assets

2.4.1 Kwenta

Kwenta is a derivatives trading platform based on the Synthetix protocol that supports three major categories of derivative trading: cryptocurrencies, forex, and commodities. Kwenta serves as the frontend for Synthetix, allowing traders to interact with the Synthetix debt pool, which consists of sUSD provided by SNX stakers. In other words, Synthetix acts as the liquidity pool behind Kwenta, providing the underlying protocol for perpetuals and managing liquidity, while Kwenta focuses on user experience and interface design. Currently, Kwenta offers over 42 pairs of cryptocurrencies, forex, and commodities, with leverage up to 50x.

Unlimited liquidity and zero slippage: Kwenta employs Synthetix’s dynamic debt pool model, which provides near-infinite liquidity for all trading targets (within the protocol’s safety range). Additionally, like GMX, Kwenta uses an oracle to feed index prices directly as the marking price, eliminating spreads and thus slippage. Users can circumvent the conventional rules of traditional order book models and automatic market maker models (AMM) when trading.

In October 2020, Kwenta was launched on the Optimism. Since February 2023, its business scale began to soar, with a record single-day trading volume of $2.8M. The annual cumulative trading volume is $55.21B, with an annual fee income of $22.59M. It has 154,560 unique users. The main trading targets are Euro, sBTC, and sETH.

Source: Token Terminal (as of August 4, 2023)

Source: Dune Analytics (impossible_finance) as of August 4, 2023

2.5 Protocol Comparison

3. Seeking New Opportunities

The DeFi Summer has stimulated the emergence of countless new protocols and has also made the current competition in the derivative DEX increasingly fierce. Both new and old protocols are thinking about how to innovate and iterate. In the face of difficulties, we believe the path to breakthrough lies in four points:

3.1 Ethereum Upgrade

In the past, many DEX protocols deployed on Alt Layer 1 networks like BSC and Solana for lower transaction costs and higher throughput. However, this came at the expense of a certain level of security. For instance, Level Finance on the BSC chain was attacked in May this year, losing 1 million dollars. With the birth and development of Layer 2, many projects that were native to Alt Layer 1 have moved to Layer 2, such as Level Finance and GMX moving from BSC to Arbitrum, and gTrade from Polygon to Arbitrum. Layer 2, relying on Ethereum, has unmatched security compared to Alt Layer 1. As it continues to upgrade, it will attract more DEX protocols, providing DEX with better-underlying infrastructure.

Compared to CEX, the core disadvantages of DEX are two-fold: slow transaction speed and high transaction costs. This is due to Ethereum’s lower throughput, but the upgrade and expansion of Ethereum are expected to completely solve this problem. The upcoming Cancun upgrade at the end of 2023 will introduce “Blob Transaction”, which is expected to save 90% of storage costs. This will greatly reduce the GAS costs of on-chain transactions, reducing the transaction costs of DEX. With the addition of more Blobs to future Ethereum blocks, the throughput will further increase, and the transaction speed is expected to greatly improve.

dYdX chose to leave Ethereum and move to the Cosmos because they wanted their chain’s consensus layer to have greater modularity, sacrificing some security for scalability in the impossible triangle. However, as Layer 2 solutions such as Optimism and zkSync are rolling out Stack solutions, the “impossible triangle” seems no longer impossible. For instance, OP Stack allows developers to build modular blockchains, which can be easily customized to meet the specific needs of a project, while relying on Ethereum for security. The Stack solution improves Ethereum’s scalability while maintaining security, giving DEX better options on Layer 2. Large-scale DEXs can even deploy Layer 2 application chains based on Layer 2 Stack.

3.2 Aggregator

Data shows that in 2022, the confidence of traders was severely affected by the FTX crisis. The mainstream centralized exchanges experienced an outflow of funds, and the market value of DeFi tokens plummeted by 72.9%. However, the spot aggregator was not affected. Taking 1inch Network for example, its number of unique users in Q4 increased by 13%, exceeding 2.4 million.

