Decentralized Perpetual Contract Exchanges Explained

Forward the Original Title: In-Depth Guide to Decentralized Perpetual Contract Exchanges: Tech, Trends, and Forecasts

Author(Student)|@elliett2077

Instructor|@CryptoScott_ETH

First release time | 2023.8.11

1. Derivatives include perpetual contracts, options, interest rates, synthetic assets, choppiness index, etc. This article primarily discusses the technology, market, and frontier developments of decentralized perpetual contract exchanges within the derivatives sector.
2. In recent years, the development of derivative DEX tracks has grown rapidly, with a market value surpassing $2 billion, accounting for approximately 7.9% of the total DeFi market value. The Defi Summer and FTX’s failure accelerated the rapid growth of derivative DEX, but from a market structure perspective, derivative trading is predominantly monopolized by CEX, with DEX only accounting for 3% of total trading volume.
3. Strong competition from CEX, constraints on on-chain order books, etc., hinder the advancement of derivative DEX. Meanwhile, the significant trading demand for derivatives and the low penetration rate of DEX are driving factors for industry development.
4. In terms of competition, nearly 90% of on-chain derivative trading occurs on Layer 2; order book DEX outperforms liquidity pool DEX, with dYdX dominating the market; GMX and dYdX have high fee income, but gTrade has stronger profitability.
5. Perpetual contract DEX mainly fall into two categories: order book and liquidity pool:

a. Order Book

Order book is essentially a matching mechanism that matches buy and sell orders. However, it relies on liquidity providers, posing regulatory risks. Representative project: dYdX.

b. Liquidity Pool

Single asset DAI as LP: No guaranteed returns, and has buffering mechanism. Representative project: gTrade

Basket of assets as LP: Provides global liquidity. Representative project: GMX

Synthetic assets: used as global debt, and can reduce spot friction. Representative project: Kwenta

vAMM model: used to protect collateral, with zero impermanent loss. Representative project: Perpetua Protocol

1. There is fierce competition in perpetual contract DEX, and to make breakthroughs, it needs to: firstly, leverage the Ethereum upgrade for performance improvement; second, provide market-best prices through aggregated liquidity; third, develope on-chain copy trading to attract more users and expand trading volumes; fourth, integrate traditional assets to address the shortcomings of futures exchanges and meet diverse demands.

   1. Industry Overview

1.1 Historical Evolution

In 2018, DeFi was born, and it reached unprecedented heights during the DeFi Summer of 2020. As spot DEXs continued to mature, derivative DEXs began to flourish. Today, three years after DeFi Summer, derivative DEXs led by dYdX, GMX, and SNX have a combined market capitalization exceeding $2 billion, accounting for approximately 7.9% of the total DeFi market capitalization.

If DeFi Summer was the big bang of derivative DEXs, where everything was born with a bang after a period of silence, then FTX’s bankruptcy can be seen as a supernova explosion in the development of derivative DEXs. The explosion illuminated the entire crypto market, and the material and energy it left behind triggered the formation of “new stars”. FTX’s downfall led to unprecedented skepticism about centralized exchanges, signaling the arrival of the era of decentralized derivative exchanges.

1.2 Market Overview

Attributed to valuation bubbles and massive capital outflows, the total market capitalization of DeFi protocols dropped by 72.9% from 2022 to 2023, reaching $17.9 billion. Although 2022 was a DeFi protocol winter, compared to the significant declines of lending protocols and yield aggregators by 80.5% and 85.3%, respectively, the market situation for derivatives was relatively optimistic, with a overall year-on-year decrease of 65.0% but a market share increase to 7.9%, overtaking yield aggregators, thanks to the strong growth of decentralized perpetual contract exchanges like GMX and Gains Network.

Derivatives Market Overview: Rapid growth in derivatives trading volume, far surpassing spot volume.

In traditional asset categories, derivatives trading volume far exceeds that of the spot market. Taking the forex market as an example, the derivatives turnover is three times that of spot. In recent years, influenced by the pandemic and economic fluctuations, derivative trading has increased significantly. In 2022, global futures and options trading volume reached 83.848 billion contracts, an increase of 33.98% year-on-year.

In the cryptocurrency world, according to TokenInsight data, derivative trading now accounts for 68.77% of the entire cryptocurrency market, only twice that of spot, a ratio lower than traditional assets. The Block shows that the spot-to-derivative trading volume ratio for the two major mainstream crypto assets, Ethereum and Bitcoin, is 0.13 and 0.23 respectively, with derivative volume far exceeding spot.

In January 2023, cryptocurrency derivative trading volume increased by 76.1% compared to December 2022, reaching $2.04 trillion. As the cryptocurrency market gradually improves and matures, its development trend is similar to that of traditional financial markets, with the scale of various derivative products continuously expanding, far exceeding spot, and with tremendous potential.

Horizontal Comparison: The vast majority of derivative trading occurs on CEXs, with DEXs having a very low market share.

Currently, only 3% of all derivative trading volume takes place on DEXs, with the remaining 97% of derivative trading volume executed on CEXs. Among the top ten derivative trading volumes, only dYdX has a presence. The derivative market is overwhelmingly dominated by CEXs, with derivative DEXs occupying only a tiny market share and not posing a threat to the position of CEXs.

Vertical Comparison: The market share of derivative DEXs is significantly lower than that of spot DEXs.

