By providing a platform that builds an integrated experience similar to iOS, perpetual DEX has the potential to usher in the next era of cryptocurrency adoption.

Author: GAURAV GANDHI

Translation: DeepTechFlow

Exchanges are the foundation of the capital market, achieving their core goal by facilitating asset trading between participants. The core goal of any exchange is to achieve efficient (low transaction costs and low slippage), fast, and secure transactions between counterparties. Decentralized exchanges (DEX) add an additional layer of trustless mechanisms aimed at eliminating the need for intermediaries and centralized control. DEX allows users to retain control of their funds, enables community participation, and promotes open innovation. However, these benefits have historically been accompanied by higher latency and lower liquidity due to throughput and latency limitations of the underlying blockchain.

Source: Chainspect, selected blockchain browser

Spot DEX now accounts for 15-20% of the total spot trading volume, while perpetual contracts only account for 5%. In the case of perpetual contracts, centralized exchanges (CEX) have two main advantages—providing a better user experience for ordinary investors and tighter spreads due to effective control by market makers. The collapse of FTX further solidified the industry, with only a few CEXs now dominating the market. This centralization poses potential risks to the cryptocurrency ecosystem. The widespread adoption of decentralized exchanges can not only reduce this risk but also support the long-term sustainable growth of the entire ecosystem.

Source: The Block

In this article, we delve into the existing perpetual DEX ecosystem and review what the best design for decentralized perpetual exchanges might be. The rise of layer-two solutions and multi-chain environments provides a solid foundation for innovative liquidity acquisition and user experience. Based on previous research and knowledge, we believe we are now entering the golden age of DEX. Finally, we discuss how perpetual DEX could potentially drive cryptocurrency adoption among mainstream audiences, beyond facilitating the core function of efficient trading.

Perpetual contracts have found product-market fit (PMF) in the cryptocurrency ecosystem for speculation and hedging.

Perpetual contracts are futures contracts with no expiration date, allowing traders to hold positions indefinitely. These contracts are similar to over-the-counter swaps offered by traditional financial institutions for decades. However, by introducing the concept of funding rates, cryptocurrencies have democratized this product, which historically was only available to qualified participants, and now open to ordinary investors.

The monthly trading volume in the perpetual market currently exceeds $120 billion, creating an efficient trading venue equipped with a centralized limit order book, clear user interface, and fast, secure trading facilitated by vertically integrated clearing systems. Additionally, projects like Ethena have been built on top of perpetual contracts, extending the use of perpetual contracts beyond speculation.

Perpetual contracts have several advantages over traditional futures contracts:

• Traders save on the trading fees and other costs associated with renewing futures contracts at each expiration.

• Investors avoid high rolling costs caused by more expensive forward contracts.

• The settlement/funding mechanism provides continuous realized profits and losses, simplifying the backend processes for contract holders and clearing systems.

• Contracts provide a smoother price discovery process, avoiding price jumps when switching from one month's contract to the next.

Source: Perpetual DEX Market Share - Artemis

Since the introduction of this concept by BitMEX in 2016, the market has experienced a Cambrian explosion of perpetual DEX, with over 100 implementations currently. While the market was initially dominated by dYdX, today we have a vibrant ecosystem across various chains. Perpetual contracts have now become an integral part of the cryptocurrency ecosystem—various leading lagging studies indicate that the perpetual market begins to promote price discovery when the spot market is inactive. Perpetual trading volume on DEXs has grown from $1 billion in July 2021 to $120 billion in July 2024, with a compound annual growth rate of approximately 393%.

However, to further mature the market, fundamental challenges such as high latency and low liquidity must be addressed to create a cheap and efficient trading environment. High liquidity reduces slippage and provides a smoother trading experience. Low latency helps market makers quote tighter, execute trades quickly, enhance active quoted liquidity, and form a positive feedback loop.

In the pursuit of the "Holy Grail" of decentralized exchanges (DEX), various implementation methods have emerged, from oracle models to virtual automated market makers (vAMMs), and "off-chain order books and on-chain settlement".

Oracle Model

The oracle model provides trading based on price data from leading exchanges with high trading volumes. This approach eliminates the cost of narrowing the gap between DEX prices and market prices but also brings significant oracle price manipulation risks. Platforms like GMX benefit from their liquidity depth, offering zero price impact trades and fixed fees, and demonstrate organic growth. By using protocols like Chainlink to provide price data, GMX ensures price accuracy and integrity, fostering a price-receiver-friendly environment and providing sufficient incentives for price makers. However, the main challenge faced by these exchanges is that they act as price receivers rather than facilitating price discovery.

AMM-based Approaches

Virtual Automated Market Makers (vAMMs) facilitate perpetual contract trading without involving actual spot exchanges, inspired by Uniswap's spot market AMM. This model is adopted by platforms such as Perpetual Protocol and Drift Protocol, allowing for decentralized, composable liquidity provisioning for new tokens. Despite the high slippage and impermanent loss issues, vAMMs provide a transparent on-chain price discovery mechanism. By adjusting virtual depth (K value), these exchanges balance liquidity demand with the risk of excessive depth or high slippage, aiming to achieve a sustainable model.