Source：Dune@1inch (2023.8.10)

In the overall DeFi spot market, the trading volume of aggregators is nearly 20,000 times that of DEX, and such a huge disparity in trading volume also proves the irreplaceable unique advantages of aggregators. On the other hand, there are no relatively mature products in the derivative aggregators, which have huge development potential. It is worth mentioning that on July 17th, Uniswap, the largest DEX protocol, launched a protocol called UniswapX that can aggregate the liquidity of decentralized trading pools. This protocol has new features such as aggregating liquidity, introducing third-party Fillers, and one-click cross-chain trading, which can provide traders with the best price that a single liquidity pool cannot provide. As a leading DEX in the industry, Uniswap’s trading volume accounts for 65% of the overall DEX. The fact that such a large-scale spot DEX is moving toward the direction of aggregators further indicates that derivative DEX also needs to move toward the direction of aggregators.

Similar to spot aggregators such as 1inch, odos, and DeFillamaSwap, the goal of derivative aggregators is to use their algorithms to compare various protocols, find the trading platform with the best price and fees, and promote the most efficient trading path.

The benefits of derivative aggregators include the following:

1) Smooth Trading Experience: As a front end, the aggregator focuses on optimizing the interface and operating experience, making it feel closer to centralized exchanges.

2) Competing with CEX’s liquidity: Aggregators can integrate the entire liquidity of DEX, CEX, LP, funds, and market makers, which is unmatched by ordinary DEXs.

3) Rich Asset Types: Due to liquidity depth and risk management considerations, a single DEX has fewer asset types and often requires permission to add assets. Aggregators can combine the asset types of many DEXs and trade assets that do not meet the requirements of many perpetual contract protocols.

4) Sustainable profitability: Traditional derivative DEXs need to share some transaction fees with LPs or pay interest to attract deposits, but the aggregator itself does not need to provide liquidity, so there is no need to increase yield and transaction fees to attract LPs.

5) Effective avoidance of token inflation: As mentioned earlier, aggregators do not need to attract liquidity by dividing profits, nor do they need to distribute tokens as rewards to users. Therefore, all profits belong to the protocol, and tokens do not need to face inflation and selling pressure. Its value capture ability is significantly improved, and the token has more investment value (for example, Uniswap has been criticized for only providing governance rights but not sharing protocol income, which also restricts the price increase of the coin).

6) Low threshold for deploying new chains: Traditional derivative DEXs only apply to one or two public chains. The main difficulty is that crossing to new chains requires a lot of funds to attract liquidity, which to a certain extent restricts the expansion of the protocol. Aggregators can save liquidity incentives on the new chain and can add multi-chain at low cost without liquidity restrictions.

7) Optimal Yield and Delta Neutrality: At present, there are many GMX Forks in the derivatives market, with similar technical architectures and similar implementation mechanisms, and it is difficult to play a differentiated advantage. But aggregators can find the highest-yielding DEX among many GMX Forks, and achieve the best return for traders; at the same time, each liquidity pool of the aggregator is a hedging counterparty to each other, through the combination of on-chain assets to hedge the risk exposure of multiple assets, achieving Delta neutrality.

Challenge: Potential Price Differences Between Protocols

Because of factors such as funding rates, liquidity depth, and the number of long and short traders, the same trading pair may have different pricing on different protocols. For derivatives aggregators, what needs to be done is not just a simple integration of liquidity on the frontend interface. More importantly, they need to balance and integrate the price differences across various protocols to provide traders with a unified price.

Without a unified price, the aggregator would just be a Defi website directory, collecting the prices of various protocols but not essentially integrating them. A unified price is the essence and core of aggregation. It can not only greatly improve the user experience, but also reduce the learning curve and maximize user benefits. How to smooth out the price difference, whether it’s through algorithms or cooperation with underlying protocols, will be up to each aggregator’s capabilities.

In summary, derivatives aggregators effectively combine the advantages of CEX and DEX. They provide a smooth experience like CEX and a trustful mechanism like DEX. With massive liquidity and high composability, these features grant them vast potential for development. Currently, the field of derivatives aggregators is a blue ocean with few mature products. The main protocols include Uniswap X, UniDEX, MUX, and Sushiswap DEX aggregator.

