In this edition, we’re giving you an update on Vertex Protocol. Following it’s TGE in late November, Vertex has generated quite a bit of buzz, even flipping dYdX in daily volume on a couple of occasions.
While appchains and finance-focused chains like Injective and Sei are gaining popularity, Vertex opted for an Arbitrum native approach. Learn about the protocol’s spot trading, perps, and lending market services, and insights from Vertex Co-Founders Alwin Peng and Darius Tabai.
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Background on Vertex
Vertex Protocol is a vertically-integrated DEX on Arbitrum featuring spot, perpetual, and integrated money markets.
The protocol is a fast, capital-efficient, and user-friendly DEX which aims to function similarly to CEXs.
The protocol chose to deploy on Arbitrum over Cosmos, as they believed Arbitrum would perform better and be a safer choice, given its EVM compatibility.
The protocol uses centralized servers and optimistic processing to optimize for speed.
This is a tradeoff vs decentralization, as the project has compromised by not allowing users to self-custody their assets.
On the other hand, it can handle trades centrally for much better performance.
State of the Perp Market
Darius Tab, Co-Founder of Vertex, says that many people believe perps are easy money printers, but that's not necessarily the case.
Several platforms have emerged and disappeared within the last six months.
Cloning popular platforms like GMX was attempted by some but didn't guarantee success.
GMX had built a successful referral program and appealed to specific users' needs for high leverage or on-chain trading.
GMX had successfully built a moat around its business model, making it difficult for others to replicate their success.
Similar strategies can be observed in centralized exchanges that aim to retain users.
Many users enter perp markets thinking it's easy money, but only a few actually make profits.
Doing less than a million dollars of volume per day may not be sustainable in the long run.
Vertex, founded by Alwin Peng and Darius Tabai, aims to build its moat with low latency, high liquidity, competitive fees, and a referral program.
Gaining User Trust and Market Share
Darius says that users who trust Vertex with millions of dollars are unlikely to switch to other platforms like GMX. While the winners in the space seem to be established, there is still room for growth in the overall market.
Crypto is still relatively small compared to traditional markets like FX trading.
To succeed, perp platforms need to plan on becoming top three or five players in the market.
He adds that Binance currently holds about half of the market share.
The entire perp market's daily trading volume is significantly smaller than what Binance alone handles.
Crypto is still a small industry compared to traditional markets, leaving room for growth for both centralized and decentralized exchanges. In the next five years, significant growth can be expected in the industry.
Darius says that the top three to five exchanges make money, while those ranked 5 to 10 do okay.
Vertex Current #6 Ranking by Volume, according to DefiLlama
Being ranked beyond 20 is not considered a great business opportunity.
Liquidity and activity are crucial for exchange success.
Darius adds that the number one spot among exchanges is highly important.
Liquidity tends to concentrate on the largest venue. Recent developments have brought attention to this idea, particularly since late 2020.
Bullish Verticals in Crypto
Darius says that he looks for off-chain successes that can be replicated on-chain.
Perp DEXs have been successful both on centralized venues and on-chain.
Borrowing and lending platforms have also shown success both centrally and on-chain.
He adds that payment integration could become more prevalent in cryptosystems.
Integrated platforms that offer multiple functionalities are gaining traction.
Examples include perp trading linked to a money market or platforms like Vertex aiming for integration across various services.
Integration and UX Improvements
Darius says that moving towards integrated platforms that offer multiple services, similar to social media platforms.
Third-party integrations or systems like Vertex aim to provide spot trading, perp trading, and money market functionalities in one place.
Improved UX is crucial, as current transaction processes can be cumbersome and require excessive button pressing.
Institutional Interest and Perpetual Futures
Darius says that most institutions dealing with Vertex are already familiar with perpetual futures contracts.
Perp contracts are seen as a significant innovation that solves problems for markets based on physical assets.
He adds that comparisons are made to other types of trading venues, such as stocks or Forex.
Darius says that education may be necessary for understanding the unique aspects of DeFi platforms like Vertex compared to traditional finance.
Perpetual futures' high-leverage positions held for extended periods with reasonable funding rates may require explanation.
He adds that perps solve the problem of availability, bridging the gap between different assets and ensuring liquidity.
They provide a simple way to trade and gain exposure to various assets through an oracle.
Perps offer a return profile and allow traders to speculate on price movements without the need for physical delivery or future rolling.
He adds that traditional finance has other mechanisms for efficient trading, but crypto heavily relies on perps.
Without perps, it would be challenging to maintain rational pricing and a fundamentally fluid market.
Traders understand the usefulness of perps once they grasp their purpose and benefits.
Differences Between Derivatives in Traditional Finance vs. Crypto
Darius says that traditional finance's derivatives market evolved from hedging practices, such as farmers selling futures contracts for their crops and buyers purchasing them for future delivery.
Liquidity and depth in traditional finance are built around managing these futures contracts.
Crypto, on the other hand, is primarily driven by speculation, attracting retail traders who seek exposure to price movements without physical delivery.
He adds that perps are ideal for speculation as they don't require rolling futures or physical delivery.
In crypto, many non-expert retail traders prefer simple exposure to price movements rather than taking actual delivery of assets.
Traditional finance's derivatives market caters more towards institutions and fundamental players who require physical delivery.
Convergence Between Traditional Finance and Crypto
Darius says that blockchain technology has the potential to solve inefficiencies present in traditional finance systems.