Off-chain Order Books and On-chain Settlement

To overcome the limitations of on-chain matching, some DEXs use off-chain order books and on-chain settlement. Trade matching occurs off-chain, while execution and asset custody remain on-chain. This approach maintains the self-custody advantages of DeFi while addressing performance and risk limitations such as miner extractable value (MEV). Notable examples include dYdX v3, Aevo, and Paradex, which utilize this hybrid approach to provide efficient trading while ensuring transparency and security through on-chain settlement.

Fully On-chain Order Books

Fully on-chain order books represent the best way to maintain trade integrity but face significant challenges due to blockchain latency and throughput limitations. These issues lead to vulnerabilities such as front-running and market manipulation. However, chains like Solana and Monad are rapidly attempting to address this challenge at the infrastructure level. Projects like Hyperliquid, dYdX v4, Zeta Markets, LogX, and Kuru Labs are also driving high-performance fully on-chain systems, whether leveraging existing chains or creating their own application chains.

The current major trends in the perpetual DEX space are community-driven cross-chain active liquidity and simple user experiences achieved through gasless transactions, session keys, and social logins.

In history, establishing liquidity on exchanges has always been a cold start problem. Exchanges acquire liquidity through a combination of incentives, rewards, and market forces. Market forces essentially involve traders seeking to exploit arbitrage opportunities between different markets. However, with the surge of DEXs vying for user attention, it's challenging for DEXs to attract enough traders to reach critical mass. In the perpetual DEX space, another popular approach is through liquidity pools with incentives and rewards. In this setup, liquidity providers (LPs) deposit their assets into a pool, which is then used to facilitate trading on the DEX. Some perpetual DEXs offer high annualized percentage yields (APY) in treasuries or airdrops to attract liquidity providers. Recently, two main approaches have emerged to more effectively address this cold start challenge—community-supported active liquidity treasuries and cross-chain liquidity acquisition.

Hyperliquid introduced the HLP treasury, which utilizes users' funds to provide liquidity for the Hyperliquid exchange. The treasury uses data from Hyperliquid and other exchanges to calculate fair prices and execute profitable liquidity strategies across various assets. The profits and losses (P&L) generated from these activities are distributed based on participants' shares in the treasury. In addition to community-guided liquidity, Hyperliquid also leverages HyperBFT to enhance the DEX's performance through optimistic execution and responsiveness. Optimistic execution means that transactions in a block can be executed before the block is finally confirmed at the consensus level. This means that once a block is proposed, validators start executing the transactions in that block in parallel with the consensus process. Optimistic responsiveness allows consensus to scale based on the number of validators able to establish consensus and network conditions. Currently, a major risk for Hyperliquid is the lack of open-source and transparent infrastructure code. Similar to Hyperliquid, multiple projects are increasingly adopting application chain-based approaches to overcome some inherent limitations of the underlying blockchain.

Source: Hyperliquid

Another interesting approach is cross-chain liquidity acquisition by projects like Orderly Network and LogX Network. These networks allow the creation of front-ends on any chain to trade perpetual contracts and leverage liquidity from all markets. By combining on-chain native liquidity, aggregated liquidity across other chains, and creating Discrete Asset, Market Neutral (DAMN) AMM pools, LogX can maintain liquidity during periods of high market volatility. These pools use stable assets such as USDT, USDC, and wUSDM, enabling traders to engage in oracle-based perpetual trading. While designed for trading, this infrastructure also creates options for building various applications on top of it.

Source: LogX

As user interfaces become increasingly commoditized, DEXs are adding features such as gasless transactions, session keys, and social logins, creating a seamless user experience using wallet adapters. Traditionally, centralized exchanges (CEX) have been integrated into the ecosystem—acting not only as core exchanges but also providing onboarding and bridging services, while DEXs typically remain isolated within their native ecosystems. These cross-chain DEXs are revolutionizing the user experience by enabling seamless trading across multiple blockchain networks, providing users with a wider range of trading pairs, and smaller spreads for certain long-tail tokens.

DEX aggregators like Vooi.io are also building integrated smart routing systems, seeking the most efficient trading paths or best venues executed across various chains. This simplifies the trading process for users, who can manage complex trading routes within a single interface. These super aggregators combine the functionalities of multiple DEXs and bridges, providing a seamless and user-friendly trading experience.

Telegram bots further simplify the trading experience for users, offering real-time trading alerts, executing trades, and managing portfolios, all conveniently within the Telegram chat interface. This integration enhances accessibility and user engagement, making it easier for traders to stay informed and seize market opportunities quickly. The listing of the BANANA token on Binance is a major success for the emerging Telegram bot ecosystem. However, Telegram bots face significant risks as users must share their private keys with the bots, exposing them to smart contract risks.

Perpetual decentralized exchanges (DEX) continue to introduce new financial products or create mechanisms to simplify the trading process of existing products to meet the evolving needs of traders.