For traders, the same trading pair may have different pricing on different protocols. For derivatives aggregators, what needs to be done is not just a simple integration of liquidity on the frontend interface. More importantly, they need to balance and integrate the price differences across various protocols to provide traders with a unified price.

3.2.1 MUX

MUX, originally known as MCDEX, is a decentralized perpetual contract exchange driven by Automated Market Makers (AMMs) deployed on Arbitrum. On December 1, 2022, MCDEX officially shut down and renamed itself as MUX Protocol. MUX is deployed on Arbitrum, BNB Chain, Avalanche, and Fantom, with a mechanism similar to GMX, allowing up to 100x leverage. Its V2 version introduced Liquidity Routing, where when a trader opens a position on MUX, the MUX aggregator dynamically compares the trading prices provided by various protocols, recommending the underlying protocol with the most suitable liquidity depth, reducing the trader’s overall costs to the maximum extent.

Its advantages include:

Source: MUX Protocol

3.3 Copy Trading

Copy trading, also known as social trading, is a process where users on a platform mimic the trading strategies of traders or KOLs. This method is commonly used in centralized exchanges, serving multiple purposes: it helps promote the brand of the exchange, attracts traffic, reduces user operating costs, captures trading opportunities, and aids those leading trades in obtaining profit sharing.

For instance, Bitget saw an increase of over 300% in total trading volume in 2022, driven by copy trading and contract trading. Bitget’s flagship product, one-click copy trading, attracted over 80,000 traders and more than 338,000 followers. It enabled more than 42 million profitable trades, which made Bitget the only centralized exchange (CEX) to achieve counter-cyclical growth in derivative trading within six months of the FTX disaster.

Source: Nansen

Off-chain copy trading operates in two modes. The first is a trading display on aggregation platforms, while the second is a one-click copy trading on exchanges.

The first mode, showcased by platforms like “BCoin” and “SnowBall”, champions a “Trading + Community” business model. These platforms integrate data from major exchanges via APIs, bringing together a plethora of professional traders and KOLs with their live trading data. This is more transparent and authentic compared to the traditional “order screenshot” methods. Furthermore, these aggregation platforms cultivate interactive communities. Through chat squares and performance leaderboards, users can easily identify genuine trading experts, benefiting from their insights and advice. For master traders, such platforms act as optimal promotional and traffic-driving tools, with paid subscriptions. For users, it serves as an authoritative learning community, backed by hard data. From the platform’s perspective, it not only attracts users and builds its brand but also offers an alternative and practical form of user education.

Source: BCoin

The second mode is the copy trading feature offered by major exchanges, such as Bitget and Bybit. Once users meet certain criteria (typically based on profit performance and follower count), they can apply to become a “master trader”. These master traders can choose to display their positions, attracting other users to follow their trades, and in return, they receive about 10% of the net profit from their followers.

Source: Bybit

Each mode has its own advantages and disadvantages.

Aggregation platforms offer the benefit of consolidating data from major exchanges, making the experience more convenient and comprehensive. By operating a community, they provide an alternative form of user education, which enhances user retention. However, the drawback lies in the inconvenience of follow-trading, as there’s a need to integrate external data.

The copy trading feature on exchanges stands out for its ease of operation. The screening and progression mechanisms for lead traders, along with robust risk control measures, ensure the safety of users’ funds. Yet, the downside is that users may blindly follow trades based solely on profit rates. They often lack understanding regarding the character, reputation, trading logic, and quantitative metrics of the master traders. Such limited insight can amplify investment risks and may not favor user retention.

On-chain copy trading platforms can potentially synergize with aggregators, combining the best of both worlds:

At present, there aren’t many derivative DEX projects that include copy trading functionality. Major protocols that do include Perpy Finance and SFTX.

3.3.1 Perpy

Perpy is an on-chain copy trading protocol based on GMX. Any trader can create a vault in Perpy, link their Twitter account and attract investments. The vault directly connects to GMX through smart contracts. We can think of traders as fund managers. They create their own funds on Perpy, attract followers to subscribe and invest through social media, and act as fund managers to operate trades and charge certain management fees. In short, the relationship between the trader and the follower is similar to the relationship between a fund manager and an investor, with the follower entrusting their capital to the trader for management and investment.

