The prevailing view in the Reddit community (e.g. Wall Street Bets) is that financial derivatives are more about gambling than managing risk.
However, a look at the increasingly popular DeFi derivatives program shows that risk and finance are inextricably linked, and Wall Street Bets is correct in saying that risk management tools are ideal for gaining leverage to increase returns. Over the past year, capital has poured into centralized digital asset futures exchanges. Decentralized derivatives programs have shown early potential to capture a growing market share.
As financial capital continues to flow into DeFi, on-chain derivatives make sense for both digital native risk takers and managers. projects such as Synthetix, UMA and Perpetual Protocol have created blockchain-based financial derivatives for the new financial system. Each project has its own unique approach to deriving value from the rapidly expanding demand for derivatives. Although the revenue model is not empirically proven, the phenomenal volume growth on Perpetual Protocol shows its huge profit potential.
Introduction to Financial Derivatives
A financial derivative is a contract to exchange assets at an agreed upon date and price. If the contract can be bought or sold, its price is derived from the price of the underlying asset.
The owner of the asset can guarantee the value of its assets by purchasing “the right to sell the asset at a fixed price in the future”. In this case, the derivative acts like insurance, guaranteeing that the asset can be traded at a minimum price. As with insurance, this entails a premium, usually calculated using a dynamic pricing model, which includes the probability that the asset price will be higher or lower than the contract price at maturity.
At any time during the life of a derivative, the value of that derivative can be converted into an equivalent amount of the underlying asset. This equivalent amount represents the derivative owner’s exposure to the underlying asset. In this way, derivatives can be considered synthetic assets because they simulate the exposure to the asset, rather than owning the asset itself.
One application of synthetic asset exposures is as a hedge to protect the value of the underlying asset relative to any denominated currency. An asset owner can combine a certain amount of the underlying asset with a long or short derivative to create a currency-linked position. This type of position management is common in foreign exchange and commodity risk management.
Digital Asset Futures Market
The digital asset futures market has grown exponentially in the last year. Most exchanges are centralized like traditional financial institutions. Despite the fact that these exchanges are not available in some countries, the monthly trading volume of BTC and ETH alone exceeded $2 trillion in 2021. In the last 12 months, the market has grown by more than 600%. Despite the impressive growth in trading volume, digital derivatives are still not widespread. The growing market is driven by traders looking for an edge, and decentralized platforms can still have a share in it.
Market participants can use derivatives to manage risk, but others can also use derivatives to earn income or use speculative leverage to generate excess returns. Just as an asset owner can combine assets with derivatives, a market maker can combine multiple derivative positions to earn the spread between buying and selling contracts. A speculator can buy or sell derivatives, betting on the price movement of the underlying asset and earning a return in excess of the capital required to purchase the contract.
Both types of participants can use leverage, or borrowed money, to increase their returns. Like any debt, trading leverage is risky because its value is a non-linear function of the price of the underlying asset. Not only can directional price movements change the value of a contract, but the rate of change, volatility and other factors can cause the value of a derivative to move in an unfavorable direction more quickly than the underlying asset. The volatility of digital assets makes futures trading attractive to sophisticated participants seeking higher returns.
Perpetual Contracts, or Swaps, are standardized agreements to buy and sell assets with no fixed settlement date. Instead, traders agree to swap the difference between the spot price of the asset and its index price. This can be useful for participants who typically want to manage their risk in two different ways. Asset owners who wish to protect the value of their assets in a declining price environment can go short, or sell permanent swaps for cash flow when the spot price exceeds the index price. Another participant takes a long position when the spot price lags the index price, or purchases a swap for cash flow. In the event of a price increase, the swap buyer protects a short position in the underlying asset.
Perpetual Protocol Getting Started
Perpetual swaps create an exchange of value between the marker price of an asset and the index price.Perpetual Protocol swaps use periodic capital payments to exchange the difference between the agreed asset price (or marker price) and the prognostic machine price (or index price). The marker price is the time-weighted average price (TWAP) from Perpetual’s virtual automated market maker (vAMM). The index price is the TWAP from the Chainlink price feed. perpetual calculates the money payout hourly by subtracting the marker TWAP from the index TWAP and dividing by 24.
When the bid TWAP exceeds the index TWAP, the funding rate is positive and the long side pays the short side. Conversely, when the index TWAP exceeds the marker TWAP, the funds rate is negative and the short position pays the long position. This exchange happens once an hour.
Perpetual’s vAMM does not store user deposits like Uniswap does. Instead, it prices the position using the user deposits calculated by the AMM curve. This prevents impermanent losses, as the amount required to close a position is equal to the amount of the original order. Any difference in the vAMM price of the asset is credited or debited from the user’s deposit as profit or loss or PnL.
Traders can use margin to take positions up to 10 times larger than their collateral deposit. The agreement automatically liquidates or closes leveraged positions that exceed 16 times the value of their collateral. This is the minimum ratio to maintain the margin level, or collateral to position value. When the ratio of collateral to position value is 6.25%, the Keeper bot will partially sell the position and collateral to bring the margin back to the maintenance level. the Keeper bot earns 1.25% of each notional position they liquidate. Robots, like nodes, can be run by anyone on the blockchain to earn revenue for services performed for the protocol.
Users interact with Perpetual Protocol on the first layer of the mainnet, Ether, while the protocol performs all transaction operations on the second layer, xDai. Users’ USDC deposits in the first layer are mirrored and mapped to xDai, and xUSDC positions are credited to Vault. root Bridge (Root Bridge) smart contracts connect Perpetual’s L1 and L2 systems, separating the two systems and allowing limited transactions between the layers to operate efficiently. Regardless of the cost of gas, transaction costs are low because the most complex and frequent transactions occur on xDai.
