Ever since Uniswap has now become a dominant player in spot asset swaps within crypto, with volume rivaling that of even most centralised exchanges users and speculators would always look for what will be the venue that allows for on chain derivatives to finally surpass the volume of centralised exchange offerings. Many exchanges have come close with novel experiences that partially differentiate themselves from Centralised exchanges or even offer a service that is comparable to that of CEX’s. Some obvious examples would be DYDX a decentralised perpetuals exchange that would host their orderbook offchain and matching engine whilst offering all other services such as deposits on chain, offering the benefits of self custody with the speed and experience comparable to that of a centralised exchange. Another example would be GMX a margin product now moving more towards a perpetuals offering. Their original V1 offered deep liquidity on the most popular assets to trade at the time such as BTC and ETH offering zero slippage as a core selling feature for whales, making it an attractive venue for larger traders to make bets on. However even though both of these venues did reach significant size in daily volume and users. They were still insignificant compared to some of the larger players in the industry. I believe this mainly stemming from the drawbacks these exchanges had, with DYDX although the experience was great, liquidity at times was still not comparable to that of most CEX offerings especially when you went further down the list of tradable assets. GMX had a similar issue mainly stemming from the potential inability to trade if all the liquidity on the platform were utilised at the time, making it inconvenient for traders during periods of excessive leverage. I believe the answer to eventually gaining a substantial foothold in the derivatives landscape, you must take a look at how similar market dynamics have shifted in the past and the way they got there. I first want to take a look at probably the most famous example of a decentralised offering rivaling centralised offerings with Uniswap.
Uniswap
Many people might have forgotten but when Uniswap was merely Uniswap V1, it wasn’t even considered the top offering in the DEX space let alone having any significant market share in the centralized exchange offering space. In 2019 the original V1 implementation of Uniswap had not really seen too much traction and usage with many of the features that users associate Uniswap with not being implemented yet. The top DEXs in the space at the time were Bancor and Kyber both having much larger market share offering for most users opinions at the time a better product. However this would all change shortly with the implementation of Uniswap V2 bringing one of its most important features of all time. Permissionless market creation. This along with the addition of automated routing made Uniswap the place for projects to launch on. If a team wanted to have their token be tradeable, you wouldn’t need to go and get it listed on a CEX, you could launch a Uniswap pool, pair your token with ETH and suddenly it would be tradable by anyone with an ETH wallet. The real beauty was the use of automated routing, meaning that majority of trades would route through the ETH/USDC pool, incentivising users to deepen the liquidity there as most users at the time were purchasing assets in either ETH or USDC. This coupled with the emergence of more and more onchain activity during 2020 (DeFi summer) created a boom for Uniswap, people kept launching questionable yield farms that would yield a token, incentivising liquidity for that token through a pool2 mechanism. This was done for almost all protocols that launched during this era and would even spread into other verticals as well, such as gaming with AXS needing its own pool, NFTs when they launched a token would need their own pool. Effectively Uniswap had captured the whole long tail asset market, listing assets faster than any centralized exchange could ever dream of. It had solidified itself as the king of DEXs with its competitors working on small UX improvements that overall did not move the needle. All markets that launched on Uniswap had their own oracle as well, allowing for some level of interplay potentially with other applications in crypto, however limited due to the overall ease of exploitation and other issues at the time. However this was enough, people loved the product and Uniswap was most likely the biggest innovation on the app layer for all of Crypto. The question is, how come this hasn’t been replicated for derivatives yet?
Issues
One of the biggest issues first of all stems around the most tradable product being perpetuals. Which rely heavily on funding rates to somewhat maintain the peg of the perp offering similar to that of the spot product. This was a big issue since most decentralised derivatives offerings use oracles to keep track of the spot price which is then utilised to calculate the funding rate. This would usually utilise an oracle provider such as Chainlink, although it does offer price feeds for a various amount of assets across a multitude of networks, it is usually a service with many requirements before you can get a price feed up. Such as liquidity for the asset in DEXs, certain market cap threshold and even usually listings on a few centralized exchanges that are reputable. They can make exceptions for assets with either a lot of traction or interest (think APE upon launch). This oracle dependency for most derivatives exchanges is a huge limiting factor for capturing the true long tail, permissionless listings cannot be possible if oracles are a huge dependency.
Another difficulty with traditional perpetuals is that all centralized formats are done on orderbooks which for LTA's are usually incredibly dubious to market make for. Protocols like GMX make it very easy to do so with GLP, however increasing the tail end will overall jeopardize the GLP model itself, hence very few assets are comprised in GLP. A LTA perpetuals exchange would need to ensure that providing liquidity would be as simple as Uniswap v2 which gave rise to token launches on Ethereum.
Promising Solutions:
There are a few promising protocols that are looking to launch LTA derivative products, personally I wanted to highlight a couple that have come out recently. Exponents a primary market for oracle free on chain derivatives takes a very novel approach using inverse bonding curves to create profitable arbitrage opportunities between the regular uniswap xy =k curve and then the inverse curve, allowing for permissionless market creation. With Exponents you could launch a regular perpetuals market on top, leverage tokens and inverse leverage tokens freely through their protocol, as they merely aim to be the base layer for a much larger derivatives ecosystem to flourish on top.
Another that has more recently come to light would be Particle trade, aiming to achieve the same goal of allowing anyone to trade with leverage utilising their new leverage AMM (LAMM) with no price oracle, no counterparty risk and no forced liquidations.
I do believe that this space will open up over the next years as builders and investors look at possible projects that can look to fill the gap between centralized derivatives offerings and decentralized derivatives offerings.
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