Looking for the next flashpoint of DeFi

In the long run, derivatives trading may become the mainstream in the DeFi world, even across the cryptocurrency market, directly competing with traditional finance.

Earlier, many people believed that DEX cryptocurrency trading would never replace CEX. How can this simple continuous trading product (AMM) replace Binance or Coinbase ? And the DEX fee is so expensive, it will definitely fail, right?

No, we believe that although DEX has not surpassed CEX in terms of transaction efficiency and cost, DEX has successfully proved its own value. DEX next two years may still be trading efficiency is not high , fees expensive problem, but even so, the application of DEX AMM model combined market value of the product has been as high as several hundred billion dollars, of which only Uniswap ‘s market capitalization reached $ 15 billion .

Can DEX surpass centralized exchange giants such as FTX? After all, centralized trading platforms like FTX have a perfect user experience, efficient and stable liquidity, and a cross-storage margin mechanism, and they operate 24 hours a day, provide inclusive services (after KYC) , and the user input cost is extremely low. CEX such as FTX should still be the most efficient trading place for derivatives in the near future.

But does this mean that DEX needs to be as efficient as FTX in order to attract user trading volume? This time we have to avoid some false assumptions put forward by some people before, and also avoid underestimating the advantages of smart contract exchanges.

So what are the advantages of decentralized derivatives exchanges?

Decentralization & censorship resistance

In addition to security, decentralization also means transparency, open decision-making, community leadership, and prohibit centralized institutions from abusing power or even censoring differences. Therefore, in addition to the cryptocurrency market, DEX has an overall potential market (TAM) , that is, DeFi derivatives , which is much larger than CEX’s TAM. This part will be launched in detail under “Market Opportunities” below.

Recently, the Uniswap web front-end has blacklisted some derivatives assets based on regulatory considerations. In contrast, Liquity (http://www.liquity.org/) hopes to maximize decentralization, and even sets up an incentive mechanism to support decentralized front-ends (https://medium.com/liquity/liquity -runs-on-decentralized-frontends-d0142f09495c) innovative design. In order for DEX to fully release its potential, the DeFi protocol can learn from Liquity’s approach.


Derivatives DEX should be permissionless. Anyone can use the agreement to develop new derivative products into the market, and anyone has the right to use this product. If you want derivative products with specific functions, DEX should allow anyone to use ERC-20 and other tokens for arbitrage trading like Uniswap.

The permissionlessness creates a unique derivatives market. Moreover, this is another prerequisite for DeFi exchanges to develop businesses other than cryptocurrencies (the former is decentralization) . As long as DEX has complete permissionlessness, securities or commodity transactions can be carried out, not just cryptocurrency transactions.

Composability: DeFi puzzle

Although composability is a cliché in the topic of DeFi, composability also opens up development opportunities beyond DeFi. In the past, composability in DeFi meant that on-chain applications used protocols as infrastructure. Now, composability means smooth cross-chain flow of assets on the chain .

After the assets on the DeFi protocol are tokenized, they can be used on multiple chains at the same time. Compared with closed centralized exchanges, DeFi networks have higher capital efficiency.

For example, you deposit ETH on Maker , mint DAI , and exchange 50% of DAI for ETH. Use DAI and ETH to provide liquidity for Uniswap and obtain corresponding LP tokens in Uniswap. Stake LP tokens on Maker, cast more DAI, and obtain leverage of LP tokens on Uniswap. Does it sound complicated? (Https://app.defisaver.com/recipes/book) .

DeFi derivatives are also composable, and liquidity can be obtained from other agreements. You can obtain LP tokens from AMM, loan agreements, income aggregators, etc., as margin for derivative transactions.

In addition, the integration of NFT and DeFi (https://medium.com/iosg-ventures/road-to-financialization-of-nfts-145f3829dfdf) also expands more possibilities. We can use fragmented NFT tokens as margin to trade derivatives on DEX. Vice versa, positions on DEX can also find more usage scenarios on DeFi Lego through NFT. There is no dazzling derivative DEX that focuses on speculative trading. Therefore, the imagination of DeFi for composability is huge.

Composability: cross-protocol margin mechanism

Recently, Kyle Samani proposed that the winner in this DEX derivatives battle will be the first agreement to support cross-margining . The main reason why FTX has become the number one derivatives platform is because it has perfect cross-margining. mechanism.

However, in DeFi, the matter of cross margin may become another Money Lego (there will be a middleware/aggregation layer agreement specifically to provide such services for DEX) , the future DEX business does not necessarily need to develop cross margin functions by itself . DeFi Money Lego provides the possibility for the operation of cross-protocol cross margin mechanism.

