The perpetual swap is undoubtedly one of the most significant innovations arising from the cryptocurrency space. Perpetuals have improved price discovery and removed a lot of the frictions in products inherited from traditional finance, such as expiry times as is the case with futures. Because of their simplicity and utility, perpetuals have since become the most popular financial instrument to trade crypto assets, like Bitcoin and Ethereum.
However, some of the structures present in the world of traditional finance have re-emerged in crypto, where most of the perpetual trading volume is conducted on centralized exchanges (CEXes). Despite the perpetual swap being invented by the centralized exchange BitMEX, decentralized exchanges (DEXes) are now carrying the torch. By broadening access of the masses to financial products and pushing the potential of derivatives to their limit, DEXes are best positioned to fulfil the true mission of crypto.
We’ll outline four key reasons why on-chain derivatives should be the preferred option for experienced traders compared to trading these same instruments on centralized venues.
The quote ‘not your keys, not your coins’ is often imparted as the key piece of advice to crypto users and traders, but this cannot be achieved with CEXs. When depositing to centralized platforms, you give up control of your assets, and since you do not control the private keys anymore, those coins are technically not yours. Despite the entire purpose of cryptocurrency revolving around the concepts of sovereignty, only DEXes embody the true spirit of cryptocurrency which is decentralized in nature.
The countless hacks over the years, data breaches and suspected foul play from centralized venues highlight the clear advantages of on-chain derivatives: traders are able to control their assets directly. Most DEXs are built on top of Ethereum, and when using these platforms, your funds are locked in a non-custodial smart contract
Smart Contract
A smart contract is a piece of software that automatically executes a pre-determined set of actions when a certain set of criteria or met. One of the key tenets of smart contracts is their ability to perform credible transactions without third parties and are self-executing, with their conditions written into the lines of code that form themAdditionally, these transactions are both trackable and irreversible. For example, a smart contract could be used to give royalty payouts to a musical artist each time a song is played on the radio. The contract detects when the song is played, and then automatically sends a payout to the artist or artist. All parties involved in a smart contract must agree to the terms of the contract before it can be executed. They must also consent to any changes made to the contract. Transactions made through a smart contract are traceable and irreversible.Smart contracts were first proposed in 1994 by American computer Scientist Nick Szabo. Szabo created a digital currency called “Bit Gold” in 1998, over 10 years before the creation of Bitcoin.Benefits of Smart ContractsMany proponents of smart contracts point to many kinds of contractual clauses that could be made partially or fully self-executing, self-enforcing, or simply both. Conversely, smart contracts can lead to a situation where bugs or including security holes are visible to all yet may not be quickly fixed.The fundamental goal of smart contracts is to provide additional layers of security that are superior to traditional contract law. In doing so, this reduces other transaction costs associated with contracting. Smart contracts appear most prevalently in the cryptocurrency space, having implemented countless instances of smart contracts.
A smart contract is a piece of software that automatically executes a pre-determined set of actions when a certain set of criteria or met. One of the key tenets of smart contracts is their ability to perform credible transactions without third parties and are self-executing, with their conditions written into the lines of code that form themAdditionally, these transactions are both trackable and irreversible. For example, a smart contract could be used to give royalty payouts to a musical artist each time a song is played on the radio. The contract detects when the song is played, and then automatically sends a payout to the artist or artist. All parties involved in a smart contract must agree to the terms of the contract before it can be executed. They must also consent to any changes made to the contract. Transactions made through a smart contract are traceable and irreversible.Smart contracts were first proposed in 1994 by American computer Scientist Nick Szabo. Szabo created a digital currency called “Bit Gold” in 1998, over 10 years before the creation of Bitcoin.Benefits of Smart ContractsMany proponents of smart contracts point to many kinds of contractual clauses that could be made partially or fully self-executing, self-enforcing, or simply both. Conversely, smart contracts can lead to a situation where bugs or including security holes are visible to all yet may not be quickly fixed.The fundamental goal of smart contracts is to provide additional layers of security that are superior to traditional contract law. In doing so, this reduces other transaction costs associated with contracting. Smart contracts appear most prevalently in the cryptocurrency space, having implemented countless instances of smart contracts.
Read this Term. Anyone can interact with these smart contracts to trade derivatives on-chain, no matter what their geography, demography or background is.
Aside from the emphasis on self-custody, another major benefit of decentralized finance (DeFi) is that any user can inspect the state transition and verify the orderly execution of smart contracts that are, for example, responsible for the price discovery mechanisms and trade matching engines of on-chain derivatives protocols.
