What are Perpetual Decentralized Exchanges?

Decentralized perpetual exchanges, commonly referred to as perp DEXs, allow investors to trade perpetual swaps. The core difference from centralized service providers such as Binance is that traders trade against community liquidity, making liquidity providers the counterparty instead of a centralized exchange and, of course, the self-custody of assets. 

Key Takeaways

• The proliferation and growth of leveraged on-chain trading has been a pocket of growth throughout the bear market, highlighting the appetite for decentralized services from crypto users.

• On-chain derivatives allow global and permissionless access to leveraged trading products.

• Perpetual future DEXs have three core constituent parts: a trading interface, a governance token, and a community-funded liquidity pool that acts as the counterparty.

Volatility – the warm pulsing blood that keeps investors glued to prices and the movements in the crypto markets. Volatility is the reason people are here, hooked and invested. Taking volatility and adding the magical ingredient of leverage creates something as marvelous as it is dangerous. Welcome the era of decentralized perps.

The rampant growth of perp DEXs has been a sub-chapter in the larger narrative of Layer 2 growth. Layer 2s and vertical scaling facilitated the performance necessary to allow for the explosion of perp DEXs that have swelled in value and popularity. 

Their growth provides an excellent example of how scaling core infrastructure leads to greater functionality. Before Layer 2s, the execution was too slow for decent fills, and unless traders were trading with size, gas costs added another fee, slowly chipping away at profit margins.

What are Perpetual Swaps?

Perpetual swaps are unique to crypto and mirror a traditional Futures Contract with a few notable adjustments. They have no expiry date and converge on the spot market price through a funding mechanism – longs pay shorts, or shorts pay longs.

Futures Contracts are a TradFi invention where two parties enter an agreement to purchase an asset on a specific date at a predefined price. These contracts have real-world application in the commodity markets where producers may want to lock in prices on volatile assets (for example oil), and purchasers may want to guarantee that the asset will be delivered on that date in the specified quantity. They provide a hedge against volatility and allow the commodity market to function as producers do not have to worry about market fluctuations. However, they have increasingly become a tool for speculation because they allow for leverage. 

Perpetual swaps allow crypto traders to speculate on price movements without owning the underlying asset and access leverage, enabling increased market exposure.

The Anatomy of a Perp DEX

Trading Interface 

The interface varies from protocol to protocol but retains several vital features. Above is the gTrade interface, the trading platform of Gains Network. Most import charts from TradingView, where traders can access their favorite tools for analysis and observe price action in the form of candlesticks.

Open Interest is the number of outstanding positions; gTrade provides a sum of both open interest long and open interest short. This provides an easy way for traders to judge market sentiment: higher open interest long means more traders have opened long positions, indicating positive market sentiment, and greater open interest short means traders expect the price to dip.

Funding is the mechanism that keeps perp prices tied to spot prices by essentially charging traders for a divergence in spot versus perp price. If the demand for ETH longs is high, there will be a premium (ETH perp price trades above ETH spot price), and in this scenario, traders with long positions open pay traders with short positions open – known as positive funding rate. The inverse is true when demand for shorts heavily outstrips demand for longs. Perp DEXs typically integrate an oracle service, the most prolific being Chainlink, to import the spot price. This financial mechanism maintains equilibrium between perp and spot prices and opens arbitrage opportunities.

For example, Delta Neutral strategies allow traders to take advantage of the funding rate. If there is a positive funding rate, traders can open ETH perp shorts and buy ETH spot, meaning they soak up the funding rate in an almost risk-free trade.

Collateral is the crypto that traders deposit to open leveraged positions, and the leverage slider allows them to select how much leverage they want to apply in their trade. Protocols provide a breakdown of fees, an estimated execution price, and, importantly, a liquidation price. 

Governance Token 

Perp protocols all have a governance token, and although there exist nuances and various types of sub-token categories, such as escrowed tokens. Conceptually, the two leading tokens are the governance token and the liquidity token. 

The governance token entitles users to a percentage of platform revenue and typically acts as a liquidity efficiency tool within the ecosystem. At its core, the governance token represents a stake in the protocol; it is how protocols capitalize in the early stages and presents the best way to gain upside potential for future growth. 

An example would be Arthur Hayes, the former CEO of BitMex (an exchange specializing in derivatives), who saw the potential in GMX and bought the governance token GMX at about $20. It now prints him hundreds of dollars denominated in ETH daily. 

Community Counterparty Liquidity Pool 

The other core token is the liquidity token which allows retail investors to participate in market-making activities and earn fees in return. In the perp DEX landscape, two dominant models have evolved: the popular index of assets pioneered and popularized by GMX and the more simplistic stablecoin approach utilized by Gains Network and Vela. 

