Perpetual swaps, the single largest primitive missing from the Bitcoin DeFi puzzle, are coming to Bitcoin-based DeFi thanks to Sovryn. Sovryn spotted the gap and responded accordingly. The original idea of just picking what works on Ethereum and bringing it to the Bitcoin sidechain was not an option here. They decided to integrate the RSK 2-way peg that will bring bitcoin into the RSK network, the bitcoin sidechain on which Sovryn perpetual swaps operate.
This article unfolds the history of perpetual futures contracts and their first appearance on major centralized trading platforms like BitMex. From there, let’s look at the scalable Bitcoin DeFi version that Sovryn offers for users who prefer the privacy and wealth control to the convenience of centralized platforms.
In finance, a perpetual futures contract, also known as a perpetual swap, is an agreement to buy or sell non-optionally a contract representing an asset and settle the trade in the near or distant future. Perpetual futures are cash-settled and differ from regular futures in that they have no predetermined delivery date and can therefore be held indefinitely without contracts needing to be rolled over as they near expiration. Payments are regularly exchanged between the holders of the two sides of the contracts, long and short, with the direction and amount of settlement based on the difference between the contract price and that of the underlying asset and, where applicable, the difference in leverage between the two sides.
Economist Robert Shiller first proposed perpetual futures in 1992 to enable derivatives markets for illiquid assets. However, perpetual futures markets did not develop for cryptocurrencies until after their introduction in 2016 by BitMEX.
In July 2022, perpetual futures entered the realm of Bitcoin DeFi On Sovryn. Sovryn is a platform built on top of RSK, a Bitcoin EVM compatible sidechain. Perpetual futures added a significant new feature to the most feature-rich DeFi platform for Bitcoin.
So what are they?
A perpetual swap is somewhat similar to a futures contract in that it allows traders to speculate on the future price movements of cryptocurrencies. The main difference is that unlike a typical futures contract, perpetual swaps do not have expiry dates.
Like other types of derivatives, including futures and options, perpetual swaps offer a way to speculate on the value of assets while the contract is held.
In perpetual swaps, the buyer takes a long exposure to an asset and the seller takes a short exposure to the asset. The word perpetual implies that the contract has no expiry date, unlike a futures contract which has a pre-determined date on which the derivative will settle. A perpetual swap tries to keep the buyer and seller at risk indefinitely until they end the contract.
How are they used?
They can be traded in different ways depending on how they are structured.
It is a way for market participants to come together and share risks.
How can the perpetual contract successfully track the underlying index price?
A futures contract specifies an index at which the derivative will settle at expiration, see for example [CME Bitcoin Futures Specification]. If the futures price is above the spot price shortly before expiry, you can buy the spot cheap and sell the futures contract high. At expiry, the trader must deliver the underlying asset that he bought cheaply. This is an arbitrage profit (which works similarly when the futures price is below the spot price and the futures contract is delivered in cash rather than in kind).
With many market participants making this trade, the futures price moves towards the spot at expiry. However, perpetual swaps do not have an expiry date and additional incentive is required for buyers and sellers to cause the price to converge towards the spot rate. Empirically, when most market participants are long, prices move above the spot rate. In order for the perpetual futures price to converge towards the spot, we want to encourage sellers to enter the market. For these incentives, perpetual futures provide funding payments. When people are bullish, the long traders pay interest to the short, which is defined as a positive funding payment. Payments are made with different frequencies depending on the trading venue – for example, every eight hours for BitMEX, every hour for FTX and continuously for Terabit. This funding payment creates an arbitrage opportunity for the seller as the seller can step in and short these perpetuals and buy the spot. Now they have essentially generated a crypto dollar as their position is no longer dependent on the price movements of the underlying asset and hence they lock the price in dollars and collect interest while holding the contract. When traders are charging an interest rate that is attractive to them, they are happy to be in that position; if not, they will relax.
This is one of the reasons why perpetual swaps are so interesting; You can enter the position knowing your value is locked.
With a futures contract, you know that the price will converge towards the index price at expiration, while with a perpetual futures contract, you don’t know that the price will converge into the index at some point of time.
