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.
Not Your Keys, Not Your Coins
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
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
Read this Term. Anyone can interact with these smart contracts to trade derivatives on-chain, no matter what their geography, demography or background is.
Transparency
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 forecast the price more accurately. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analy
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 forecast the price more accurately. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analy
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.
Anyone Can Become a Market Maker
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.
Not Your Keys, Not Your Coins
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
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
Read this Term. Anyone can interact with these smart contracts to trade derivatives on-chain, no matter what their geography, demography or background is.
Transparency
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 forecast the price more accurately. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analy
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 forecast the price more accurately. This predictive model of analytics generally involves the analysis of historical price patterns that are used in an attempt to determine certain price outcomes. Analy
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.
Anyone Can Become a Market Maker
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