In the first case, investors mint the liquidity token by supplying any of the assets contained within the index. Then when desired, they can redeem any asset contained within the basket. In the second case, users supply stablecoin often with a locking period. 

This community-funded liquidity pool is the counterparty for all trades, and protocols channel the bulk of platform rewards to these liquidity providers. In essence, supplying liquidity to a perp DEX in this format makes a bet that more traders will lose than win, and losses will outpace gains. Judging from the success of perp DEXs, this certainly appears to be the case. 

The Holy Grail: Leverage 

Leverage – using borrowed capital to increase returns – the cornerstone of modern economies. 

The modern world has become increasingly financialized, and leverage has become hard-baked into the system. Specifically in the West, when demographics soured in the 1980s, and organic growth slowed, the economy turned to cyclical credit boosts.

Powerful demographics drive organic growth: more young people participating in the economy results in a highly productive population. The inverse is true; an aging population means more dependents and a shrinking labor force. The meta of the modern Western world is relying on cyclical credit boosts and creating credit to bolster balance sheets to supplement poor organic growth. 

This can be most keenly observed in the 1990s with Alan Greenspan, then chair of the Federal Reserve, who kept interest rates artificially low, allowing for wealth creation unbacked by real economic growth. Alan Greenspan began with a little, which has since become a lot. For the past few decades, the Western world has operated with either incredibly low, effectively zero, or even negative interest rates. 

Arguments can be made that this credit amplifies growth today at the cost of tomorrow, and everything that is leveraged up must eventually be deleveraged. Historical examples include The Wall Street Crash of 1929, leading to The Great Depression or, more recently, the 2008 Financial Crisis. 

This section is not meant to critique, solely sketch the larger narratives at play in economics. Leverage presents an integral part of the entire economy far beyond crypto. The greatest wealth-creation tool for many ordinary individuals is homeownership – one of the only times people use leverage. It is a potent tool that humans naturally tend toward, further explaining the explosive growth of perpetual exchanges. 

Leading Perp DEXs

Before Layer 2s, traders had to go to the BNB Smart Chain to trade perpetual futures on-chain. ApolloX was the runaway leader in this epoch, providing perpetual trading services for PancakeSwap, the dominant DEX on the BNB Smart Chain. 

The only other alternative was to use centralized exchanges, and trading volume has caused Binance to grow into the platform it is today. But as advances in scalability provide new possibilities, the next generation of perp DEXs rapidly evolve, and most of these reside on Layer 2s, specifically the Arbitrum network.

GMX 

It is impossible to talk about perp DEXs without discussing GMX, which has played an oversized role in popularizing on-chain perps. GMX dominates in terms of TVL (Total Value Locked), three times larger than its closest on-chain competitor, dYdX, and five times larger than gTrade. GMX has seen over $108 billion in trading volume and generated $163 million in fees for GMX and GLP holders on the Arbitrum network alone. 

GMX benefits from its liquidity depth, providing zero price impact trades with flat fees of 0.1% of position size to open and close a position. GMX is fully open-sourced and has, at the time of writing, already been forked 27 times. 

The GMX V2 testnet has just gone live, and V2 will increase capital efficiency, introduce isolated liquidity for each market, and open new markets with new tradable assets. GMX is undeniably the protagonist of the perp DEX narrative. 

Gains Network

Gains Network offers 91 trading pairs, including cryptos, commodities, forex, US stocks, and US indices, providing the closest experience to trading on a centralized exchange. 

Gains Network’s wide variety of assets and DAI vault, where liquidity providers can earn high single-digit APYs on DAI, have made it a top competitor to GMX. One of the only disadvantages of Gains Network is that trade positions must be larger than 7,500 DAI, meaning traders must be well-capitalized or utilize excessive leverage. 

For all the degens, Gains Network does allow 150:1 leverage on cryptos, three times greater than GMX’s 50X leverage.

Source: Dune

Gains Network has seen nearly 15,000 unique traders, close to $40 billion in trading volume, and generated roughly $30 million in fees for stakers in the DAI vault across Arbitrum and Polygon. 

Vela

Vela launched its Beta earlier this year. It reached an impressive $70 million in TVL at its peak, saw more than $4 billion in trading volume, and attracted 50,000 unique traders. 

Unfortunately, the Beta closed earlier than anticipated due to complications that arose from the USDC depeg (liquidity providers utilize USDC to provide counterparty liquidity on Vela), and there were some complications for traders with open positions that have been partially resolved – 50% refund already processed, and a 50% refund pending with the official launch.  

The official Vela Exchange launch should take place in May, along with an airdrop for Beta participants. If Vela can replicate its Beta performance, it will rapidly rip through the TVL rankings again. Vela supported several crypto assets and provided leveraged trading on the Euro, Sterling, and Yen. 

