Perpetual Protocol (PERP) | On-Chain Perpetual Swaps For Crypto Assets | Deep Dive
Review Date: January 14th, 2021
The perpetual protocol is a decentralised derivative protocol built on Ethereum, focused on offering perpetual swap contracts with low slippage trade execution on a variety of crypto assets. The cryptocurrency derivatives market is set for disruption as shown by the success of automated market maker (AMM) protocols such as Uniswap eating into the cryptocurrency spot market legitimising the ‘DeFi eating CeFi’ narrative.
Perpetual protocol solves trade liquidity by introducing virtual AMM’s a modification of DEX liquidity pools and transaction latency via integration with Ethereum sidechain xDai plus a flexible architecture that allows migration to any other L2 scalability solution seamlessly.
Virtual Automated Market Maker (VAMM)
Automated market maker’s are the core technology of decentralised exchanges and are used for both asset pricing and facilitating asset swaps in a liquidity pool. The most common is the constant-product AMM (x*y = k) as used by Uniswap. Virtual AMM’s use the same constant product pricing equation but the key difference is instead of storing assets in a liquidity pool they are instead stored in a smart contract that emulates a vault that manages all the collateral backing the vAMM [1].
This means that liquidity providers are not needed to facilitate leveraged trading compared to a central limit order book model which requires market makers to facilitate low slippage trades by providing liquidity to the bid and ask side of a market.
The following trading example better illustrates how a vAMM operates:
- A trader wants to long ETHUSDC with 100 USDC at 10x leverage.
- The 100 USDC collateral will be locked in a vault contract and 1000 vUSDC will be credited to the vAMM.
Using the constant-product equation the trader’s unrealised PnL in vETH is calculated using the constant product equation. Essentially one trader’s gain is another trader’s loss and the vault is fully collateralized to credit every trader’s position.
Layer-2 Scalability: xDai & Beyond
When it comes to on-chain derivatives trading it’s imperative that transaction execution time is near-instant in order to capitalise on a market opportunity. The Ethereum mainnet is still suffering from a transaction bottleneck resulting in increased transaction fees in order for transactions to be included in the latest block which is not an ideal trading execution environment. Therefore, it’s essential that derivative protocols integrate a layer-2 scalability solution to first bypass the transaction bottleneck of the main chain and to secondly have the ability to instantly execute a trader’s order.
L2 scalability solutions have progressed immensely over the last year and several DeFi protocols such as Uniswap and Synthetix’s are actively integrating Optimism’s optimistic rollup to sufficiently scale for protocol demand. However, many solutions are not production ready. Perpetual protocol has taken an interesting approach to this problem. First by creating a flexible architecture that would allow at any moment a snapshot of the current state and the ability to port that state to another L2 solution once they become production-ready. Currently, the L2 solution being used is the xDai Ethereum sidechain.
xDai is an Ethereum sidechain that uses a POSDAO consensus algorithm but is EVM compatible meaning any smart contracts deployed on Ethereum can be deployed on the xDai chain. This sidechain is very attractive to derivative trading protocols due to it’s fast transaction times averaging at around 5.7 seconds per block and extremely low gas fees per transaction [2]. During the latest mainnet trading competition on Perpetual protocol, there were 48k trades executed which cost $1.69 in gas fees covered by the team meaning traders were essentially trading via gasless transactions.
Perp Tokenomics
The PERP token first and formally is a governance token which when staked will allow holders to accrue and delegate voting rights to vote on protocol improvement proposals. In addition to protocol governance, there is significant utility deriving from the upcoming staking mechanic which will allow holders to capture PERP inflation and also 50% of the trading fees generated by derivative trading distributed in USDC.
Although decentralised derivative protocols are in their infancy, the potential for growth and fee capture is huge. In the last 7 days $300k USDC of fees have been generated through 93k trades on the platform meaning $150k USDC would be distributed to those staking PERP. The total daily volume and open interest of each market is continually increasing and will see larger volumes on the addition of new assets with YFIUSDC being the most recent addition.
In an increasingly harsh regulatory environment on cryptocurrency derivative trading, traders will look for a non-KYC solution resulting in a mass exodus from centralised exchanges to protocols like Perpetual. The greater the volume generated on the platform, the larger the amount of fees distributed to stakers and greater the incentive for market participants to purchase PERP and lock-in to capture the fee distribution.
Perp Token Distribution
Perpetual protocol raised $1.8M in a strategic round led by Multicoin Capital with notable participants such as Three Arrows Capital, Alameda Research, Divergence Ventures and Mechanism Capital. Since the launch of mainnet 25% of seed and strategic investors PERP tokens have been unlocked with 25% per 3-month period being unlocked afterward.
| Lot | Token | Vesting Period | Description |
Balancer Liquidity Bootstrapping pool | 7.5M PERP (5%) | Sep 2020. | Balancer LBP Token launch. |
| Seed Investors | 6.25M PERP (4.2%) | 25% unlocked on mainnet launch. 25% unlocked per 3-month period. | Early investors into the protocol. |
| Strategic Investors | 22.5M PERP (15%) | 25% unlocked on mainnet launch. 25% unlocked per 3-month period. | Strategic Investor round. |
| Team & Advisors | 36M PERP (21%) | Vested until 6 months after mainnet launch. Unlocked at a rate of 2.1% at a 3-month period. | Team and advisor token equity. |
| Ecosystem & Rewards | 77.75M PERP (54.8%) | All unlocked after transition to community governance. | Rewards for traders, stakers and community developers. |
Coming Protocol Additions
Staking Mechanism
As outlined above the Perpetual staking mechanism is still under development with the Staking Reserve. sol contract is publicly available in the Perpetual Protocol GitHub repository. The contract is currently being audited and is set to release sometime at the end of January.
Limit Orders
In its current state, Limit orders are absent from Perpetual protocol meaning traders are at risk of being liquidated as no stop-loss order is there to manage the risk of the position. Limit orders are a fundamental requirement for traders who do not want to constantly manage their position and want a specific entry based on their technical analysis of the market. There is an open Gitcoin grant incentivising community developers to contribute to Perpetual protocol and be rewarded in its governance token.
Addition Of New Markets
As the DeFi ecosystem and its crypto-assets continue to penetrate both Institutional and retail focus there will be an increased demand for perpetual swap contracts on these emerging crypto assets. With the recent addition of YFIUSDC and more to come, this has the potential to attract significant volume to the DEX. As per the staking incentive structure, this will reap obvious benefits for PERP stakers with increased fee capture and distribution.
Summary
Perpetual protocol has demonstrated technical ability in its vAMM innovation for providing on-chain liquidity for leveraged traders without the need for liquidity providers and flexible architecture for migrating to new layer-2 scalability solutions. As new markets are added and new functionality such as limit orders are introduced, the daily volume and subsequent trading fees captured by the protocol will bootstrap PERP staking. Backed by notable funds and advisors in the DeFi ecosystem this protocol has the potential to be a leader in the emerging market of decentralised derivative protocols.
REFERENCES
- https://medium.com/bollinger-investment-group/constant-function-market-makers-defis-zero-to-one innovation-968f77022159
- https://exchange.futureswap.com/
- https://medium.com/futureswap/announcing-futureswap-v2-on-chain-perpetuals-with-live-pricing-e6a440939033
- https://medium.com/futureswap/futureswap-governance-token-distribution-d2712c855da5