In addition to the cross-protocol deposit, this aggregation layer can also play the role of an aggregator in a broader sense, helping users optimize price slippage, payment interest rates, and so on. Therefore, it can support an unprecedented market depth, allowing multiple DeFi DEXs to compete with CEX. In addition, it should resolve the pricing differences between different DEXs and ultimately promote the transfer of most trading volumes to the market with the best liquidity.

Positive impact of DeFi derivatives

The derivatives market essentially needs external information. As shown above, a powerful oracle is essential to the development of this direction. Therefore, oracle service providers will be in a favorable position to monetize the growth of DeFi derivatives.

In addition, DeFi derivatives offer possibilities for a range of products that were not possible before. For example, Lemma  (https://docs.lemma.finance/what-is-lusdc) aims to use derivative DEX to create a decentralized and USD-pegged synthetic stablecoin. Although there are some flaws in the design, its mortgage rate is reduced to 100% , which still has advantages over other agreements.

The growth of derivatives on the chain provides opportunities for integration with revenue aggregation agreements that can arbitrage differences in capital interest rates and generate another source of income.

In addition, on-chain derivatives can increase liquidity on the AMM platform . Up to now, the role of on-chain liquidity solutions in hedging impermanence risks is still very limited. Recent research shows (https://dune.xyz/vividot/Uniswap-V3-Vault-Range- src=”https://img.jinse.com/5588343_image3.png”>

Source: IOSG Ventures; Data Source: Coingecko API

Larger trading volume does not mean that derivatives have greater market opportunities. Due to virtual exposure and leveraged trading , the pricing power of derivatives exchanges will be weaker than that of spot exchanges. For example, spot trading exchanges such as Coinbase, Binance, Huobi or Kraken charge between 0.1% and 0.5% , while futures trading fees will be as low as 0.04% . Therefore, from the perspective of an exchange, the trading volume of 1 dollar in the derivatives market is not as valuable as the trading volume of 1 dollar in the spot market.

A similar situation applies to DEX. For example, Sushiswap pledgers can receive 0.05% of the total transaction volume in the form of dividends, while MCDEX DAO and PERP pledgers will receive approximately 0.015% of the total transaction volume on Mai v3 and Perpetual Protocol, respectively.

We expect that even with the conversion of derivatives trading volume, the medium and long-term derivatives will grow into a market that is several times larger than the spot market. In the medium term, the institutionalization of the industry will add more transactions to the derivatives market.

In the long run, the volume of decentralized derivatives, based on its non-censorship and permissionless features, may surpass the cryptocurrency market and solve the problem of the global derivatives market.

Simply put, the ultimate development goal of derivatives DEX is not FTX but the Chicago Mercantile Exchange. This means that eventually DEX can be extended to more traditional stock market derivatives, such as agricultural products (wheat, raw cattle) , as well as energy derivatives (crude oil) and metals (gold and copper) . All of these are not geographical, which means that DEX can meet global hedging needs.

In addition, DeFi can bring liquidity to various industries. For example, changing traditional finance from Monday to Friday trading to all-weather trading, or tokenizing real estate with extremely poor liquidity to increase its liquidity.

Looking for the next flashpoint of DeFi

Source: https://markets.businessinsider.com/news/stocks/all-of-the-worlds-money-and-markets-in-one-visualization-2020-1029239678

Current Derivatives DEX Industry Map

Looking for the next flashpoint of DeFi

DeFi derivatives market projects

Options (Options)

Most projects are building crypto options. Among them, Opyn, Pods, Hegic, Siren, Primitive, etc. are creating ordinary options on the chain. Thales and Divergence have issued binary options. Ribbon and UMA combine their respective option proceeds to build financial products. Volmex used option data to derive the implied volatility of encrypted assets, and Shield and Deri also issued perpetual options.

Looking for the next flashpoint of DeFi

Option agreement; classified according to trading mechanism 

Interest rate derivatives (Interest Rate Derivatives)

Interest rate swap projects are creating interest rate-based derivatives that allow users to bet on the direction of DeFi yields or hedge against volatility. Even in the nascent DeFi field, this direction is still at an early stage, but there are already competitive participants. Among them, Swivel relies on the order book mechanism to promote interest rate swaps, Pendle and Element have unique AMM designs, and Sense uses Uniswap v3 As the executive layer.

DeFi interest rate derivatives products

Sustainable contract (Perpetual Swaps)

Finally, the largest market in the derivatives sector is the perpetual contract/future exchange. According to data from tokeninsight.com, the trading volume of cryptocurrency futures and options in 2020 will reach US$12 trillion and US$77.2 billion, respectively, which is more than 150 times that of the cryptocurrency options market .