Vela offers a brilliant user interface, and its roadmap details its expansion plans, eventually becoming a ‘home base’ for traders, including OTC trading and a tax and finance dashboard. 

MUX 

MUX is a cross-chain leveraged trading protocol currently live on Arbitrum, Binance Smart Chain, Avalanche, Optimism, and Fantom. The protocol offers leverage of up to 100X and employs an index of assets for its community liquidity pool. 

But it is MUX’s aggregator function that sets it apart. Currently, across perp DEXs, liquidity remains scattered, and the pricing of opening and closing trades varies; MUX’s aggregator optimizes routing, reducing costs for traders while allowing positions to be opened. For example, through MUX, traders can open positions on Gains Network with a size of less than 7,500 DAI. 

MUX’s strength comes from the protocol leveraging the composability of DeFi.

MUX has processed $7.7 billion in total trading volume, possesses an impressive TVL of over $40 million, and this will steadily grow given MUX’s cross-chain functionality and trade routing functionality. 

Kwenta 

The Synthetix team – a decentralized liquidity provision protocol – created Kwenta, and it has become a prominent player due to the wide range of crypto assets it supports. The protocol powers 25:1 leverage for all cryptos and 50:1 for Bitcoin and Ethereum. Kwenta benefits from Optimism rewards, with token distribution currently ongoing. 

The Role of Perp DEXs in DeFi

Source: Dune

There have been several pockets of growth throughout the current bear market: Layer 2s, the famous up-only ETH staking chart, and perp DEXs. The total trading volume across all perp DEXs in DeFi continues to climb, with over $210 billion in total volume and nearly 2 million discrete traders. 

Trading fees and losses offer a source of yield and have already become building blocks within DeFi. Two key use cases would be the construction of vaults that leverage perp DEXs in their strategies and the ability to leverage returns over time. The most salient example of the former being RageTrade’s Vaults. And of the latter, Pendle. Pendle is a protocol that splits assets into principal and yield-bearing components, and investors can purchase DAI at a discount with a maturity date thanks to Pendle integrating the Gains Network DAI vault.  

Why Perp DEXs Have Grown

Derivatives provide traders with greater exposure and increased leverage. Markets are highly liquid and allow for rampant speculation. Given crypto’s volatile nature, skew towards younger investors with a higher risk threshold, and the markets trading around the clock, an expanding derivatives market almost seems natural.   

No single factor can pin down the rapid expansion of perp DEXs, and as with most things in life, the reasons remain multi-faceted. But several core factors can be identified. 

Derivatives markets naturally appear as markets mature, and as crypto enters its next curve of the adoption cycle, it inherently demands a more robust derivatives market. 

Leveraged trading has always been prevalent in crypto; it pairs exceptionally well with the volatility in the space. The general swing toward self-custody and the outflow from centralized exchanges has been a considerable boon for DeFi and all its components. Pair this with the execution performance offered by Layer 2s, and it laid the perfect groundwork for on-chain leveraged trading to grow. 

Traders only need volatility; market direction is not overly critical, which helps to explain the growth seen throughout the bear market. The permissionless nature of perp DEXs also means citizens living in jurisdictions where crypto derivative products may be banned can easily access them in DeFi. 

From a more human perspective, perp DEXs give traders and investors who follow the market religiously an outlet to test their knowledge and understanding of markets. Additionally, in the modern world of instant gratification, the idea of fast money and high leverage exercises extraordinary force over the lizard part of the human brain.

The Future of the Derivatives Market: A Swing Toward DeFi

Academic literature establishes that the estimated total size of the TradFi derivatives markets is over $1 quadrillion, and some market analysts even place the size of the market at more than ten times that of the total world Gross Domestic Product.

Every expanding market naturally develops a derivatives market, which typically becomes more extensive than the underlying market. Since the 1970s and what many economists view as the divergence of the real economy and the financial economy, derivatives have been a core part of the financial industry’s toolkit, and this growth shows crypto is no exception.

Napkin math leads to a prediction that the crypto derivatives market size could swell to $10 trillion in value once the market has fully matured at today’s valuation.

A definite trend towards on-chain trading has been established, a minor trend within the meta of the move towards self-custody, which defined 2022 and 2023. More funds on-chain and in DeFi increases the propensity of users to utilize decentralized products. 

Perpetual future DEXs have grown enormously in a relatively short period, rapidly devouring liquidity. As sentiment becomes increasingly risk-on, trading volumes rise, hinting at another expansionary phase for these protocols waiting in the wings. 

The central question is whether community liquidity can support a bull market’s increased volume and trading activity. Will liquidity providers remain profitable? Perp DEXs have flourished throughout the bear; the real test will come from the bull.