In the derivative market, trading volume on DEX accounts for only 1.3% of the total trading volume; whereas in the spot market, this proportion is close to 6%, with the largest centralized exchange Binance holding only 16.95% market share, half of its derivative market share. This indicates that within decentralized exchanges, derivatives are far less mature than spot trading, with significant room for growth.

1.3 Industry Barriers

Intense Competition from Centralized Exchanges

While the FTX incident indeed shook users’ confidence in centralized exchanges and raised awareness of the risks associated with central custodial agencies, DEXs still lag behind CEXs in many aspects, including higher trading fees and barriers to entry, limited trading functionalities, and risks of fund loss. Therefore, DEXs still have a long way to go before achieving widespread adoption.

Constraints of On-Chain Order Books

Although the order book model performs well in liquidity depth and price discovery, implementing a fully on-chain order book system is challenging even for perpetual contract DEXs like dYdX, due to technical limitations. Therefore, dYdX needs to rely on Amazon Web Services for order matching off-chain instead of complete on-chain matching.

Furthermore, the order book model faces potential regulatory risks. The smooth operation of the order book model relies heavily on liquidity depth, thus heavily relying on market makers. In the United States, market makers are subject to strict supervision from financial authorities such as the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), and they need to comply with securities laws and government anti-money laundering requirements. The FTX incident further exposed the risks faced by market makers, which could directly affect the stability of order book exchanges like dYdX.

Lack of Viable Models

Although the current AMM model has many innovative designs and improvements to address its shortcomings, such as virtual automated market makers (vAMM), hybrid AMM, and MEV-capture AMM, the current designs remain to be improved and require a lot of trial and continuous product iteration.

Furthermore, most current derivative protocols are inspired by the Uniswap V2 spot market model, featuring an unlimited liquidity pool and an automated market maker model. However, this model’s shortcomings lie in its high requirements for LP risk management systems and LP incentives, requiring strong risk control and high incentives to hedge against higher risks and stimulate LP motivation.

1.4 Industry Drivers

Urgent Need for Mechanism Innovation and Improved User Experience

The success of the GMX model has led many teams to emulate it, resulting in the emergence of numerous GMX clones on the market, such as Vela Exchange, Mummy Finance, Level Finance, and others. However, due to the similarity in mechanisms and implementation methods, these products struggle to stand out and find it challenging to surpass imitators in terms of trading volume and fee revenue. Additionally, they often fall short in terms of user experience compared to centralized exchanges, which offer 24/7 customer service and robust fund recovery mechanisms.

Greater Demand for Derivative Trading Compared to Spot

Following the natural progression of things, cryptocurrency derivative trading volumes are expected to far surpass spot trading volumes, indicating significant potential for derivatives. Moreover, in the decentralized exchange realm, the trading volumes of platforms like Uniswap and Pancakeswap have already come close to matching those of centralized exchanges at their peaks. However, decentralized derivative trading volumes still lag behind their centralized counterparts by several orders of magnitude (Binance’s daily derivative trading volume has surpassed $50 billion, whereas the combined daily trading volume of all decentralized derivative exchanges remains around $100 million).

Low Market Penetration Rate of DEXs

In the derivative market, centralized exchanges like Binance, OKX, and Bybit dominate the majority of the market share. While the leading perpetual contract protocol, dYdX, accounts for only 0.86% of derivative trading volume, it commands a market share of 89.67% within the perpetual contract niche. This indicates an extremely low market penetration rate for derivative DEXs, suggesting significant room for DEX development.

Market Cycles

A volatile market is more suitable for derivative trading. Intense market fluctuations not only increase protocol fee revenue but also provide more opportunities for derivatives. During bear markets, derivatives are often more popular as they can be used for shorting opportunities and risk hedging to reduce exposure.

Furthermore, market volatility undermines user confidence, leading them to be more concerned about risks associated with centralized trading and thus inclining towards derivative DEX platforms for trading. Conversely, during prolonged periods of market stability, users may pay less attention to the potential risks of centralized exchanges and be more willing to accept the convenience and efficiency offered by CEX platforms.

Compliance and Regulation

The biggest competition for derivative DEXs does not come from each other but from the centralized exchange giants like Binance, Bybit, and OKX, each of which individually surpasses the total trading volume of DEXs. For derivative DEXs, the key is how to “carve out a piece of the pie” from centralized exchanges.

Fortunately, increasingly stringent regulatory policies have provided a glimmer of hope for DEXs. Events like the FTX debacle and investigations by the SEC into exchanges like Binance and Coinbase have made users wary of the potential shutdown of centralized exchanges by regulatory authorities and prompted them to explore alternative trading opportunities. This is expected to create more short-term demand for DEXs. However, in the long run, the key to retaining users lies in how DEXs can reduce trading costs and enhance user experience.

1.5 Competitive Landscape

Public Chain Distribution:

Derivative trading primarily occurs on Layer 2, where Optimism leads with $9.01 billion in on-chain monthly transaction volume, accounting for half of the market share, while Arbitrum follows with $6.3 billion, representing 35%. BSC contributes $1.33 billion in on-chain transaction volume, capturing 8% of the market share, with the remaining public chains collectively holding a 10% market share. Notably, in the past month, the on-chain derivative trading volume on the zkSync Era has increased tenfold, reaching a total transaction volume of $39.4 million in July, four times that of Solana.