The price is determined by the ratio between longs and shorts. When there are many more shorts than longs, shorts have to pay a fee to longs based on the price difference between the spot price and the contract price. When there are more longs than shorts, longs pay shorts.
summary so far
When a futures contract relates to the price of bitcoin, traders are not trading bitcoin itself, but are using its value to define the trade. This is called cash settlement. Futures contracts are derivatives, meaning their market prices are derived from the price of an underlying instrument. So, unlike traditional markets, you are not trading assets, only contracts that represent them. When a trade is open, the trader receives an unrealized profit, which is compounded when the trade goes in the desired direction. In this case, the maintenance margin level of this trade is positive and the trader can remain in the trade for as long as desired. On the contrary, if the trade is not going well for you, the maintenance level will drop and the trader will be asked to increase their maintenance margin to hold the position and protect it from liquidation. Liquidation is the forced closure of a position, where the trader’s position is liquidated as a penalty for unsuccessfully forecasting the market and trading the opposite position.
So far you have learned about perpetual swaps, also known as perpetual futures on centralized exchanges. Let’s see how this product performs on Sovryn, the DeFi platform that uses automated market makers instead of the classic order book approach.
What do Sovryn perp swaps allow?
Sovryn Perp Swaps allow you to go long or short on any defined trading pair while using Bitcoin as collateral. The first trading pair is USDT/BTC, but the future potential goes beyond that. Sovryn plans to add more assets such as: B. Various stocks backed by Bitcoin.
You can take the risks and rewards of spot price movement without actually buying or selling the asset. You cover risk by providing margin figures that cover any losses you suffer if the price moves against your position. Sovryn Perpetual Futures are similar to traditional futures contracts but do not have an expiration date.
What makes Sovryn Perps different?
Sovryn Perpetual Futures uses a different mechanism to track the spot price. When market pressure creates more long demand than short demand at spot, longs pay a funding rate to shorts for the privilege of holding the long position at (or near) spot. When short positions outweigh long positions, short positions pay a funding rate to long positions. Like other derivatives, including futures and options, perpetual swaps offer an opportunity to speculate on the value of assets while the contract is held and managed.
Then, Sovryn employs an Automated Market Maker (AMM) for fully decentralized perpetual futures contracts on the BTC/USD pair. Perpetuals with the same collateral currency can share a liquidity pool, resulting in a capital efficient setup. Liquidity is first provided by protocol governance and then owned by the protocol. External liquidity providers can participate in AMM profit and loss, but do not affect prices and do not face volatile losses. The AMM accepts perpetuals collateralized in each token and therefore any type of synthetic assets that have an oracle-based index can be added as a perpetual as long as the model assumptions adequately represent the asset properties.
The AMM pricing approach is based on a risk-neutral assessment that differs from the current one
DeFi implementations.
- Sovryn Perpetual Swaps work according to the principle defined above if the Automated Market Maker approach is used instead of classic order books.
- Since Sovryn is built on the RSK Bitcoin sidechain, it uses BTC for perpetual swap trading.
What challenges is Sovryn currently working on to improve the user experience?
- Enhance UX – Simplified, more polished version
- Better TX Speed - Leveraging graph technologies for faster indexing
Perps are currently being launched as a Labs product on the Sovryn platform, using the BSC blockchain to bypass the current RSK network limitations that impact the required functionality. The end goal for Sovryn perp swaps is to migrate to ZK rollups on RSK once they become available.
Why are Automated Market Makers (AMM) so popular these days and what advantages do they bring over using traditional order books?
One reason AMMs have become so popular in DeFi, as opposed to traditional order book systems, is that they require far fewer blockchain interactions to facilitate a trade. That is, in the traditional financial markets, market makers publish their limit orders. When new information arrives or trades take place, the market makers cancel and replace open orders. In contrast, in AMMs, the role of market maker is filled by passive liquidity providers. If a trader wants to exchange tokens, this can be done inexpensively with a transaction on the blockchain – no limit orders have to be replaced by market makers.
Benefits of AMM’s Perpetual Swaps
AMMs do not require active market makers to provide a good trading experience. Furthermore, unlike traditional constant product AMMs, there are AMMs for perpetuals that do not suffer from the inconsistent loss problem. Therefore, even in the presence of L2 solutions, an AMM is a viable solution for perpetuals trading. It is possible that a hybrid model will emerge, allowing market makers and order matching using the traditional model, which will then be combined with an AMM that fills liquidity gaps.
Where can we try this?
Other useful links about Sovryn
documentation
LOADING
. . . Comments & more!
Comments are closed.