These same processes are opaque on centralized platforms. We cannot be entirely sure of what’s going on behind the scenes. And, despite the cryptographic tools existing for CEXs to prove and verify the reserves of cryptocurrencies that are their custody on behalf of their users, there are hardly any exchanges that actually do so.
Two major concerns with CEXs from a user perspective are:
- Do they have sufficient reserves to process everyone’s withdrawals, if and when such a time comes?
- Are we certain that a lot of the activity on these platforms isn’t fake, i.e., wash trading?
As mentioned before, when using fully on-chain DEXs, your assets are never under anyone else’s custody (so you can be sure there’ll never be a bank run style situation). Everything is transparent, and there can be no doubts about trading volumes. Open and free-to-use platforms like Dune Analytics are useful tools that enable anyone to shine a spotlight onto different aspects of DEXs, even allowing you to write your own queries to obtain the information you need.
Composability
Perhaps the biggest advantage relative to centralized derivatives platforms that some on-chain platforms have is composability, which refers to the concept where a protocol can be used in other on-chain applications. As a result of this property, it can foster innovation by opening up opportunities that do not exist outside of DeFi.
Building on top of DeFi ‘money legos’, which are essentially the building blocks of programmable money, is also a permissionless process, so any developer can start creating new things on top of composable protocols. For on-chain perpetuals, that could range from the creation of structured products, to analytics
Analytics
Analytics may be defined as the detection, analysis, and relay of consequential patterns in data. Analytics also seeks to explain or accurately reflect the relationship between data and effective decision making. In the trading space, analytics are applied in a predictive manner in an attempt to more accurately forecast the price. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analytics may also be structured with a descriptive model, where readers attempt to draw a correlation and better understanding as to how and why traders react to a particular set of variables. Traders sometimes implement technical indicators such as moving averages, Bollinger Bands, and breakpoints which are built upon historical data and are used to predict future price movements. How Analytics Relates to Algo TradingAnalytics are relied upon in the concept of algorithmic trading where software is programmed to autonomously signal and/or execute buy and sell orders based upon a series of predetermined factors. In the institutional space, Algo-trading has become vastly competitive over the years as trading institutions seek to outperform competitors through automated systems and the virtual application of trading strategies.The digestion and computation of analytics are also seen in the emerging field of high-frequency trading, where supercomputers are used to analyze multiple markets simultaneously to make near-instantaneous automated trading decisions. Platforms that support HFT have the capability to significantly outperform human traders.This is due to the innate ability to be able to comprehensively analyze big data sets while taking under do consideration an innumerable sum of factors that humans are incapable of comprehending in such speed. Additionally, analytics are seen with backtesting. Backtesting is used by traders to test the consistency and effectiveness of trading strategies and software-based trading solutions against historical price data. Backtesting also serves as an ideal playground for the further development of high-frequency trading as well as evaluating the performance of manual or automated trades. Analytics will continue to have an increasingly significant role in trading as emerging technologies and the advancement of trading applications progress beyond human capability.
Analytics may be defined as the detection, analysis, and relay of consequential patterns in data. Analytics also seeks to explain or accurately reflect the relationship between data and effective decision making. In the trading space, analytics are applied in a predictive manner in an attempt to more accurately forecast the price. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analytics may also be structured with a descriptive model, where readers attempt to draw a correlation and better understanding as to how and why traders react to a particular set of variables. Traders sometimes implement technical indicators such as moving averages, Bollinger Bands, and breakpoints which are built upon historical data and are used to predict future price movements. How Analytics Relates to Algo TradingAnalytics are relied upon in the concept of algorithmic trading where software is programmed to autonomously signal and/or execute buy and sell orders based upon a series of predetermined factors. In the institutional space, Algo-trading has become vastly competitive over the years as trading institutions seek to outperform competitors through automated systems and the virtual application of trading strategies.The digestion and computation of analytics are also seen in the emerging field of high-frequency trading, where supercomputers are used to analyze multiple markets simultaneously to make near-instantaneous automated trading decisions. Platforms that support HFT have the capability to significantly outperform human traders.This is due to the innate ability to be able to comprehensively analyze big data sets while taking under do consideration an innumerable sum of factors that humans are incapable of comprehending in such speed. Additionally, analytics are seen with backtesting. Backtesting is used by traders to test the consistency and effectiveness of trading strategies and software-based trading solutions against historical price data. Backtesting also serves as an ideal playground for the further development of high-frequency trading as well as evaluating the performance of manual or automated trades. Analytics will continue to have an increasingly significant role in trading as emerging technologies and the advancement of trading applications progress beyond human capability.
