Hidden worries in high heat? A brief analysis of GMX’s token design and potential risks

In this article you will learn:

1. How GMX is distinguished from other protocols (zero slippage for traders + no impermanent losses for LP);

2. How the value of GMX tokens is accumulated;

3. Potential risks and solutions for GMX.

Protocol overview

Launched in September 2021, GMX is a decentralized perpetual and spot exchange that trades BTC, ETH, AVAX, UNI and LINK directly from the user’s wallet on a fast and cheap network with 0% slippage, 10bps fees and up to 30x leverage, with no KYC or geographical restrictions.

GMX has a liquidity pool, GLP, a multi-asset pool that provides liquidity for margin trading: users can go long/short and execute trades by minting and destroying GLP tokens. The pool earns LP fees from trades and leveraged trades, which are distributed to GMX and GLP holders.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

In order to trade leverage, the trader deposits the collateral into the agreement. Traders can choose up to 30 times leverage, the higher the leverage, the higher the liquidation price, and as the borrowing fee increases, the liquidation price will gradually increase.

For example, when multiple ETHs are used, the trader is “renting out” the ETH’s upside space from the GLP pool; When ETH is short, traders are “renting out” stablecoins from the GLP pool with respect to ETH. But the assets in the GLP pool are not actually rented out.

When closing a position, if the trader is betting correctly, the profit will be paid from the GLP pool in the form of a token long; Otherwise, the loss will be deducted from the collateral and paid to the pool. GLP profits from the trader’s losses and profits from the trader’s profits.

During this process, traders pay transaction fees, opening/closing fees, and borrowing fees in exchange for the upside space of long/short specified tokens (BTC, ETH, AVAX, UNI and LINK) against the US dollar.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

If the trader chooses to withdraw a different collateral than the deposited collateral, it is considered trading activity and a transaction fee will be charged, as a percentage of the size of the collateral.

GLP stands for share of the liquidity pool, similar to the asset index used for trading and leveraged trading. It can be minted and destroyed using any asset in the index to redeem any index asset.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

The GLP token price is the value of the total value of assets in the index, including unrealized profits and losses for unrealized positions divided by GLP supply. The basic assumption is that every open position can be closed in the next second.

LP bears the delta risk of the asset index by minting and holding GLP tokens, i.e. holding a basket of crypto assets if the market value of the asset pool increases after LP deposits any of the specified assets.

Since GLPs are minted based on the market value of the pool of funds, the new casting activity will not make existing LP holders better/worse.

The fee for minting/destroying GLPs depends on whether the index assets are reduced/overweighted, i.e. the weights of the assets in the index are below or above their target weights. If ETH is reduced, the cost of casting GLP by depositing ETH is lower and therefore incentive.

How are the target weights set? Weekly adjustments are made based on the volume of positions: if a large number of traders go long for ETH on Arbitrum, the GLP pool will set a higher ETH target weight, and conversely, if a large proportion of people are short, the target weight of the stablecoin will also increase.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

Target weighting is easier to achieve with DEX aggregators: when some index assets are downsized, cheaper swap fees plus zero slippage can provide the best price to facilitate the large number of transactions routed to GMX, rebalancing the asset weights in the GLP pool.

Holding GLP is actually the following:

  • providing liquidity (no impermanent losses, as described below);
  • Earn 70% of the platform fees paid in ETH or AVAX;
  • Counterparties (i.e. houses in casinos) who act as leveraged traders profit from their losses;
  • Get a custodial GMX reward;
  • Diversify your investments in crypto indices.

Instead of using the standard Automated Market Maker Model (AMM) (x*y=k), GMX uses the dynamic aggregate oracle fed (from Binance and FTX) provided by Chainlink to determine the “true price” of an asset. This helps to achieve zero slippage for the execution of market orders.

This is because GMX simply extracts prices from CEX in real time, providing the best execution for traders without the need for arbitrageurs to adjust price differences between different DEXs. LPs are also protected from impermanence losses because they do not have to bear the cost of price discovery.

Token design

GLP holders, in return for their exposure to delta risk and counterparty risk (the trader wins), will receive 70% of the platform fees, profit from the trader’s losses, and esGMX, which is a reciprocal issue.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

Staking GMX tokens on the platform will earn 30% of the platform fee, esGMX and multiplier points. esGMX is a managed model similar to CurveFinance’s ve model, but it does not have a hard-lock system. Conversely, if you choose to claim the reward, esGMX will linearly release for one year.

There are two ways to use esGMX rewards:

  • It can be staked like a regular GMX to get rewards, as well
  • It can become a GMX token within 1 year, as mentioned above.

