Perpetual Protocol launched its new V2 a little more than a week ago called - Curie.
The protocol is a decentralized exchange for trading perpetual options and it is getting a major redesign. In fact, it is the largest decentralized futures exchange with over 70% market share. Why change things up? Well, there is always bigger fish to fry. To fry bigger fish, you need more liquidity. The key goals are to improve upon capital efficiency and attract more participants to the platform.
Before we jump into how it works here’s the tl;dr on the update in case you’re feeling extra lazy.
Launching on Arbitrum (optimistic rollup solution for Ethereum. 2000 tps vs 32 tps).
Using Uniswap V3 as the execution engine
Moving from an AMM-based trading method to more of an Order book-based model (Uniswap V3)
Permissionless markets (anyone can create a perp market for any token)
Multi-Collateral (roadmap item but hold ETH or BTC as collateral instead of USDC)
The biggest change with V2 is the shift away from the virtual AMM trading model in favor of using Uniswap V3. The virtual AMM (vAMM) acted as the counterparty in each of the trades in V1. This has the effect of the protocol taking on risks when positions get unbalanced. It also cripples the protocol from scaling (attracting new, bigger users) since the price is only updated once traders trade against the AMM. When there are only a few thousand traders at most, the price and funding rates can be slightly out of line with the broader market. And of course, since the original x*y=k model was used, liquidity was spread across all price ranges making it inefficient. All of this changes when using Uniswap V3.
Introducing UniV3 as the execution engine enables market makers to step in and create a much more efficient market to trade in due to Uni’s ability for LPs to dynamically provide liquidity in ranges on the price curve. Market makers will provide liquidity around the current price and dynamically update positions to reflect market conditions. Assuming that market makers are able to provide deep liquidity, traders will see more accurate price representations.
Market Method
So how does it all work? How can they just use a permissionless Uniswap V3 and not have other people interfere with the trading? Is there now impermanent loss? How do you do leverage on Uniswap?
Curie’s contracts will take in USDC as collateral from traders just as before and issue virtual USDC in exchange when a trade is placed. The virtual USDC is kept within the smart contract and is used to swap in Uniswap AMM pools that only use Perpetual Protocol’s virtual tokens. That way only the protocol is the one interfacing to the AMM pools.
How a trade would work on say 3x leverage long would be as follows. Trader deposits $100 USDC and is allotted 300 vUSDC in the smart contract. That is swapped in the vUSDC/vETH Uniswap pool to receive vETH. This represents the position. Once the trader closes the position, the vETH is exchanged in the same AMM pool at the current USD price of ETH.
Market makers follow a similar set of events except instead of swapping in the pool, virtual assets can be supplied to the pool as liquidity along ranges defined by the market maker. For example, 1000 vUSDC could be deployed as 0.25 vETH and 500 vUSDC (assuming an ETH price of $2000). This introduces a unique factor for LPs - leveraged market making.
In Curie, market makers or liquidity providers will have the same ability to leverage as the trader. The same way 100 USDC turns into 300 vUSDC for the trader applies to the market maker. By leveraging the market position, you are able to earn more fees relative to capital.
That’s not without risk since, in V2, LPs are directly taking the other side of the trade - not the whole AMM. However, professional market makers are able to balance risk to remain whole. Overall, this is a net positive allowing for much deeper liquidity to be provided to traders which is one of the chief inhibitors to scaling version 1.
What about impermanent loss? Does being a liquidity provider - much less a leveraged LP - in Curie mean being subjected to Impermanent loss? Short answer is no. Since the underlying collateral is all USDC, there is no real IL. The trading pools may say vUSDC or vETH or vLink or whatever, but know these are just manifestations of the USDC collateral provided by traders and market makers.
Markets
Markets will be permissionless meaning that anyone will be able to create a perpetual market for a token. While the specifics are not released, it can be assumed that the permissionless nature will attract more down-risk assets. In turn, expect more traders (especially retail). They will now - given the grand power of DeFi - be able to go 10x long on dog tokens while answering to no one.
However, the other side of the coin remains. We know in Curie that liquidity is sourced from market makers and that means you need makers willing to provide inventory to each market. The team has already stated that there will be liquidity mining (token rewards) for top markets although the details have not been announced. Attracting competent makers to tail assets may be more challenging especially if LP rewards won’t apply across the board.
Sort of related to attracting liquidity to specific markets is understanding the chain it runs on. You could frame launching on Arbitrum doesn’t necessarily mean there will be infinite liquidity there from day one. It will take time for enough liquidity to make its way since in effect it will be fragmented among many competing chains. However, to help size the risk, at least for Perpetual Protocol, understand Perp grew to be the largest decentralized futures market with 70%+ market share on xDai. A sidechain with a fraction of the usage of Polygon and other competing chains. If they could do it there, they can do it on Arbitrum.
Uniswap Impact
The first thing that jumps out is the fact it is built on top of Uniswap V3. This is the first project to actually implement something new on top of UniV3 (other people just manage LP positions - not that sexy or net new). The design (and legal protections) of UniV3 lends itself well to becoming a foundation for DeFi apps. Look at Solana and the Serum DEX there. Serum serves essentially as a single exchange for multiple projects in Solana where it is the norm to build directly on top of it. If market makers can navigate Uni’s order ranges effectively, then Uniswap has a legitament chance at dominating order execution on Ethereum. And that’s not just for spot. Derivatives - which is what the futures traded on Perpetual are - require fast price updates and Uniswap’s original design performed poorly in pricing these assets. Now we have the largest decentralized futures exchange deciding to build on Uni.
Quick note on Uni fees. Uni currently and for the foreseeable future returns all fees to the LP. Meaning that Perpetual protocol may bring a lot of volume to Uniswap, the fees are kept within the protocol (all the LPs come through Perpetual) and not collected by Uni.
Since we are on the topic of the AMM, a hot topic there is MEV. Is MEV possible with Perpetual’s new design? Does the leverage nature juice up the MEV rewards. No and No. Since the pools being traded are the virtual token pools like vUSDC/vETH and the v assets are only controlled by the Perpetual smart contracts, then there is no straightforward avenue for a miner to extract MEV.
Looking Ahead
From a competitive standpoint, it seems Perpetual Protocol’s new update address the key selling points of top competitors. dYdX runs on an efficient order book -building on Uni V3 puts the protocol toe to toe here. MCDEX runs a permissionless perpetual market also launching on Arbitrum and was the only permissionless game in town until Curie was announced.
It seems from a competitive standpoint, Perpetual is positioned well to retain much of its users/volume. The next trick will be how effective the protocol can be in attracting enough liquidity and centralized traders to the platform. When it comes to spot markets you get the underlying token. In DeFi, that token is used to unlock a plethora of rewards and utility. However, with perpetual markets, positions have yet to be utilized in broader DeFi in part due to the composability challenge. That is solved by being on Arbitrum. If traders are able to trade the same size and gain additional benefits from DeFi for their activities, then making the switch may be worthwhile.
Saypien
Noteworthy Items
Axie is now over 500k daily active users and did over $300M in volume….. last week. [Tweet]
TikTok bans crypto/investment pitches [Twitter]
New AMM for Terra launches in Astroport (supported by Delphi and IDEO) [Tweet]
Synthetix announce Optimism Launch end of July [Tweet]
Crypto venture funding nearly doubles from Q1 2021 to Q2 [Link]
Greyscale becomes an SEC-reporting company [Link]
A couple big developer tools announce support for Arbitrum - Truffle and Infura [Tweet/Tweet]
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