Read this Term tools, or even alternative front ends to trade these contracts. The possibilities are endless!
Composable derivative protocols can be the building blocks for new financial products. Just like how individual stocks can be put into a basket to create an index product, the same can be done for on-chain derivatives. One relevant example is the creation of the SOLUNAVAX index by Beverage Finance and Galleon DAO. By building on Perpetual Protocol’s on-chain derivatives, their index gives investors exposure to three popular crypto-assets (SOL, LUNA and AVAX) through a tokenized position.
In general, a market maker is an institution that stands ready to buy or sell an asset, generating a profit from the bid-ask spread: the difference between the ask (the rate at which the market maker sells an asset) and the bid (the rate at which the market maker buys an asset). In contrast, the Automated Market Maker (AMM) model used by many decentralized derivative platforms automates this by allowing traders to place orders with said AMM, which then algorithmically provides a price. In traditional finance as well as when it comes to centralized platforms the ability to be a market maker is limited to market-making firms or exchanges themselves.
However, with DeFi, anyone can become a market maker, so it opens up the fee revenue to anyone who is willing to supply crypto assets to specific ‘liquidity pools’. To be sure, new traders should be aware that while DeFi trading provides great innovations to help traders meet their goals, there are also risks to be aware of. While solving many of the problems encountered with centralized platforms, decentralized derivatives present their own unique set of problems but these will only lessen as the space matures.
With the mindshare behind DeFi and the continuing maturation of this sector, the future is definitely decentralized. In the future, we’ll eventually see CEXs connect to various DeFi protocols for increased efficiency, transparency and better access to aggregated liquidity.
To get started with DeFi trading, it’s recommended that you become familiar with the mechanism of automated market makers (AMMs), which can be done by studying the Uniswap whitepaper. Since there are no restrictions on minimum deposits, another suggestion is to deposit a small amount of funds or use a protocol’s testnet platform to get some experience under your belt before trading with size.
By Yenwen Feng, Co-Founder, Perpetual Protocol
The perpetual swap is undoubtedly one of the most significant innovations arising from the cryptocurrency space. Perpetuals have improved price discovery and removed a lot of the frictions in products inherited from traditional finance, such as expiry times as is the case with futures. Because of their simplicity and utility, perpetuals have since become the most popular financial instrument to trade crypto assets, like Bitcoin and Ethereum.
However, some of the structures present in the world of traditional finance have re-emerged in crypto, where most of the perpetual trading volume is conducted on centralized exchanges (CEXes). Despite the perpetual swap being invented by the centralized exchange BitMEX, decentralized exchanges (DEXes) are now carrying the torch. By broadening access of the masses to financial products and pushing the potential of derivatives to their limit, DEXes are best positioned to fulfil the true mission of crypto.
We’ll outline four key reasons why on-chain derivatives should be the preferred option for experienced traders compared to trading these same instruments on centralized venues.
The quote ‘not your keys, not your coins’ is often imparted as the key piece of advice to crypto users and traders, but this cannot be achieved with CEXs. When depositing to centralized platforms, you give up control of your assets, and since you do not control the private keys anymore, those coins are technically not yours. Despite the entire purpose of cryptocurrency revolving around the concepts of sovereignty, only DEXes embody the true spirit of cryptocurrency which is decentralized in nature.
The countless hacks over the years, data breaches and suspected foul play from centralized venues highlight the clear advantages of on-chain derivatives: traders are able to control their assets directly. Most DEXs are built on top of Ethereum, and when using these platforms, your funds are locked in a non-custodial smart contract
Smart Contract
A smart contract is a piece of software that automatically executes a pre-determined set of actions when a certain set of criteria or met. One of the key tenets of smart contracts is their ability to perform credible transactions without third parties and are self-executing, with their conditions written into the lines of code that form themAdditionally, these transactions are both trackable and irreversible. For example, a smart contract could be used to give royalty payouts to a musical artist each time a song is played on the radio. The contract detects when the song is played, and then automatically sends a payout to the artist or artist. All parties involved in a smart contract must agree to the terms of the contract before it can be executed. They must also consent to any changes made to the contract. Transactions made through a smart contract are traceable and irreversible.Smart contracts were first proposed in 1994 by American computer Scientist Nick Szabo. Szabo created a digital currency called “Bit Gold” in 1998, over 10 years before the creation of Bitcoin.Benefits of Smart ContractsMany proponents of smart contracts point to many kinds of contractual clauses that could be made partially or fully self-executing, self-enforcing, or simply both. Conversely, smart contracts can lead to a situation where bugs or including security holes are visible to all yet may not be quickly fixed.The fundamental goal of smart contracts is to provide additional layers of security that are superior to traditional contract law. In doing so, this reduces other transaction costs associated with contracting. Smart contracts appear most prevalently in the cryptocurrency space, having implemented countless instances of smart contracts.