It’s worth mentioning that many Layer 1 and other public chain-leading derivative protocols are gradually expanding to Layer 2. For instance, Level Finance, born on BSC, has recently launched on Arbitrum, and the native Avalanche project Futureswap is deploying its V3 version on Arbitrum. Layer 2 has not only nurtured new protocols with its superior performance and low costs but also attracted deployments from established protocols.

Trading Volume:

In terms of 24-hour trading volume, order book DEXs significantly outperform liquidity pool-based DEXs. Among order book DEXs, dYdX holds absolute dominance, boasting the largest and most widely used perpetual contract market, with a daily trading volume of $873.94 million, 1.5 times the total trading volume of all liquidity pool perpetual contract DEXs. Among liquidity pools DEXs, Kwenta, GMX, and Vertex each exceed $100 million in daily trading volume, accounting for 20% of the total trading volume, while gTrade captures 12%, totaling $68 million.

Market Cap and TVL:

In terms of market capitalization, dYdX remains the leader, accounting for one-third of the total market value of derivative DEX with $339 million. GMX and gTrade follow, with $258 million and $131 million respectively. In terms of Total Value Locked (TVL), GMX surpasses all other protocols with assets totaling $560 million. The reason for GMX’s higher TVL compared to dYdX, despite lower trading volume, is that dYdX operates on an order book mechanism, with liquidity provided by market makers, thus requiring less LP. (Kwenta’s liquidity is backed by Synthetix and is therefore not included in the statistics).

It’s worth noting that although the market cap of MUX is only $40 million, its locked value exceeds that of gTrade, reaching $58 million. This is because of its unique profit distribution mechanism; holding $MCB and $MUX does not directly generate income, as only staking $veMUX allows users to share platform profits, with the staking ratio weighted by staking time.

Fees:

In terms of fees, GMX outshines the rest, with a cumulative income of $26.6 million over the past 90 days, maintaining a strong performance since last year, especially during bear markets. However, due to 70% of GMX’s fee revenue being allocated to incentivize GLP, the revenue potential for GMX is relatively limited, with only $8 million in income over the past 90 days. Although dYdX’s transaction fees are not as impressive as that of GMX, totaling only $16.2 million, all of its fees go directly to the protocol. Additionally, facing intense competition, dYdX allocates $16 million for token incentives, resulting in moderate profitability.

Currently, dYdX has not fully achieved decentralization, but plans to allocate fees to users in the V4 version. Level ranks third in terms of fees, reaching $12.1 million, but 45% of it is used to incentivize liquidity, and 20% is used to reward stakers. In the last 90 days, $12.2 million was allocated for token incentives, resulting in the protocol actually losing $5.6 million. gTrade charges fees on opening and closing positions, with 40% of market order fees and 15% of limit order fees allocated to $GNS stakers. Despite generating less fee revenue than GMX at $4.4 million, gTrade ultimately surpasses GMX in profitability, earning $3.7 million.

In summary, GMX and dYdX have high fee income and strong fee-capturing capabilities, but gTrade demonstrates stronger profitability.

Source: Tokenterminal （2023.8.2）

Source: Tokenterminal （2023.8.2）

Implementation Mechanisms and Their Characteristics

Based on different implementation principles, the mainstream perpetual contract protocols on the market can be divided into two categories: Order Book mode and Liquidity Pool mode. Liquidity Pool mode can be further divided into Single Asset LP, Basket Asset LP, Synthetic Asset, and vAMM mode.

1.6.1 Order Book

Order Book:

Order book is also known as Peer-to-Peer. It provides liquidity through market makers, where users and market makers act as counterparties, and the platform matches buy and sell orders. Prices are determined by market dynamics. The order book mechanism is commonly used by most centralized exchanges, offering deeper liquidity than other modes but comes with certain centralization drawbacks.

Representative Project: dYdX.

Features:

1. Price Discovery: Market participants can freely determine asset prices through buy and sell orders in the order book, without control from centralized institutions.
2. Transparency: The order book publicly displays buy and sell orders in the market, allowing traders to clearly understand market supply, demand, and price levels.
3. Higher Trading Costs: In situations of low market liquidity, significant bid-ask spreads may occur, requiring users to wait longer to complete trades.
4. Smooth User Experience: The order book mode offers a user experience closest to that of traditional CEX, supporting various order types such as market order, limit order, and stop-loss order, with relatively low entry barriers.
5. High Gas Costs: The off-chain matching and on-chain settlement model often requires on-chain operations, resulting in high gas fees, especially during congested periods on the ETH mainnet, deterring many retail traders.

1.6.2 Liquidity Pool

It can be called Peer-to-Pool, also known as Point-to-Pool. It is a mechanism where protocols attract liquidity providers (LPs) to form a liquidity pool. Users trade with the liquidity pool, with prices provided by oracle.

1) Single Asset LP:

Providers deposit a single asset (often a stablecoin like DAI) into the vault to form the liquidity pool. Users trade with the protocol, and the counterparty is the liquidity provider. Providers earn profits from traders’ losses.

