Over the past year, many decentralised futures exchanges have emerged. I think this phenomenon is quite significant and should not be overlooked. People with conservative strategies who do not trade futures at all can make money from them. And those who have traded futures on centralised exchanges can make excellent money.
How it all works
Exchanges can be roughly divided into 2 types:
1. They are similar to classic exchanges, where BID and ASK, and demand crosses with supply and so the price is formed in the exchange glass. This means that for each transaction there is a buyer and a seller. Such a decentralised exchange is dYdX.
2. trading through pools of liquidity. With the help of oracles. This means that the price is determined by the average of other exchanges using an oracle, such as PYTH. And the transaction does not necessarily involve a buyer and a seller. Everything is balanced by a pool of liquidity and funding rates. Examples of such exchanges are GMX, Hyperliquid, AEVO, VELA.
How to make money on such exchanges without expecting to be a successful speculator.
Liquidity Pooling
The most reliable and easiest way to make money on the second type of exchange is through liquidity pooling.
To keep such an exchange liquid, a liquidity pool is needed. And to attract holders to the liquidity pool, the exchange shares:
– A share of the commission,
– Revenue from funding rates, which result from balancing the volumes of short and long positions.
– Revenue from penalties on the liquidation of positions.
These are generalities, each DEX sets its own rules.
In a liquidity pool there are often very good returns, especially in the early stages.
In exchanges where there is a single liquidity pool: for example Hyperliquid ARP (yield) reached 200% per annum (ARP), while you invest in the USDC liquidity pool, I followed AEVO much less and there I managed to catch 50-60% ARP.
GMX is more complicated and depends on the assets.
Such returns are often available at an early stage for a number of reasons
– Grants from the network to launch such a project, which generates a lot of transactions, i.e. network activity, attracts a lot of users + and accumulates TVL well. And the DAO of the blockchain itself gives generous grants to such projects, which smart teams share with users.
– Interest in the project is greater than investor confidence. The exchange is actively traded, but no one is in a hurry to freeze their money in the liquidity pool. And here, according to the law of classical swap, the liquidity pool becomes very profitable because the commissions are distributed among a small number of investors.
– Airdrop. Such projects arrange airdrops. And the airdrop hunters pump up the exchange accounts, not paying much attention to the huge amount of commissions they generate, because they believe that the airdrop will return everything. And before the distribution of free tokens, we see a lot of active users on the exchange and as a result a large amount of commissions and liquidations.
Yields fall over time
After some time, the returns on the liquidity pools of such exchanges start to fall significantly. For the same reasons that made them high.
Grants run out, airdrops take place and activity on the exchange drops dramatically, resulting in low commission generation. At the same time, a large number of investors are added to the liquidity pool and you share the rest of the former volume among yourselves.
Risks
Sometimes players come to the exchange with capital commensurate with the size of the liquidity pool, sometimes there are imperfect oracles and high volatility – all of which can lead to losing days for investors in the liquidity pool. Over the course of a month, the pool will be in the black, but be aware that there will be some bad days and even weeks.
The exchange assumes that the vast majority of people who trade futures lose money
These are not just words or statistics. It is a hypothesis that has led to the emergence of decentralised futures exchanges that organise trading through an oracle and a liquidity pool.
How does the stock exchange draw up a balance sheet?
I have already written about this in the first part, but now I will go into more detail.
Perp DEX exchanges are organised in different ways, with many peculiarities and nuances, I will describe the general scheme, setting the vector of your thoughts.
Let’s take a hypothetical asset, SuperCoin, which is unpopular and very few traders trade it (quite a realistic situation).
So trader A buys it for $10,000.
Trader B – opened a short at $20,000 (at another time).
Trader C – bought it for $50,000. There were no other trades that day.
Open interest:
$60,000 long and $20,000 short.
This imbalance evens out over time. On the DEX, usually once an hour, one side pays to hold a position and the other side is rewarded.
For example, let’s say that every hour those who are long pay 0.3% and those who are short receive 0.3%. This will equalise the number of those who are short and those who are long, and the Funding Rate will change accordingly.
For example, because of the funding rate, trader A may decide that it is not profitable for him to hold a long position, he believes in growth but not so much that he is willing to pay 0.3% per hour.
Arbitrageurs may appear, they may buy SuperCoin on another exchange or spot and short it here and earn 0. 3% on the amount per hour, which will also balance the open interest imbalance.
And there are market makers on every exchange, they can also arbitrage.
In a high volatility environment, the funding rate will not result in a balance sheet
If Trader C in the example above closes his trade with a profit of $10,000 due to a sharp rise in the price of the SuperCoin token, who will take the loss and whose pocket will pay for the profit?
The liquidity pool will cover the loss. It will take some kind of balancing position.
In rare cases, especially until the project has a large enough liquidity pool, the team can either hedge certain large positions themselves, i.e. open an opposite position on another exchange, more often in this case using the services of market makers.
For example, a liquidity pool of $1 million, a trader goes short $400,000 on the PEPE token, if PEPE falls by 25%, the trader’s profit is $100,000 and the potential loss to the liquidity pool (here I am simplifying and not taking into account opposite positions of other players) is $(-100,000). This is significant for a $1 million cash pool. So an opposite position can be opened on some OKX, Binance or DEX and the risk of loss is eliminated.
In fact, such arbitrage is rarely done, and the bet is that the majority of futures traders will lose money.
And the pools earn part of the commission, part of the traders’ losses and part of the penalties for liquidating positions. So statistically it is similar to a casino, where the losses of the players are the profits of the casino.
All of the above is only described for the DEX on futures. As you can see, the liquidity pool may have bad periods, but there is a long term bet on traders trading at a loss.
Over time, with the active involvement of market makers, DEX may abandon the practice of earning on client losses altogether, which will reduce risks, equalise equity, but also reduce the profitability of the pool.