A smart contract is a piece of software that automatically executes a pre-determined set of actions when a certain set of criteria or met. One of the key tenets of smart contracts is their ability to perform credible transactions without third parties and are self-executing, with their conditions written into the lines of code that form themAdditionally, these transactions are both trackable and irreversible. For example, a smart contract could be used to give royalty payouts to a musical artist each time a song is played on the radio. The contract detects when the song is played, and then automatically sends a payout to the artist or artist. All parties involved in a smart contract must agree to the terms of the contract before it can be executed. They must also consent to any changes made to the contract. Transactions made through a smart contract are traceable and irreversible.Smart contracts were first proposed in 1994 by American computer Scientist Nick Szabo. Szabo created a digital currency called “Bit Gold” in 1998, over 10 years before the creation of Bitcoin.Benefits of Smart ContractsMany proponents of smart contracts point to many kinds of contractual clauses that could be made partially or fully self-executing, self-enforcing, or simply both. Conversely, smart contracts can lead to a situation where bugs or including security holes are visible to all yet may not be quickly fixed.The fundamental goal of smart contracts is to provide additional layers of security that are superior to traditional contract law. In doing so, this reduces other transaction costs associated with contracting. Smart contracts appear most prevalently in the cryptocurrency space, having implemented countless instances of smart contracts.
Read this Term. Anyone can interact with these smart contracts to trade derivatives on-chain, no matter what their geography, demography or background is.
Aside from the emphasis on self-custody, another major benefit of decentralized finance (DeFi) is that any user can inspect the state transition and verify the orderly execution of smart contracts that are, for example, responsible for the price discovery mechanisms and trade matching engines of on-chain derivatives protocols.
These same processes are opaque on centralized platforms. We cannot be entirely sure of what’s going on behind the scenes. And, despite the cryptographic tools existing for CEXs to prove and verify the reserves of cryptocurrencies that are their custody on behalf of their users, there are hardly any exchanges that actually do so.
Two major concerns with CEXs from a user perspective are:
- Do they have sufficient reserves to process everyone’s withdrawals, if and when such a time comes?
- Are we certain that a lot of the activity on these platforms isn’t fake, i.e., wash trading?
As mentioned before, when using fully on-chain DEXs, your assets are never under anyone else’s custody (so you can be sure there’ll never be a bank run style situation). Everything is transparent, and there can be no doubts about trading volumes. Open and free-to-use platforms like Dune Analytics are useful tools that enable anyone to shine a spotlight onto different aspects of DEXs, even allowing you to write your own queries to obtain the information you need.
Composability
Perhaps the biggest advantage relative to centralized derivatives platforms that some on-chain platforms have is composability, which refers to the concept where a protocol can be used in other on-chain applications. As a result of this property, it can foster innovation by opening up opportunities that do not exist outside of DeFi.
Building on top of DeFi ‘money legos’, which are essentially the building blocks of programmable money, is also a permissionless process, so any developer can start creating new things on top of composable protocols. For on-chain perpetuals, that could range from the creation of structured products, to analytics
Analytics
Analytics may be defined as the detection, analysis, and relay of consequential patterns in data. Analytics also seeks to explain or accurately reflect the relationship between data and effective decision making. In the trading space, analytics are applied in a predictive manner in an attempt to more accurately forecast the price. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analytics may also be structured with a descriptive model, where readers attempt to draw a correlation and better understanding as to how and why traders react to a particular set of variables. Traders sometimes implement technical indicators such as moving averages, Bollinger Bands, and breakpoints which are built upon historical data and are used to predict future price movements. How Analytics Relates to Algo TradingAnalytics are relied upon in the concept of algorithmic trading where software is programmed to autonomously signal and/or execute buy and sell orders based upon a series of predetermined factors. In the institutional space, Algo-trading has become vastly competitive over the years as trading institutions seek to outperform competitors through automated systems and the virtual application of trading strategies.The digestion and computation of analytics are also seen in the emerging field of high-frequency trading, where supercomputers are used to analyze multiple markets simultaneously to make near-instantaneous automated trading decisions. Platforms that support HFT have the capability to significantly outperform human traders.This is due to the innate ability to be able to comprehensively analyze big data sets while taking under do consideration an innumerable sum of factors that humans are incapable of comprehending in such speed. Additionally, analytics are seen with backtesting. Backtesting is used by traders to test the consistency and effectiveness of trading strategies and software-based trading solutions against historical price data. Backtesting also serves as an ideal playground for the further development of high-frequency trading as well as evaluating the performance of manual or automated trades. Analytics will continue to have an increasingly significant role in trading as emerging technologies and the advancement of trading applications progress beyond human capability.