Representative Project: gTrade

Features:

1. Overcollateralization: The initial value ratio between DAI and gDAI is 1:1. If overall traders on the platform are at a loss, the balance of DAI in the insurance pool increases, exceeding the total amount of DAI deposited by providers, forming overcollateralization (insurance pool collateral ratio >1).
2. Theoretically no guaranteed returns: The biggest difference from the traditional LP model is that LP providers may face direct losses (not just impermanent losses). When staking DAI as counterparties to traders, their profitability depends on whether the traders incur losses. If the platform incurs losses, theoretically, the stakers may not be able to retrieve all of their assets.
3. Buffer Mechanism: Although theoretically it is non-principal protected for LP providers, a portion of the transaction fees is used as a buffer by the vault pool when the overall profit/loss is negative. These funds enter gDAI to protect provider funds and incentivize them to remain in the vault pool.

2) Basket Asset LP:

Users provide liquidity to a basket of assets, no longer providing two tokens in proportion (such as staking $100 worth of ETH and $100 worth of USDT). Instead, they purchase a basket of assets to provide “global liquidity.” In the case of GMX, users directly purchase and stake GLP, the liquidity token issued by the GMX protocol, whose index is composed of prices of various assets such as ETH, WBTC, LINK, UNI, USDC, etc.

Source: GMX (2023.7.20)

In summary, users provide global liquidity by staking GLP and participating in GMX liquidity provision.

Features:

1. Zero Slippage: Trades are against a basket of assets, with prices provided by oracles, so even large trades do not incur slippage.
2. Infinite Liquidity: As long as there are assets in GLP, any trading pair has liquidity, and the depth is integrable.
3. Permissionless: Anyone can fairly participate in platform liquidity provision, and profits are distributed equally based on GMX and GLP holdings.
4. Speculators and Casinos: Traders and liquidity pools are counterparts in a zero-sum game. Profits earned by traders are losses incurred by the liquidity pool, and vice versa. In the long run, the losses incurred by traders on GMX result in GLP earning an annualized return higher than the market average. From a statistical perspective, trader failures are a high-probability event; gamblers consistently lose to the gambling house, and higher leverage increases the probability of losses.

3) Synthetic assets

Synthetic assets mirror the prices of target assets. For example, sUSD represents the price of the US dollar, and sGold represents the price of gold. Essentially, they are derivative tokens pegged to the prices of other assets fed by oracles. Their liquidity comes from a shared debt pool and requires DeFi protocols to help users issue them, existing in standardized token form on the blockchain.

Representative project: Synthetix——Kwenta

This model consists of two parts: minting and trading.

First, minters overcollateralize a certain asset in the protocol to mint synthetic stablecoin assets. Minters can then earn fees in proportion to asset ratios and bear variable global debt in proportion.

Second, traders can obtain synthetic assets through minting or over-the-counter trading to go long or short.

For example, Ellie stakes $500 worth of SNX in Synthetix and mints $100 worth of sUSD. Assuming the total debt pool is valued at $200 and consists entirely of sUSD. At this point, Ellie’s Synthetix profile shows assets of $500 in SNX, liabilities of $100 in sUSD, a collateral ratio of 500%, and debt ratio of 50%.

Scenario 1: Ellie is bullish on BTC, so she exchanges all $100 of sUSD for sBTC. A week later, BTC’s price rises by 50%, and the total debt pool value increases to $250. Since Ellie bears 50% of the global debt, her Synthetix profile shows assets of $500 in SNX, liabilities of $125 in sUSD, a collateral ratio of 400%, and a profit of $25 (sBTC - sUSD). Meanwhile, she needs to add collateral or repay sUSD to increase her collateral ratio.

1. Scenario 2: Ellie chooses to hold $100 worth of sUSD. A week later, BTC’s price rises by 50%, and the global debt rises to $250. Similar to Scenario 1, Ellie bears 50% of the debt, resulting in a loss of $25 (sUSD). In this case, the profit goes to users holding sBTC.

1. In summary, the characteristics of this model are:

1. Global debt fluctuates: All synthetic assets form the debt pool, and the value of global debt changes with the quantity, variety, and price changes of synthetic assets in the pool.
2. Collateral providers bear the risk of all system debts.
3. All SNX collateral providers are counterparts in trading.

4) AMM mode

Market makers pre-deposit a certain amount of assets as a base to form a trading pool, eliminating the need for users to place orders. Instead, algorithms, often referred to as “robots,” calculate the real-time exchange rates between two or more assets, facilitating instant trading without the need to wait for orders to be placed.

5) vAMM mode

It is an innovation built upon AMM, the Virtual Automated Market Maker (vAMM). It stores liquidity providers’ funds in an intelligent contract vault. Users engage in trades solely within a virtual asset pool, separating funds from transactions and effectively mitigating risks.

Representative Project: Perpetual Protocol

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

vAMM Trading Platform = AMM Automated Quoting Algorithm

The basic model of vAMM is: x * y = K. However, vAMM itself does not store the actual asset pool (K). The value of K is manually set by the vAMM operator at startup and can be adjusted freely according to the latest market conditions. Real assets are stored in a smart contract vault, which manages all collateral of the vAMM, and the operator has no authority to move the collateral.

Using Perpetual Protocol as an example. Its V2 utilizes Uniswap V3 as the execution layer, leveraging aggregated liquidity for market-making. Users are required to use USDC as collateral, which is stored in the vault. The protocol updates the vAMM based on the vault data, and the vAMM provides quotes.

Source: Perpetual Protocol

In summary, vAMM serves solely as a pricing mechanism and does not provide liquidity itself; its LP relies on other protocols.