Although the concept of perpetual contracts was proposed as early as the 90s (https://ideas.repec.org/a/bla/jfinan/v48y1993i3p911-31.html) , it can also be regarded as an innovation in the encryption industry. Because this concept was first realized in 2016, BitMex decided to launch permanent futures on its exchange. Since then, perpetual contracts have become the most popular financial product in the crypto field, and the trading volume of large centralized exchanges has been increasing.

Considering the obvious market opportunities, many teams are attracted by the DeFi perpetual track and create new solutions here, among which we have compared several interesting designs.

Looking for the next flashpoint of DeFi

Source: IOSG Ventures

As of now, only Perpetual Protocol v1 and dYdX in the above table are already running on the mainnet, while Perpetual Protocol v2, MCDEX Mai v3 and Futureswap v3 are waiting to be released on Arbitrum (  Note: Arbitrum has launched the mainnet public beta version on September 1st , MCDEX V3 has also been launched on the Arbitrum mainnet for the first time) , SynFutures is also testing their v1.

Until recently, dYdX opened transaction mining, Perpetual Protocol has been the number one in transaction volume growth . Therefore, we will explore the fundamental reason why Perpetual can have such a large market share and understand its development potential.

Looking for the next flashpoint of DeFi

Source: IOSG Ventures; Data Source: Coingecko API

Growth analysis of Perpetual Protocol

As shown in the figure below, an ordinary user will generate a daily transaction volume of more than 250,000 US dollars, with a peak value of close to 3 million US dollars. The highest daily transaction record is maintained by 0x1a48776f436bcdaa16845a378666cf4ba131eb0f. This account generated more than 12,000 transactions on May 24, 2021, with a transaction volume of more than 100 million U.S. dollars .

Looking for the next flashpoint of DeFi

Source: IOSG Ventures; https://duneanalytics.com/momir/Perpetual-Protocol

The emergence of users with such a large transaction volume shows that Perpetual is basically robot trading. In order to further explore this hypothesis, we can classify the transaction volume according to the transaction frequency, assuming that if the address has more than 100 transactions per day, it is likely to be a robot.

We divide traders into three categories:

  • The number of daily transactions is less than 10 times -low-frequency traders. Generally speaking, this is what they most want to trade users, which is the random flow of retail investors.
  • The number of daily transactions is 10-100 times -medium frequency traders. This is the middle category, lower than it is the random trading volume, higher than it is the arbitrage bot.
  • The number of daily transactions is 100 -high-frequency traders.


As shown in the figure below, high-frequency traders account for about 80%-90% of the total agreement !

Looking for the next flashpoint of DeFi

Source: IOSG Ventures; https://duneanalytics.com/momir/Perpetual-Protocol

Robot trading on Perpetual

If Perpetual does not minimize the use of oracles, then such a large volume of machine transactions/quantitative transactions cannot exist.

vAMM only uses the oracle once an hour, and the oracle allows the robot to correct the price difference between Perpetual and other protocols. Recently, Perpetual Protocol published an article (https://medium.com/perpetual-protocol/perpetual-protocol-arbitrageur-bot-8742c6d72e80) and code to help users run their own robots on the platform.

Initially, most of Perpetual’s trading volume was contributed by only a few traders. 0x1a48776f436bcdaa16845a378666cf4ba131eb0f has been ensuring that the vAMM price is accurate since the first day. In the first ten days of Perpetual ‘s launch , the address continued to generate about 90% of the transaction volume .

Looking for the next flashpoint of DeFi

Source: IOSG Ventures; https://dune.xyz/queries/114916

However, trading is a zero-sum game. If there is no other party to trade, what is the motivation of this address? Therefore, this address may be an internal address only used to pull up Perpetual data and prove the vAMM concept.

However, the recent agreement has much less dependence on 0x1a48776f436bcdaa16845a378666cf4ba131eb0f. Generally speaking, the contribution of this address does not exceed 15% of the total. The number of robots has also increased significantly, especially after the integration with Hummingbot in March, there are currently more than 50 robots competing regularly every day .

Looking for the next flashpoint of DeFi

Source: IOSG Ventures; https://duneanalytics.com/momir/Perpetual-Protocol

Minimizing the use of oracle machines and large-scale robot trading makes Perpetual the number one competitor of DEX derivatives. However, the most worrying point is that they cannot attract a larger user base. There is no DEX derivative that can attract a large number of users, so this track still has a chance to compete.

Perpetual is moving forward from the initial design and is preparing to release v2 on Arbitrum and use Uniswap v3 as the execution layer . Compared to the original version, Perpetual’s biggest upgrade is the license-free feature of DEX , cross-margin engine , and the benefits of being part of the Uniswap v3 ecosystem . Capital efficiency and a larger retail base are the most important changes.