Perpetual has designed its architecture to be transferable to any other L2 extension solution. The entire system, including the existing ledger of user positions, can be transcribed to any other L2. Perpetual’s flexibility means that it can grow with the ethereum community independent of the success of xDai or the adoption of any extension solution.
The insurance fund protects the agreement against rapid losses (rapid losses) in any extreme price event. The swap trader pays 0.1% of the trading volume to Perpetual DAO as a fee. Each week, the agreement pays 50% of the transaction fee to the PERP pledge and 50% to the insurance fund. While the trading activity increases the liquidity risk of the agreement, or the ability to pay the funding rate and liquidate positions, it also adds capital to the insurance fund. As the ratio of insurance funds to open positions increases, liquidity risk is more effectively mitigated.
PERP Token Economics
Perpetual uses a native token, PERP, for governance and protocol usage. perpetual DAO participants use ERC-20 tokens and vote based on their PERP holdings relative to total supply.
Perpetual DAO uses pledging to control the supply and demand for PERP. Pledgers are rewarded with PERP tokens based on their share of the PERP pool. Currently in beta, the protocol issues 150K PERP per week in two tranches: flow rewards and vested (vested) rewards. The liquidity bonus is calculated as 50% of the Perpetual Exchange transaction fee earned for that week. An equivalent amount of PERP is deducted from the 150K issued each week and made available to the insured. Any remaining weekly issuance is paid as a vested incentive and is available for withdrawal after six months. A 14-day cooling-off period is required for all pledge withdrawals before PERP can be used.
Transaction fees incentivize pledges. The PERP for pledges controls inflation and overall liquidity. The agreement is designed for deposit requirements to grow with perpetual swap transactions. As transactions increase, the transaction fees paid to pledgers also increase, which can attract PERP pledgers to the Perpetual Protocol’s pledge pool. The increase in pledges limits the supply of PERP for trading, which should create upward pressure on prices.
Pledge rewards will change from capped, PERP-denominated weekly rewards to transaction fee sharing. perpetual DAO has partnered with Delphi Digital to develop a new pledge reward program. Testing is currently underway to finalize the percentage of the insurance fund, currently 5% of open positions, and to demonstrate the long-term stability of the agreement.
As with most derivatives platforms, both token market supply and protocol trading drive the value of PERP. synthetix and UMA are two of the largest decentralized derivatives protocols by market capitalization. synthetix uses the Chainlink prophecy machine to mint ERC-20 tokens, using the prophecy machine to match the price of its underlying assets, which span multiple sectors of cryptocurrency, forex, UMA is a set of tools that enable developers to create ERC-20 and other blockchain-based derivative assets. They have different models, and we can compare them on the aspect of how effectively they collect revenue from trading capital.
Perpetual has led the DeFi derivatives program in volume growth by a wide margin. six months later, the program has more than quadrupled its average daily trading volume. This is no fluke. Digital asset trading volumes have grown at a similar rate over the same timeframe, and Perpetual’s swaps product has grown alongside the industry as a whole with key features that could sustain its volume advantage.
The perpetual swap product offers more straightforward, combinable returns than other DeFi products. Both long and short users can build income-generating strategies with their existing positions without the need to deposit capital. A small capital outlay of one perp can increase price risk through leverage up to 10x. Synthetix and UMA are clear that they do not offer leverage. The combination of leverage and volume growth presents a tremendous opportunity for Perpetual and PERP holders as they continue to develop their revenue strategies.
Perpetual swaps are traded independently of PERP supply and pledges (except for PERP swaps used to hedge PERP pledges). In contrast, SNX pledgers capitalize all minted Synths, creating a closed feedback loop between the SNX value, sUSD, and Synths in circulation. synthetix sets higher transaction fees because the fees contribute to the capitalization of the system. Perpetual agreements incentivize PERP holders to control PERP supply, but more bets do not increase the system’s derivatives capacity. the UMA program enables developers to mint and pledge their own derivatives assets. As a set of tools, UMA helps developers maintain the value of their assets, but the protocol itself does not take risk, so UMA tokens are used strictly for governance, not capitalization or incentives.
PERP holders are rewarded for locking their PERPs into the protocol, and Perpetual Protocol controls the market supply of PERPs in this way. The transaction costs of the perpetual swap contracts boost the pledged rewards above the planned PERP inflation rate. The Protocol is designed with this structure so that the value of PERP increases as transactions increase. the PERP pledge yield also increases as the volume of transactions in the Protocol increases, which should increase the pledge supply of PERP and reduce the supply on the exchange.
Perpetual Protocol’s 70% utilization rate is indicative of its high capital efficiency, as the swap is collateralized by its posted margin. Available collateral, including USDC discounted margin deposited in Clearing House Vault, and transaction fees deposited in an insurance fund. This is closer to a traditional financial model than a blockchain protocol. synthetix uses SNX collateral to collateralize derivative assets. synthetix is self-backed by the system itself, so it requires more collateral because synths do not settle after they are minted. The developer casts derivatives with UMA and determines its eligible collateral types and ratios. network participants on UMA remain capitalized, so the collateral value has a wide range from the derivative value, which reduces efficiency.
Perpectual’s usage will continue to grow as the derivatives market grows. In the early years of the program, the growth in trading volume suggests that users prefer Perpetual’s leverage and yield opportunities. When Perpetual finalizes its transaction fee model, PERP pledgers will receive higher yields than established programs. More importantly, maintaining the current level of trading will allow the agreement to stabilize by increasing the incentive and insurance funds for PERP pledgers. The agreement could use leveraged trading to mitigate unavoidable risks, thereby turning current trading volumes into a sustainable competitive advantage.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/volume-advantage-shows-perpetual-protocols-huge-profit-potential/
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