Features:

1. Extremely high trading efficiency: The automation of vAMM eliminates the need to wait for market makers to manually adjust prices and provide orders, instead executing trades in real-time through smart contracts, thus enhancing the speed and efficiency of transactions.
2. Zero impermanent loss: Since there is no real liquidity and no LP providers (traders act as liquidity providers), vAMM only serves as a price discovery mechanism, eliminating the issue of impermanent loss.
3. Leveraged trading: With the separation of funds and trades, traders can engage in leveraged trading within the virtual pool through a reasonable liquidation mechanism, maximizing the efficiency of capital utilization.
4. Limited liquidity: Depending on LP depth, liquidity for different trading pairs cannot be shared.

2.Main participants / Protocol Product Introduction

dydx

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

Despite being a decentralized exchange, similar to most centralized exchanges, dYdX adopts off-chain order books and on-chain settlement for trading, making it one of the few DeFi protocols that has not yet launched a governance token.

dYdX features lending, margin trading, and perpetual contracts. Margin trading includes borrowing functionality, where funds deposited by users automatically form a liquidity pool. If funds are insufficient during trading, users automatically borrow and pay interest. It is worth noting that dYdX’s margin trading is only user-friendly for large trades. Orders smaller than 20 ETH can only be executed as market orders, incurring high fees to compensate for gas costs.

dYdX’s perpetual contracts operate on both Layer 1 and Layer 2, with Layer 2 utilizing StarkWare’s layer 2 solution. The public testnet of dYdX V4 was launched on July 5, 2023, with plans to move away from Ethereum and develop an independent blockchain within the Cosmos ecosystem for increased scalability.

Since its launch in 2017, dYdX has experienced rapid growth and has consistently maintained its leading position among derivative DEX platforms, with trading volumes far exceeding those of its competitors. As of August 4th, the platform has amassed a total of 101,288 unique users, with USDC deposits totaling $4.7 million. The deposit volume has fluctuated significantly, reaching its peak at $142.7 million in September 2021. The platform’s annual cumulative trading volume has reached $275.46 billion, with a growth rate of 26%. However, despite generating $66.99 million in annual cumulative trading fees, the platform has incurred a net loss of $15.8 million over the past 365 days due to spending $96.5 million on token incentives.

Source: Dune Analytics@impossiblefinance（2023.8.4）

Source: Tokenterminal（2023.8.4）

2.2 Single-Asset DAI as an LP

gtrade(Gains Network)

Gains Network is a decentralized leverage trading platform on the Polygon and Arbitrum chains, with gTrade being the trading protocol on this platform. Its liquidity is provided through a DAI vault, offering trading pairs including cryptocurrencies, commodities, and forex.

The core advantage of gTrade lies in its multiple sophisticated risk management mechanisms. gTrade manages trading-side risks through a triple safeguard mechanism involving Price Impact, Rollover Fee, and Funding Fee.

1. Price Impact: This refers to the additional spread where larger opening positions and poorer asset liquidity result in increased prices. It is used to prevent oracle manipulation risks and facilitate the listing of coins with low market value.
2. Rollover Fee: This controls traders’ use of lower leverage.
3. Funding Fee: This minimizes the gap between long and short open contracts to prevent significant risk exposure on one side.

After gTrade went online, it presented mediocre performance in the early stage. Until January 1, 2023, after expanding to the Arbitrum network, gtrade’s trading volume increased significantly. Currently, gtrade has a market share of about 12-15%, with 15,959 unique users and a cumulative trading volume of $39.51 billion.

Source: Dune@shogun (2023.8.4)

2.3 Basket of assets as LP

GMX

GMX is a perpetual contract trading DEX, initially deployed on BSC, publicly launched on Arbitrum in 2021, and integrated with the Avalanche network in 2022.

Zero slippage: GMX has abandoned the automated market maker model (AMM) and adopted an oracle-based pricing approach. GMX only needs to inject funds into the pool, and users can complete a perpetual contract transaction relying on oracle quotes. The protocol will exchange based on the real prices from the oracle, eliminating slippage costs during the exchange process and avoiding the problem of the trading engine needing to match orders off-chain. It provides zero-slippage spot and margin trading.

GLP liquidity pool: The GLP pool is a multi-asset pool containing mainstream tokens such as USDC/BTC/AVAX, supporting users’ long or short contract demands. 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” stablecoins from the pool. This allows the GLP pool to earn LP fees for the protocol, and all profits will be distributed to GMX and GLP stakers.

Completely decentralized: The data of GMX exchange is entirely on-chain, and no KYC is required. All assets are held by smart contracts, which are open-source, and all operational data is transparently available.

Unique product innovation and the anticipation of Arbitrum’s airdrop have propelled GMX’s rapid growth. As of August 4, 2023, GMX’s cumulative annual trading volume reached $34.63 billion. Over the past three months, GMX’s market share in the category of fund pool derivative DEX has slightly decreased, with its peak occurring in April 2023 at 50%. The platform boasts a user base of 117,097 independent users. With a cumulative fee income of $81.8 million over the past 180 days, GMX ranks 8th among all protocols, surpassing even established protocols like Pancakeswap and dYdX.

Source: Tokenterminal （2023.8.4）

Source: Dune@shogun (2023.8.4)

2.4 Synthetic assets

Kwenta

Kwenta is a derivatives trading platform based on the Synthetix protocol, supporting cryptocurrencies, forex, as well as commodities like gold and silver. Kwenta acts as the frontend for Synthetix, with Synthetix serving as the liquidity pool behind Kwenta. Traders on Kwenta can trade against the Synthetix debt pool, which consists of sUSD provided by SNX stakers.

