Perptual Futures DEX: From Niche Trading Venue to on-chain Application Driver

Perptual Futures DEX has shown rapid development in the recent cryptocurrency market, with significant improvements in efficiency, speed, and scalability. This article aims to explore how Perptual Futures DEX is not only limited to trading scenarios but is also expanding the scope of blockchain applications, paving the way for the large-scale adoption of Web3.

Exchanges, as a core component of the cryptocurrency market, support market operations through trading activities among users. The primary goal of any exchange is to achieve efficient, fast, and secure trade matching. Based on this goal, DEX has made numerous innovations on top of CEX, such as eliminating trust assumptions, avoiding intermediaries and centralized control, retaining user control over funds, and allowing community participation in product iteration.

However, looking back at the development of DeFi, it can be found that DEX, despite having multiple advantages, often comes at the cost of higher latency and lower liquidity, which is mainly limited by the throughput and latency of the blockchain. According to data, the spot trading volume of DEX accounts for 15%-20% of the total trading volume in the cryptocurrency market, while Perptual Futures trading only accounts for 5%.

Developing Perptual Futures business on DEX faces many challenges, as CEX has the following advantages in Perptual Futures trading:

1. Better product experience
2. Market makers efficiently control and provide more precise spreads.
3. Better liquidity, especially for mainstream assets
4. One-stop combination with multiple functions

The centralization and monopoly of CEX have become issues that users cannot ignore, especially as the collapse of FTX further exacerbated the trend of centralization. Currently, the CEX sector is almost entirely dominated by a few giants, and this centralization brings systemic risks to the crypto ecosystem. By increasing the usage rate and market share of DEX, such risks can be effectively reduced, promoting the sustainable development of the entire crypto ecosystem.

The rise of Ethereum Layer 2 and multi-chain ecosystems has provided innovations for liquidity sources and user experience, creating favorable conditions for the development of DEX. Currently, it is an opportune time for the development of Perptual Futures DEX. This article will delve into the current state of Perptual Futures DEX and introduce some design concepts of DEX.

Perptual Futures in the Crypto Ecosystem: An Important Tool for Speculation and Hedging

Perptual Futures allow traders to hold positions indefinitely, similar to over-the-counter futures trading in traditional financial markets for many years. The difference is that Perptual Futures introduce the concept of funding rates, popularizing the futures trading method and enabling more retail investors to participate, while creating a "under-damping effect" that prevents the long-short structure from becoming excessively imbalanced to a certain extent.

The current monthly trading volume of the Perptual Futures market has exceeded $120 billion, a scale that benefits from the good user experience provided by exchanges, the trading efficiency promoted by the order book mechanism, and the fast and secure clearing achieved by the vertically integrated clearing system.

In addition, projects like Ethena that utilize Perpetual Futures as an underlying mechanism bring diversified uses to Perpetual Futures beyond speculation. Generally speaking, Perpetual Futures have four advantages over traditional futures contracts:

1. Traders save on rollover fees and other associated costs at each contract expiration.
2. Avoid making the futures contracts more expensive
3. The funding rate system provides continuous real-time profit and loss, simplifying the backend processing flow for contract holders and the clearing system.
4. Perptual Futures provide a smoother price discovery process, avoiding severe fluctuations caused by overly coarse price granularity.

Since BitMEX introduced Perptual Futures in 2016, perpetual contract DEXs have rapidly developed, and now there are over 100 DEXs supporting Perptual Futures in the market. Early perpetual contract DEXs were small in scale; in 2017, dYdX launched on the Ethereum ecosystem and dominated the perpetual contract market for a considerable time. Nowadays, we can see active perpetual contract DEXs on various chains, and contract trading has become an indispensable part of the crypto ecosystem.

Multiple studies have shown that as the trading volume of Perptual Futures increases, the Perptual Futures market has begun to possess price discovery functions during times of inactivity in the spot market. The trading volume of Perptual Futures on DEX grew from 1 billion USD in July 2021 to 120 billion USD in July 2024, with a compound annual growth rate of approximately 393%.

However, Perptual Futures DEX faces bottlenecks due to blockchain performance limitations. To further develop the Perptual Futures market, it is essential to address the two core issues of low on-chain liquidity and high latency. High liquidity can reduce slippage, making the trading process smoother and minimizing user losses; low latency allows market makers to quote tighter prices, enabling fast execution of trades and enhancing market fluidity.

Perptual Futures DEX Pricing Model

In perpetual futures DEX, the pricing mechanism is key to ensuring that market prices accurately reflect supply and demand dynamics. Different perpetual futures DEXs have adopted various pricing mechanisms to balance liquidity and reduce volatility. Here are several main models:

Oracle Mode

The oracle model refers to how perpetual futures DEXs obtain price data from leading exchanges with high trading volumes and provide services. Although there is a risk of price manipulation, it can reduce the pricing costs of DEXs. For example, the decentralized perpetual futures exchange GMX.

By using Chainlink oracles to obtain price data, GMX ensures the accuracy and integrity of prices, creating a friendly trading environment for price takers while providing substantial rewards for price makers. However, exchanges that complete pricing using oracle models are extremely dependent on the price data sources of leading exchanges and can only act as price takers, unable to actively participate in price discovery.

Virtual Automated Market Maker vAMM

The virtual automated market maker (vAMM) model is inspired by Uniswap's AMM model, but the difference between the two lies in the fact that the AMM model provides liquidity and pricing through actual liquidity pools and corresponding exchange rates, while the vAMM's liquidity pool is virtual and does not actually hold assets; it simply simulates the buying and selling behavior of trading pairs through a mathematical model, thereby achieving pricing.