Analytics may be defined as the detection, analysis, and relay of consequential patterns in data. Analytics also seeks to explain or accurately reflect the relationship between data and effective decision making. In the trading space, analytics are applied in a predictive manner in an attempt to more accurately forecast the price. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analytics may also be structured with a descriptive model, where readers attempt to draw a correlation and better understanding as to how and why traders react to a particular set of variables. Traders sometimes implement technical indicators such as moving averages, Bollinger Bands, and breakpoints which are built upon historical data and are used to predict future price movements. How Analytics Relates to Algo TradingAnalytics are relied upon in the concept of algorithmic trading where software is programmed to autonomously signal and/or execute buy and sell orders based upon a series of predetermined factors. In the institutional space, Algo-trading has become vastly competitive over the years as trading institutions seek to outperform competitors through automated systems and the virtual application of trading strategies.The digestion and computation of analytics are also seen in the emerging field of high-frequency trading, where supercomputers are used to analyze multiple markets simultaneously to make near-instantaneous automated trading decisions. Platforms that support HFT have the capability to significantly outperform human traders.This is due to the innate ability to be able to comprehensively analyze big data sets while taking under do consideration an innumerable sum of factors that humans are incapable of comprehending in such speed. Additionally, analytics are seen with backtesting. Backtesting is used by traders to test the consistency and effectiveness of trading strategies and software-based trading solutions against historical price data. Backtesting also serves as an ideal playground for the further development of high-frequency trading as well as evaluating the performance of manual or automated trades. Analytics will continue to have an increasingly significant role in trading as emerging technologies and the advancement of trading applications progress beyond human capability.
Read this Term tools, or even alternative front ends to trade these contracts. The possibilities are endless!
Composable derivative protocols can be the building blocks for new financial products. Just like how individual stocks can be put into a basket to create an index product, the same can be done for on-chain derivatives. One relevant example is the creation of the SOLUNAVAX index by Beverage Finance and Galleon DAO. By building on Perpetual Protocol’s on-chain derivatives, their index gives investors exposure to three popular crypto-assets (SOL, LUNA and AVAX) through a tokenized position.
In general, a market maker is an institution that stands ready to buy or sell an asset, generating a profit from the bid-ask spread: the difference between the ask (the rate at which the market maker sells an asset) and the bid (the rate at which the market maker buys an asset). In contrast, the Automated Market Maker (AMM) model used by many decentralized derivative platforms automates this by allowing traders to place orders with said AMM, which then algorithmically provides a price. In traditional finance as well as when it comes to centralized platforms the ability to be a market maker is limited to market-making firms or exchanges themselves.
However, with DeFi, anyone can become a market maker, so it opens up the fee revenue to anyone who is willing to supply crypto assets to specific ‘liquidity pools’. To be sure, new traders should be aware that while DeFi trading provides great innovations to help traders meet their goals, there are also risks to be aware of. While solving many of the problems encountered with centralized platforms, decentralized derivatives present their own unique set of problems but these will only lessen as the space matures.
With the mindshare behind DeFi and the continuing maturation of this sector, the future is definitely decentralized. In the future, we’ll eventually see CEXs connect to various DeFi protocols for increased efficiency, transparency and better access to aggregated liquidity.
To get started with DeFi trading, it’s recommended that you become familiar with the mechanism of automated market makers (AMMs), which can be done by studying the Uniswap whitepaper. Since there are no restrictions on minimum deposits, another suggestion is to deposit a small amount of funds or use a protocol’s testnet platform to get some experience under your belt before trading with size.
By Yenwen Feng, Co-Founder, Perpetual Protocol
Source: https://www.financemagnates.com/cryptocurrency/explained-the-case-for-decentralised-derivatives-trading/