Synthetix manages the underlying liquidity and provides the contracts, while Kwenta focuses on user experience and interface design. Currently, Kwenta offers over 42 pairs of cryptocurrencies, forex, and commodities, with leverage of up to 50x.

Infinite liquidity and zero slippage: Kwenta utilizes Synthetix’s dynamic debt pool model, providing near-infinite liquidity for all trading pairs within the protocol’s safety margins. Additionally, similar to GMX, Kwenta uses oracles to directly feed index prices as the reference price, eliminating spreads and thus avoiding slippage.

In October 2020, Kwenta was launched on the Optimism public chain, and since February 2023, its business has seen rapid growth, with the highest single-day trading volume reaching $2.8 million. The annual cumulative trading volume amounts to $55.21 billion, with annual fee revenue of $22.59 million. The platform has attracted 154,560 independent users, with the euro, sBTC, and sETH being its main trading pairs.

Source: Tokenterminal （2023.8.4）

Source: Dune@impossiblefinance (2023.8.4)

2.5 Comparison of Underlying Assets

1. Seeking a way out

The Defi Summer has spurred the emergence of countless new protocols, intensifying the competition among perpetual contract DEXs. Both new and established protocols are contemplating how to iterate and innovate. When faced with challenges, we believe the breakthrough lies in four aspects: firstly, leveraging the Ethereum upgrade for performance enhancement; secondly, providing market-optimal prices through aggregated liquidity; thirdly, developing on-chain copy trading to attract more users and expand trading volume; fourthly, integrating traditional assets to compensate for the shortcomings of futures exchanges and meet diverse demands.

3.1 Ethereum Upgrade

3.1.1 Layer 2

In the past, many DEX protocols were deployed on alternative Layer 1 solutions such as BSC and Solana in pursuit of lower transaction costs and higher throughput. However, this came at the cost of sacrificing certain security measures. For instance, in May of this year, Level Finance on the BSC chain was attacked, resulting in a loss of $1 million.

But with the development of Layer 2, many projects native to Alt Layer 1 have been migrating to Layer 2. Examples include Level Finance and GMX, both of which have deployed on Arbitrum. Layer 2, relying on Ethereum, offers unparalleled security compared to Alt Layer 1. Coupled with reduced costs and improved speed after upgrades, Layer 2 will attract more DEX protocols, providing them with better underlying infrastructure.

3.1.2 Ethereum Cancun Upgrade

Compared to CEX, DEX has two core disadvantages: slow transaction speeds and high transaction costs. This is due to Ethereum’s lower throughput, but Ethereum’s upgrades and scalability are expected to solve this issue. The upcoming Cancun upgrade at the end of 2023 will introduce “Blob Transactions,” expected to save 90% of storage costs. This will significantly reduce GAS fees for on-chain transactions, lowering DEX transaction costs. As Ethereum adds more Blobs to future blocks, throughput is expected to further increase, significantly improving transaction speeds.

3.1.3 Layer 2 Stack Solution

dYdX chose to leave Ethereum and move to Cosmos’ application chain because they wanted greater modularity in their chain’s consensus layer. They sacrificed some security for scalability in the “Trilemma”. However, with Layer 2 solutions like Optimism and zkSync introducing Stack solutions, the “Trilemma” seems less impossible to be solved.

Taking OP Stack as an example, it allows developers to build modular blockchains that can be easily customized to meet project-specific needs while still relying on Ethereum to ensure security. The Stack solution balances security while enhancing Ethereum’s scalability, giving DEX better options on Layer 2. Large DEXs can even deploy Layer 2 application chains based on Layer 2 Stack.

3.2 Aggregator

From a data perspective, in 2022, due to the FTX crisis, trader confidence was severely hit, leading to outflows from mainstream centralized exchanges and a 72.9% drop in the market capitalization of Defi tokens. However, spot aggregators were unaffected and even saw growth. Taking 1inch Network as an example, it saw a 13% increase in independent users in Q4, 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. Such a significant gap in trading volume also proves the irreplaceable unique advantages of aggregators. However, in contrast, there has not yet been a relatively mature product for derivative aggregators, indicating enormous development potential. It is worth mentioning that on July 17th, Uniswap, the largest DEX protocol in terms of scale, launched a protocol called UniswapX, which aggregates liquidity from decentralized trading pools.

This protocol introduces new features such as liquidity aggregation, third-party Fillers, and one-click cross-chain trading, which can provide traders with the best prices that single liquidity pools cannot achieve. As a leading DEX in the industry, Uniswap accounts for 65% of the overall DEX trading volume. The fact that even DEX with such a large trading volume is moving towards aggregation further indicates that derivative DEX also needs to move towards aggregation.

Similar to spot aggregators like 1inch, Odos, and DeFillamaSwap, the goal of derivative aggregators is to use their algorithms to compare various protocols and find the best trading platform in terms of price and fees, facilitating the most efficient trading paths.