The vAMM model supports Perpetual Futures trading without the need to invest large amounts of capital and does not have to be associated with spot trading. Currently, the vAMM model has been adopted by Perpetual Protocol, Drift Protocol, and other Perpetual Futures DEXs. Although vAMMs have issues with high slippage and impermanent loss, they remain an excellent on-chain pricing mechanism due to their transparency and decentralized characteristics.

off-chain order book combined with on-chain settlement

To overcome the performance limitations of on-chain order matching, some DEXs have adopted a hybrid model of off-chain order books and on-chain settlement. In this model, the trade matching process is completed off-chain, while trade settlement and asset custody remain on-chain. As a result, user assets are always under their control, which is known as "self-custody." Meanwhile, since trade matching occurs off-chain, risks such as MEV are significantly reduced. This design retains the security and transparency of decentralized finance while addressing issues like MEV, providing users with a safer and more reliable trading environment.

Some well-known projects, such as dYdX v3, Aevo, and Paradex, have adopted this hybrid model. This approach improves efficiency while also ensuring security, which is in line with the concept of Rollup.

on-chain order book

The full-chain order book, which completely places and processes all data and operations related to trading orders on-chain, is the optimal solution among traditional methods for maintaining trading integrity. The full-chain order book is almost the safest option, but its drawbacks are also quite evident, being significantly affected by the delays and throughput limitations of the blockchain.

In addition, the full-chain order book model also faces risks such as "front-running" and "market manipulation". Front-running refers to when someone submits an order, other users (usually MEV Searchers) monitor pending transactions and jump ahead before the target transaction is executed, thereby earning profits. This situation is relatively common in the full-chain order book model because all order data is publicly recorded on-chain, allowing anyone to view and formulate MEV strategies. At the same time, in the full-chain order book model, since all orders are transparent, certain participants may exploit this by influencing market prices through large orders and other means, thereby obtaining improper benefits.

Despite the aforementioned issues with the on-chain order book, it still possesses considerable narrative appeal in terms of decentralization and security. Public chains like Solana and Monad are working to improve infrastructure in preparation for the full-chain order book. Some projects, such as Hyperliquid, dYdX v4, Zeta Markets, LogX, and Kuru Labs, are also continuously expanding the scope of the full-chain order book model, either innovating on existing public chains or building their own application chains to develop high-performance full-chain order book systems.

Acquisition of Liquidity and UX Improvements in DEX

Liquidity is the foundation upon which every exchange relies, but acquiring initial liquidity is a tricky issue for exchanges. In the development of DeFi, emerging DEXs generally obtain liquidity through incentives and market forces. Incentives often refer to liquidity mining, while market forces provide traders with opportunities for arbitrage between different markets. However, as more DEXs emerge, the market share of individual DEXs decreases, making it difficult to attract enough traders to reach the "critical mass" of liquidity.

The term "Critical mass" here refers to "effective scale," which means that after a certain thing reaches a sufficient scale, it breaks through the minimum cost required to maintain the development of the thing, in order to achieve maximum long-term profits. If it exceeds or does not reach the effective scale, the product cannot achieve maximum profitability; a good product must operate sustainably under the effective scale.

In a DEX, critical mass refers to the threshold of trading volume and liquidity; only by reaching such a threshold can a stable trading environment be provided, thereby attracting more users. In Perptual Futures DEX, liquidity is spontaneously provided by LPs, so a common method to achieve critical mass is to set up LP pools with economic incentives. In this model, LPs deposit assets into the pool and receive certain incentives to support trading on the DEX.

Many traditional DEXs offer very high annual percentage yields (APY) or airdrop activities to attract LPs, but this approach has a downside. To meet high APY and airdrop returns, DEXs must allocate a large portion of their Tokens as LP mining rewards, and such an economic model cannot be sustained for long. It will fall into a vicious cycle of LP mining "digging, withdrawing, and selling," and DEXs may soon collapse and be unable to operate continuously.

To address the challenge of acquiring initial liquidity for DEX, two new approaches have recently emerged: community-supported active liquidity vaults and cross-chain liquidity acquisition.

The perpetual futures DEX Hyperliquid on Arbitrum is a typical case of an actively supported liquidity vault by the community. The HLP vault is one of the core products of Hyperliquid, utilizing funds from community users to provide liquidity for Hyperliquid. The HLP vault calculates fair prices by integrating data from Hyperliquid and other exchanges and executes profitable liquidity strategies across multiple assets. The profits and losses (P&L) generated from these operations will be distributed based on the shares of community participants in the vault.

Cross-chain liquidity allocation is proposed by Orderly Network and LogX Network, among others. These projects allow the creation of a frontend for perpetual futures trading on any chain, enabling liquidity leverage across all markets. The so-called "inter-market liquidity leverage" refers to the integration and utilization of liquidity resources across multiple markets or public chains, allowing trading platforms to access liquidity on different markets or public chains.

By combining on-chain native liquidity, cross-chain aggregated liquidity, and creating discrete asset market neutrality (DAMN, which refers to the integration of various independent assets to construct a portfolio that is insensitive to market conditions, hedging the impact of market fluctuations on the portfolio) AMM pools, LogX can maintain liquidity during periods of extreme market volatility. These pools use stablecoins such as USDT, USDC, and wUSDM.