Reasons why DeFi derivatives have not yet exploded

Under the leadership of Uniswap and other AMM mechanisms, the spot market has become very prosperous. The DEX agreements have yet to find the key to open the door to the derivatives trading market. At the peak stage, the spot transaction volume of the DeFi agreement can reach 40% of the transaction volume of the largest centralized trading market . This is a considerable number, especially when DeFi did not get much attention in the industry a year ago.

On the other hand, decentralized derivatives trading is even more unmatched than centralized derivatives trading. The trading volume of the former only accounts for 0.2% of the trading volume of the latter .

Looking for the next flashpoint of DeFi

Source: IOSG Ventures; Data Source: Coingecko API

The decentralized derivatives trading market is still in its infancy, and most protocols are currently under development or have just been launched recently, such as the Starkware version of dYdX. The development process is relatively slow because derivatives transactions are much more complicated than spot markets or simple token swaps, which involve a series of risk management, margin transactions, clearing mechanisms, and stable price-feeding mechanisms.

For example, although Synthetix was launched as early as 2017, it is only preparing to start futures trading on Optimisim Layer 2 later this year. The founder of Synthetix wrote a recent article-“Frontrunning Synthetix: A History” (https://blog.synthetix.io/frontrunning-synthetix-a-history/) , which summed up the possibility of developing a leveraged trading platform Challenges that will be encountered.

In Synthetix’s first 50 improvement proposals , 25% are solving the problem of running away. In 2019, the runaway event almost made Synthetix disappear from the DeFi world, and one of the robots had a chance to withdraw 11 billion sETH from the price feed failure ! Fortunately, the Synthetix team discovered and froze the agreement in time, avoiding worse results. The runners will observe the Ethereum Mempool and use this to determine the updated oracle price of the next block, and then they will use this information to submit a transaction with a higher gas fee.

Considering that derivatives trading is a leveraged transaction, and derivatives agreements will also rely heavily on oracles, so at the current stage, risk management is almost a difficult task for many agreements.

The future development of derivatives

Some solutions include reducing its dependence on the oracle when designing the protocol, adapting to current technical limitations or waiting for the improvement of the infrastructure.

Most agreements choose the latter. Therefore, dYdX chose Starkware, Synthetix chose Optimism, MCDEX is waiting to be launched on Arbitrum, Perpetual is running its v1 version on xDAI, and it is preparing to run its v2 version on Arbitrum. There are many protocols that choose low-latency public chains such as Solana. On issue.

The main risk

Considering that most derivatives agreements use liquidity pools and counterparty transaction mechanisms, the risk of preemption restricted to Ethereum Layer 1 becomes critical.

Due to its higher throughput, Layer 2 can achieve low latency for the oracle, so it is possible to prevent preemptive runs. At the same time, Layer 2 can also support the operation of more complex decentralized leveraged trading protocols including Synthetix and MCDEX. Of course, due to the leverage of these agreements, the oracle risk is also magnified, and any small mistake or any complicated arbitrageur playing with the system may cause great losses.

Even if Perpetual v2 does not choose an oracle and chooses an active liquidity provider to increase capital utilization, there is still a risk of loss due to arbitrage.

The difference is that in Synthetix or MCDEX, risk is systematic and may affect the entire pool, but in Perpetual, risk is limited to individual liquidity providers. The extent to which Perpetual can alleviate this problem depends in large part on the quality of the LP strategy yet to be developed. 


The advancement of infrastructure and the continuous development of innovative designs give us confidence that in the near future, decentralized derivatives exchanges will slowly catch up with centralized derivatives exchanges and take away their market share. .

In short, in the long run, derivatives trading may become the mainstream in the DeFi world, even across the cryptocurrency market, directly competing with traditional finance. However, we are still at the beginning of the marathon. Although arbitrage is positive for the development of the track, because they ensure price efficiency and create a real quantity for the AMM protocol, it is the project that can win the largest user group that can win in the end (https://twitter.com/ SBF_FTX/status/1426431416850657280) , it may be ordinary retail investors, giant whales, or institutional investors seeking to hedge or speculate in different assets.

In order to achieve large-scale applications, the composability of the ecosystem, as well as the permissionless listing and flexibility of collateral driven by the community, will play a key role. The consideration of liquidity or capital utilization may be secondary to the demand for the product. That is to say, in the early stage of product development, derivatives agreements should pay more attention to meeting the needs of the community rather than considering how to maximize the liquidity of BTC transactions. Of course, these factors may become key differentiating features in the later stages of the derivatives competition and are also reasons for attracting institutional capital.


Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/looking-for-the-next-flashpoint-of-defi/
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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