Derivative aggregators offer several benefits:

1. Smooth trading experience: Aggregators serve only as front-ends, focusing on optimizing interfaces and user experiences, making the user experience closer to that of centralized exchanges.
2. User
3. Offering liquidity that rivals CEX: Aggregators can integrate liquidity from DEX, CEX, LP, funds, and market makers, offering depth that is comparable to traditional DEX.
4. Rich asset categories: Due to considerations of liquidity depth and risk management, single DEX may have fewer asset types, and adding assets often requires permission. Aggregators can merge various asset categories from numerous DEX, allowing trading of assets that do not meet conditions on many perpetual contract protocols.
5. Sustainable profitability: Traditional derivative DEX needs to allocate part of the trading fees to LPs or pay interest to attract deposits. However, aggregators themselves do not need to provide liquidity, so there is no need to increase yield rates and trading fees to attract LPs.
6. Effective avoidance of token inflation: As mentioned earlier, aggregators do not need to attract liquidity by splitting revenue or distributing tokens as rewards to users. All fee income belongs to the protocol, and tokens do not face inflation and selling pressure. This significantly improves the token’s value-capturing ability, making it more investment-worthy.
7. Low deployment threshold for new chains: Traditional perpetual contract DEX are only applied to one or two public chains. The main difficulty lies in the high cost of attracting liquidity when expanding to new chains, which to some extent restricts the expansion of protocols. Aggregators can save liquidity incentives on new chains and can add multiple chains at low cost without liquidity restrictions.
8. Optimal revenue and Delta neutrality: Currently, there are numerous GMX Forks in the perpetual contract market, with similar technical architectures and implementation mechanisms, making it difficult to differentiate. However, aggregators can find the highest-yielding DEX among many GMX Forks, optimizing profits for traders. Additionally, each aggregated liquidity pool serves as a counterparty hedge, hedging against multi-asset risk exposure through various on-chain asset combinations, providing Delta neutrality for LPs.

Challenges for aggregators: Potential price differences between protocols. Due to factors such as funding rates, liquidity depth, and long/short counts, the same trading pair may have different prices on different protocols. For derivative aggregators, the goal is not only to integrate liquidity on the front-end interface but also to balance the price differences between various protocols and provide traders with a unified pricing.

Without unified pricing, aggregators are like a compilation of Defi webpages, collecting prices from various protocols but not fundamentally integrating them. Unified pricing is the essence of aggregation and integration. It not only greatly improves the user experience but also reduces the learning curve, maximizing user benefits. As for how to smooth out price differences, it depends on the capabilities of individual aggregators, whether it relies on algorithms or collaborates with underlying protocols.

In summary, derivative aggregators effectively combine the advantages of both CEX and DEX, offering the smoothness of CEX and the trustworthiness of DEX, along with massive liquidity and high composability. These factors provide them with significant room for development, although challenges remain in unifying asset prices.

Currently, derivative aggregators represent a vast and largely untapped market, with few mature products. The main protocols include Uniswap X, UniDEX, MUX, and Sushiswap DEX aggregator.

3.2.1 MUX

MUX, originally known as MCDEX, is a decentralized perpetual contract exchange powered by an AMM deployed on Arbitrum. On December 1, 2022, MCDEX officially closed and rebranded as MUX Protocol. MUX is deployed on Arbitrum, BSC, Avalanche, and Fantom, with mechanisms similar to GMX, allowing up to 100x leverage. Its V2 version introduced Liquidity Routing, where the MUX aggregator dynamically compares trading prices offered by various protocols when a trader opens a position on MUX and recommends the underlying protocol with the most suitable liquidity depth to minimize the trader’s overall costs.

Its advantages include:

1. Cross-chain liquidity sharing: In the upcoming V3 version, MUX will also support cross-chain aggregation, allowing its products to be used on public chains such as Arbitrum, Optimism, BSC, Avalanche, and Fantom. MUXLP pools on different public chains can borrow from each other and share liquidity depth.
2. Unified Pricing: To address pricing disparities, MUX will employ two methods: deep collaboration with underlying protocols and absorbing price differences itself. This ensures uniform pricing for traders seeking cross-chain positions. Traders need not be distracted by the liquidity providers behind the aggregator; they can focus solely on the unified trading interface. Currently, MUX has achieved a 7-day trading volume of $159 million, surpassing Perpetual Protocol, indicating promising growth momentum.

Source: MUX Statistics

3.3 Copy Trading

Copy trading, also known as social trading, allows users to replicate the trading strategies of traders or KOLs on the platform. This method is commonly used in centralized exchanges to build the exchange’s brand, attract traffic, reduce user operating costs, seize trading opportunities, and help signal providers earn commissions.

In terms of data, taking Bitget as an example, in 2022, driven by copy trading and contract trading, Bitget’s total trading volume grew by over 300%. The platform’s one-click copy trading product attracted over 80,000 traders and over 338,000 followers, with profitable trades exceeding 42 million, making Bitget the only CEX to achieve counter-trend growth in derivative trading within six months of the FTX collapse.

Source: Nansen

Off-chain copy trading transactions mainly come in two modes: the first is the trading display of aggregation platforms, and the second is one-click copy trading on trading platforms.

The first type of aggregation platform focuses on the “trading + community” business model, with typical examples being CoinCoin and Snowball. These platforms aggregate data from major exchanges through APIs, gathering real-time trading data from many professional traders and KOLs. Ordinary investors can see the real-time operations of experts in their accounts through these platforms, which are more transparent and real compared to traditional “order screenshots”.