Variance Perpetual Contracts

These innovative financial instruments allow traders to speculate on the volatility of assets. In highly volatile crypto markets, this product offers a unique way to hedge risks or capitalize on market fluctuations. Opyn develops new types of perpetual contracts based on existing markets, which can replicate complex strategies, hedge unique risks, and improve capital efficiency. Opyn's perpetual products include Stable Perpetual Contracts (0-perps), Uniswap LP Perpetual Contracts (0.5-perps), Regular Perpetual Contracts (1-perps), and Square Perpetual Contracts (2-perps, also known as Squeeth). These perpetual contracts serve different purposes: Stable Perpetual Contracts provide a stable foundation for trading strategies, Uniswap LP Perpetual Contracts mirror returns without directly providing liquidity, Regular Perpetual Contracts offer simple long/short positions, and Square Perpetual Contracts amplify returns through quadratic exposure. These perpetual contracts can be combined into more complex strategies. For example, the Crab strategy involves shorting 2-perps in a stable market while longing 1-perps to generate funds. Another example is the Zen Bull strategy, which combines shorting 2-perps, longing 1-perps, and shorting 0-perps to earn funds in a calm market while maintaining long exposure.

Source: Opyn

Pre-launch Futures

Pre-launch token perpetual contracts allow traders to speculate on the future price of digital assets before they are officially launched, serving as a gray market version of an on-chain IPO. These contracts enable investors to trade based on the expected market value. Several perpetual DEXs, including Aevo, Helix, and Hyperliquid, have created unique niche markets in the market through pre-launch futures. The main advantage of these pre-launch contracts is their ability to attract and retain users by providing access to exclusive assets not available elsewhere.

Real-World Assets

Perpetual contracts may become the primary listing method for Real-World Assets (RWAs). Listing new assets as perpetual contracts is simpler than tokenizing them, requiring only liquidity and data sources. Additionally, the spot market does not need to exist on-chain for perpetual markets to exist on-chain, as perpetual contracts can exist independently. In this scenario, once sufficient market interest/liquidity is established through perpetual contracts, they become a springboard for spot tokenization. The combination of spot and perpetual contracts on RWAs opens up new avenues for sentiment prediction, event-based trading, and executing cross-asset arbitrage strategies. Companies like Ostium Labs and Sphinx Protocol are some emerging players in this field.

Exchange-Traded Products

Perpetual contracts can also be used to create exchange-traded products holding futures contracts to maturity, such as ETFs holding WTI light crude oil futures (e.g., USO) and ETNs holding VIX futures (e.g., VXX), to reduce costs and mitigate net asset value (NAV) depreciation. This eliminates the need to convert their basket into long-term contracts as the expiration approaches. Companies needing long-term economic hedging protection but not physical delivery of commodities can reduce operating costs through perpetual contracts. Speculating or hedging risks on restricted foreign currencies typically involves non-deliverable 30-day or 90-day forward contracts, which are non-standard and traded over-the-counter. These can be replaced with perpetual contracts denominated in USD.

Prediction Markets

Perpetual DEXs can fundamentally transform prediction markets by providing flexible and continuous trading mechanisms to adapt to non-periodic markets, such as elections/irregular weather forecasts. Unlike traditional prediction markets relying on real events or oracles, perpetual futures allow the creation of prediction markets based on continuously changing market data. This design enables the formation of submarkets within long-term markets, providing users with short-term trading opportunities and immediate gratification. The continuous settlement of perpetual futures ensures the regularity of market activity, enhancing liquidity and user engagement. Additionally, community-controlled perpetual futures markets can incentivize participation through reputation and token rewards, ensuring alignment of interests and creating a solid foundation for decentralized prediction markets. This approach democratizes market creation and provides scalable solutions for diverse prediction scenarios.

By providing a platform that offers an integrated experience similar to iOS, perpetual DEXs have the potential to usher in the next era of crypto adoption.

As the crypto financial system evolves, the design of perpetual DEXs will continue to improve. The focus may shift from simply replicating centralized exchanges (CEX) functionalities to leveraging the unique advantages of decentralization—transparency, composability, and user empowerment. Building the optimal design for perpetual DEXs requires careful balance between efficiency, speed, and security. Perpetual DEXs also focus on fostering community participation through presales and involving developers in the ecosystem. This approach nurtures a sense of belonging and loyalty among users. Community-led initiatives, such as market making through the Hyperliquid bot, further democratize access to trading activities.

Creating an integrated and user-friendly experience similar to iOS is crucial for mass crypto adoption, which in turn requires developing more intuitive user interfaces and ensuring consistency in the user journey. These can make crypto trading more appealing to the general consumer, who may not be native to crypto, ultimately guiding them to engage with other decentralized applications. Perpetual DEXs like Hyperliquid, LogX, and dYdX can also develop user-friendly and intuitive markets in various fields outside of finance, such as elections and sports, opening up new channels for public participation.

Source: LogX

The past decade of DeFi development has focused on DEXs and stablecoins. However, the next decade may see DeFi consumer applications intersecting with various fields such as news, politics, and sports. These applications may become the most valuable and widely used, further driving crypto adoption. We look forward to collaborating with the participants building the crypto future.

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