To stake an esGMX reward immediately, you can get exactly the same reward as a normal stake GMX – more esGMX, multiplier, and ETH/AVAX rewards from platform fees.

To belong to esGMX for 1 year, no rewards will be awarded and the main tokens (GLP or GMX) derived from esGMX cannot be withdrawn during this period, otherwise esGMX will be deducted proportionally. For example 50% of the principal token withdrawal = 50% of the reward is cut.

What are Multipller points (MP)? MPs are not GMX, but can earn fees like stakes (except MPs can’t earn more MPs), thus providing a bonus for long-term GMX holders by increasing the yield of GMX pledges. Earn MP at a fixed rate of 100% per second.

Percentage increase = 100 * (stake multiplier) / (stake GMX + stake esGMX); That is, the proportion of MPs to the total amount of GMX & esGMX pledged by users.

GMX earns fees by:

  • Trading fee: opening / closing a position is 0.1% of the position size;
  • Swap fee: If swap is required at the time of closing, 0.2-0.8% of the dynamic collateral size will be charged;
  • Borrowing fee: (total assets in borrowed assets /GRP) * 0.01%, accumulated at the beginning of each hour;
  • The dynamic cost of minting, destroying, or enforcing a swap depends on whether the action contributes to achieving the target weights for a particular asset in the GLP index.

The fees returned to GLP holders and GMX pledgers this week are charged from the previous week’s trading activity starting at noon on Wednesday, and the actual APR for that week depends on the trading activity of the previous week.

Potential risks to GMX

Bear bears are skewed

The biggest risk is that when the market falls sharply, some short traders win a lot, causing the GLP pool to shrink due to delta exposure, and having to pay the short trader’s profits with stablecoins, further shrinking the pool size.

A bearish short skew can cause GLP holders to suffer huge losses, making GLP no longer attractive to LP and causing TVL to decline, but as a rule of thumb, the delta risk of the GLP pool is somehow hedged (or compensated) by the trader’s losses.

One of the reasons is that it is more difficult to sell short, which is why most people lose money in a bear market

Exhausts the GLP pool

Another risk is that traders will not be able to collectively profit to exhaust the GLP pool. This can happen if the OI net exposure accounts for a significant portion of the available liquidity on the platform, especially for the bears in a bear market.

To ensure that this does not happen, a dynamic OI cap may be set based on the real-time net exposure of all asset positions that are long/short on GMX.

Long-tail asset risk

The oracle pricing model works for liquid assets such as ETH, but not for less liquid assets. Especially under extreme market conditions, the Chainlink oracle may stop offering prices for certain tokens, and GMX may suffer huge losses as a result.

Since most of the perpetual trading volume comes from liquid assets, reducing the number of long-tail trading pairs will not cause major problems for GMX’s business. CEX has the same problem, which is why perpetual trading pairs are always much lower than spot trading pairs.

Potential risk solutions

There was a recent problem that Avalanche’s traders used GMX’s oracle pricing model and AVAX’s thin liquidity in CEX to get $566,000 from the GLP pool by manipulating AVAX’s off-chain price. Many people start to worry excessively about and FUD GMX. But I don’t think so.

How did the event occur? For example, a big ETH whale familiar with GMX buys $50 million ETH through GMX and then goes to a large CEX like Binance and FTX to buy $40 million ETH, raising the price by about 2%. $10 million * 2% of net exposure is revenue. Slippage and transaction fees are the costs.

How can I avoid exhausting my GLP pool due to zero slippage? GMX can extract more data, such as order depth (or implied DEX slippage), in order to pass on more accurate costs/fees to the trader. GMX can lower the OI cap for less liquid tokens and automatically set the OI cap based on CEX liquidity

AVAX is priced at 20 million on Binance and FTX, and the OI cap on the GMX platform should be 20 million, so if new open positions add up to more than 20 million, slippage should be charged and returned to the GLP pool to ensure that traders don’t have better results.

One might ask: What is the value proposition of @GMX_IO if slippage fees are charged? The short answer is that the liquidity available for zero-slippage trading on the platform may be higher than that of any single CEX, at least at any time interval.

Other Information

I strongly recommend that you also take a look at @Riley_gmi’s comprehensive report, and I have also taken some reference from the report.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

Flood Capital also posted several high-quality tweets.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

@rektdiomedes also wrote a good summary that is also worth your time reading.

Hidden worries in high heat? A brief analysis of GMX's token design and potential risks

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/hidden-worries-in-high-heat-a-brief-analysis-of-gmxs-token-design-and-potential-risks/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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