Additionally, aggregation platforms also create a communication community where users can intuitively identify true trading experts from data through chat rooms and performance leaderboards. Users can also receive guidance and advice from experts. For professional traders and KOLs, aggregation platforms are the best promotional tools, and subscription fees can bring substantial revenue. For users, these platforms serve as authoritative learning communities backed by data. For the platform, it achieves the goals to attract users to build brand awareness while providing alternative and practical user education.

Source: Coin

The second type is the copy trading products offered by major exchanges, with typical examples being Bitget and Bybit. Users can apply to become signal providers when they meet specific criteria, usually based on performance and followers. Signal providers showcase their positions to attract other users for copy trading and share around 10% of their followers’ net profits.

Source: Bybit

Both models have their pros and cons. The advantages of aggregator platforms lie in their ability to integrate data from various exchanges, providing convenience and comprehensiveness. Additionally, they foster community engagement, offering alternative forms of user education and enhancing user stickiness. However, a drawback is that copy trading is not convenient and requires accessing external data.

On the other hand, the advantages of exchange-based copy trading lie in its ease of operation. The selection and promotion mechanisms for leading traders, along with robust risk controls, offer users a sense of security for their funds. However, a disadvantage is that users may blindly follow trades based solely on profitability, lacking insight into the reputation, trading logic, and quantitative metrics of the leading traders. This lack of understanding may increase investment risks to some extent and hinder user retention.

On-chain copy trading platforms can be linked with aggregators to combine the advantages of the two modes mentioned above.

1. Integrate trading data from all protocols, compile a leaderboard of traders’ performance, and then match the best followers based on the liquidity depth of DEX;
2. By establishing a community for communication and linking wallet addresses with social media accounts such as Twitter, the investment logic and industry insights of leading traders can be highlighted;
3. On-chain copy trading requires no permission, allowing anyone to become a leader and replicate the trading strategies of others.

Currently, there are not many projects with copy trading functionality in perpetual contract DEXes, with the main protocols being 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, attract followers through Twitter, and link the vault directly to GMX through smart contracts. Traders can be seen as fund managers who establish their own funds on Perpy to attract followers for subscription investment through social media. As fund managers, they are responsible for managing trades and charging certain management fees. In essence, the relationship between traders and followers mirrors that of fund managers and investors, with followers entrusting their funds to traders for management and investment.

Since its launch in 2023, Perpy Finance has accumulated a total trading volume of $50 million, while another protocol, STFX, has reached $7.7 million in trading volume. Despite the relatively low trading volumes of both protocols, the track for derivative on-chain copy trading is still in its early stages of development.

3.4 Derivative DEX + Traditional Assets

In 2022, global trading volumes for futures and options in traditional assets reached record highs for five consecutive years, showing strong momentum. However, whether CEX or DEX, most products are predominantly crypto assets. Can DEX break free from the world of cryptocurrencies and enter the broader traditional asset derivatives market?

Taking gTrade as an example, on August 1st, the outstanding volume of traditional assets (commodities and forex) on gTrade was $16 million, accounting for 42% of the total volume. At its peak, the outstanding volume of traditional assets reached three times that of cryptocurrencies, making a significant contribution to fees. However, this volume only represents a small fraction of the traditional asset derivatives market, with much more potential waiting to be explored.

Compared to traditional futures commodity exchanges and CEX, DEX has the following advantages:

1. DEX is permissionless, that is, anyone can develop any new product on the protocol without any authorization and approval, and anyone can trade the product without KYC certification. This means more flexibility and ease in adding trading categories to traditional assets.
2. DEX is also censorship-resistant and can effectively resist manipulation by centralized institutions. Under the trend of increasingly stringent central agency review and withdrawal, DEX has a broader potential market.
3. DEX can be traded 24/7, fully meeting the market’s personalized hedging needs and making up for the time constraints of traditional futures exchanges. In the future, in addition to BTC and ETH, DEX derivatives can also be agricultural products (soybeans, corn and palm oil), metals (zinc, gold and nickel), energy (crude oil, asphalt, coking coal) and so on.

Faced with such broad hedging demand for traditional assets, perpetual contract DEXes have the opportunity to expand traditional asset trading and differentiate themselves in internal competition. DEX doesn’t need to become the next Binance but rather the first decentralized Chicago Mercantile Exchange (CME).

1. Conclusion and Outlook

The competition among decentralized perpetual contract trading platforms has intensified, and facing challenges, token and LP incentives are only temporary measures. Innovating and breaking through mechanisms is the fundamental solution.

1. Seizing the opportunity, leveraging the Ethereum upgrade to enhance DEX infrastructure and increase throughput limits;
2. Integration and optimization, improving operational experience by aggregating liquidity from multiple sources and unifying prices through aggregators;
3. Learning from centralized exchanges, implementing copy trading functionality on-chain to simplify investment steps and lower trading barriers;
4. Exploring new paths, expanding beyond the cryptocurrency world to embrace the massive demand for traditional asset derivatives using blockchain advantages.

Decentralized exchanges already have advantages such as non-custodial features and high transparency. If they can provide the same quality of user experience and liquidity as centralized exchanges on top of these advantages, then the era of decentralized exchanges may be just around the corner.

Disclaimer：

1. This article is reprinted from [Gryphsis Academy], Forward the Original Title‘In-Depth Guide to Decentralized Perpetual Contract Exchanges: Tech, Trends, and Forecasts’,All copyrights belong to the original author [@elliett2077]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
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