Atomic trading, transparent settlement on public databases, and mutability recognition can address issues like lack of interoperability and inefficiency in large investment banks.
He adds that while some changes may not align with open permissionless networks favored by crypto maximalists, there will be a shift towards adopting blockchain-based solutions in traditional finance. T
his convergence will lead to new strategies emerging as private blockchains gain liquidity and parallel the public blockchain ecosystem.
Darius says that the crypto market offers numerous trading strategies, reflecting the diverse range of traders involved.
He mentions that if someone had suggested a few years ago that randomly participating in decentralized applications could lead to significant profits, it would have been dismissed.
However, this approach proved highly profitable during that time.
Different Trading Strategies
Darius says that there is value in pursuing different trading strategies, such as flipping NFTs or engaging in cash and carry trades.
Two years ago, people were making significant profits by flipping NFTs.
Cash and carry trades offer consistent returns and are considered dependable.
He adds that options trading and pairs trading are other strategies that can be explored in the crypto market.
Vertex is integrating with Pearl Protocol to enable pairs trading, allowing users to evaluate correlations between assets.
This integration allows users to assess asset correlations more effectively.
Darius says that by integrating with other platforms, Vertex becomes a liquidity layer underneath these apps.
Composability is crucial for increasing volume on Vertex, so partnerships with aggregators and other protocols are sought after.
Fees Landscape in Onchain Trading
Darius says that onchain trading has been expensive for a long time, even with advancements like Arbitrum and ZK rollups reducing gas fees but not protocol fees significantly.
Centralized exchanges tend to have lower fees compared to decentralized exchanges like Uniswap or Synthetix.
Vertex aims to charge fees as low as possible to increase market share, targeting high-volume trading firms rather than charging high fees that deter traders.
The long-term goal is to attract different market segments and clients while maintaining low fees.
He adds that Vertex has its own offchain sequencer that services its contract, making it a conventional decentralized exchange with perps, spot, and margin markets on Arbitrum.
The sequencer allows for fast processing of orders and transactions even if Arbitrum experiences short-term issues or congestion.
Transactions are fired off to the chain quickly, providing low latency similar to centralized exchanges.
Users have signing rights locally but cannot withdraw funds, ensuring security and convenience during one-click trading.
App Chains and Latency Challenges
Darius says that app chains are an intermediate execution environment.
Distributed blockchains require consensus across globally distributed nodes, resulting in latency due to the speed of light.
Achieving low latency for high-frequency trading is crucial but challenging with distributed blockchains.
Collocating servers in one place can improve latency but raises questions about decentralization and the value of being a blockchain.
He adds that faster blockchains allow market makers to be more confident in placing orders at the top of the book, leading to better prices and execution for users.
To achieve the best user experience with deep liquidity, super-low latency is necessary.
Other app chains like Hyperliquid operate at 200 to 900 milliseconds, slower compared to their setup.
Darius says that running a decentralized app chain on top of a layer two solution compromises performance and speed.
The need for speed may outweigh the security benefits provided by a distributed execution environment.
Their setup focuses on order book security rather than asset security, with professionals monitoring real-time transactions.
Trust in the order book security is maintained through social enforcement and open liquidations.
Trust and Preferential Treatment
Trust in the absence of preferential treatment is established through social proof and transparency.
Market makers would immediately notice any manipulation or reordering of transactions, leading to a loss of liquidity providers.
Open liquidations and external Oracle execution prevent manipulation by the platform.
Professionals continuously monitor the execution of orders to ensure adherence to stated protocols.
The Value of Risk in Trading nn On-Chain Environments
Darius says that trading on pure onchain environments allows for execution within a block or two, which can take a few seconds or even minutes.
This significantly reduces the value of risk.
He mentions that preferential deals cannot be given to specific individuals as it would contradict the concept of a preferential deal for everyone.
Controlling a node in an open network provides more security compared to being in an open network where risks are higher.
Extreme Speed and Information Passing
Darius says that opting for extreme speed allows for information passing within the time frame of order placement, making it nearly impossible to pass information effectively even with fast bots.
He adds that market makers closely monitor such activities to prevent any unfair practices.
Best Execution and Onchain Settlement
Darius says that lower latency enables market makers to provide better pricing by taking more risk.
He highlights the power of on-chain settlement in achieving the best execution and reducing market makers' vulnerability.
Operating at true time price priority without any preferences ensures fair execution for all traders.
Darius says that by being consistent, fast, and predictable, liquidity providers can offer better liquidity to traders.
Maintaining a state on the sequence level rather than printing all orders on-chain helps manage costs and ensures smooth operation.
Oracle Choice, UX, and Risk Management
Vertex uses the Stork Oracle, a less tested oracle provider
Co-Founder Alwin Peng praises Stork for their customer support and explains that their design works well with their architecture.
The off-chain price generation saves gas and suits their needs.
Alwin explains that the risk engine has been doing well, with no single day where the insurance fund has been drawn down.
The system is set up with a summary bot that tells the status, and says that the insurance fund and the liquidator have made money.
The matching engine constantly looks for accounts to be liquidated, making the system robust.
Alwin explains the process of liquidations, where if an account is underwater and has BTC, he buys the BTC and gives USDC in return.
He says that the purchase price is computed using the Oracle price of Bitcoin, and a slight discount incentivizes him to liquidate.
A part of the gap between the Oracle price and the liquidation price is sent to the insurance fund.
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