After its launch in 2023, Perpy Finance’s total trading volume was $50M, and another protocol, STFX, was $7.7M. Neither is sufficient to control or monopolize the market, so the derivatives on-chain copy trading market is still a vast, treasure-filled new world.

3.4 Derivatives DEX + Traditional Assets

In 2022, the global in-house futures and options transaction volume of traditional assets hit a record high for five consecutive years, presenting a more vast blue ocean. However, whether it’s CEX or DEX, most of their products are cryptocurrencies. Can DEX break away from the world of cryptocurrencies and advance into the broader market of traditional asset derivatives? For instance, Gains Network on August 1, the open interest of traditional assets (commodities and forex) on gTrade was $16M, accounting for 42% of the total volume. At its peak, the open interest of traditional assets once reached three times that of cryptocurrencies, making a considerable contribution to fees. Yet, this volume only accounts for a tiny portion of the traditional asset derivatives trading, with a lot more scale awaiting exploration.

Compared to traditional commodity futures exchanges, the advantages of DEX lie in:

1) DEX is permissionless, meaning that anyone can develop any new product on the protocol without any authorization approval, and anyone can trade that product without KYC verification. This implies that the trading categories of traditional assets can be increased more flexibly and easily.

2) DEX also has censorship resistance, which can effectively resist the control of centralized institutions. Amid increasingly stringent scrutiny and delisting trends from centralized institutions, DEX has a broader potential market.

3) DEX can operate 24/7, fully meeting the personalized hedging needs of the market and making up for the time limitations of traditional futures exchanges. In the future, DEX derivatives could be not only BTC and ETH, but also agricultural products (soybeans, corn, palm oil), metals (zinc, gold, nickel), energy (crude oil, asphalt, coking coal), and more.

In the face of such broad hedging needs of traditional assets, DEX should further enlarge the pie, and take the lead in the trading experience of specific assets, not aiming to become the next Binance, but striving to become the first decentralized Chicago Mercantile Exchange (CME).

4. Conclusion and Outlook

The competition among decentralized derivative trading platforms has turned into a red ocean situation. In the face of difficulties, token and LP incentives are merely stopgaps. Innovation and breakthroughs at the mechanism level are the fundamental solutions.

Decentralized exchanges already have advantages such as non-custodial management and high transparency. If, based on this, they can provide user experience and liquidity of the same quality as centralized exchanges, then decentralized exchanges will have the power to come out of the predicament.

References

Official website of each perpetual futures protocol

https://blog.uniswap.org/uniswapx-protocol

https://www.shfe.com.cn/upload/20230320/1679301499457.pdf

https://news.marsbit.co/20230409091626346085.html

https://dune.com/hagaetc/dex-metrics

https://tokeninsight.com/zh/research/analysts-pick/beginners-guide-to-crypto-derivatives-kwenta-case-study

https://tokeninsight.com/zh/research/market-analysis/crypto-decentralized-derivatives-exchange-2022-q3-report?_gl=1*19w2acb*_ga*MTE4MjUzMjMyMy4xNjg5MTY2MDY0*_ga_3F9MFYLVT6*MTY4OTI1Mzk4Mi4xMC4wLjE2ODkyNTM5ODIuNjAuMC4w

https://foresightnews.pro/article/detail/20783

https://dune.com/leveluptrading/gtrade-gains-network-gns

https://dune.com/shogun/perpetual-dexs-overview

https://foresightnews.pro/article/detail/23808

Declaration

The present report is an original work of @elliett2077, @GryphsisAcademy trainee, under the mentorship of @CryptoScott_ETH. The author(s) alone bear the responsibility for all content, which does not essentially mirror Gryphsis Academy’s views or that of the organization commissioning the report. The editorial content and decisions remain uninfluenced by the readers. Be informed that the author(s) may own the cryptocurrencies mentioned in this report.

This document is exclusively informational and should not be used as a basis for investment decisions. It is highly recommended that you undertake your own research and consult a neutral financial, tax, or legal advisor before making investment decisions. Keep in mind, the past performance of any asset does not guarantee future returns.