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Decentralized Futures is Still a Trillion Dollar Opportunity: A Thesis for KTX
The market for cryptocurrency futures will continue to evolve.
Cryptocurrencies have fascinated me from a multitude of perspectives; as a tool to privatize monetary policy of the state; as an incentive framework for strangers to govern common goods; as a “third place” for the internet-native creative class. Whether you’re the politically charged, or a financier, crypto attracts talent and interests from all backgrounds, of all shape and form.
I myself began as a trader in cryptocurrencies, after I took my first job at a decentralized derivatives protocol. Today, I’m happy to have circled back to supporting KTX, the leading decentralized derivatives exchange that will be first deploying on BNB Chain.
In this post, I want to revisit the core principles that separate cryptocurrency futures from traditional financial futures, and lay out an open thesis for KTX.
A primer on decentralized futures.
Unlike stocks, cryptocurrency markets trade 24/7. This fundamental difference enabled the creation of the 100x perpetual contract – a first of its kind unique to cryptocurrencies. Usual futures contracts expire on a certain date, where your position would be settled. You could create a “perpetual” future by rolling it over on your own (selling an expiring contract and buying a contract that expires further out in date), but then you have all that roll-over risk and more. Robert Shiller had proposed something similar to a perpetual future in a paper in early 1992, but Bitmex brought it to life in 2016.
So centralized futures dominated the landscape, and it wasn’t until 2020-2021 where decentralized derivatives products began to accelerate in innovation. Chain throughput was always the limiting factor and the advancement of L2s/App-chains lifted the ceiling of what could be achieved. I still remember some of the key players of those days: Leverj, Injective, DerivaDEX etc.
Many of these were known as order-book based exchanges. They had all sorts of intricate technical differences between one another. One just has to remember that these exchanges compete along the dimensions of decentralization, trade efficiency (fees), margin efficiency (leverage), and liquidity.
Out of all, DYDX then became one of the first ever derivatives exchanges to introduce cross-margining – the ability to use one asset as collateral to open positions in another; this was a breakthrough moment, as it gave traders far more complex strategies to trade with. The presence of margin limits such as these have produced very anomalous phenomena in crypto markets, such as consistently high (~10%) funding yield. In fact, back in 2021, the now-defunct FTX only allowed a maximum 30,000 loss on any position, capping the implementation of the classic “cash and carry trade” as published in the BIS.
Cross-margining allowed traders to take more complex Long and Short trades since your positions could net out. DYDX attained nearly trillions in daily trading volume, though at the cost of running a centralized order book matching engine, which the team intends to decentralize in the fourth version of the protocol.
Besides order-book based exchanges, a separate branch of Peer-to-Pool models, inspired by spot AMMs, began to develop. Multicoin has a great blog post about them, featuring Perpetual Protocol. Their key advantages follow those of AMMs: composability of underlying asset positions, where anyone could use your tokenized form of ownership to do other cool things with (or really just rehypothecate even more), and the ability to easily bootstrap markets for long-tail assets.
GMX enters the game.
GMX launched on Arbitrum in late 2021 and has accrued more than 120 trillion in trading fees to date. Unlike DYDX, GMX runs a “peer-to-pool” model but in a very different way. It is improved in many ways, but I want to highlight 2 core innovations:
Liquidity is concentrated in a single pool. Ownership of the pool is represented by an index token that comprises of approximately 50% stablecoins ($USDC, $USDT, $FRAX, $MIM) and 50% blue-chip tokens ($ETH, $BTC, $LINK and $UNI).pool. Liquidity providers that deposit in the pool mint $GLP and earn 70% of trading fees.
For those concerned, it means that the market making function is decentralized. If you trade In a centralized exchange, there is always the possibility your stops could be hunted. If you trade on an orderbook-based decentralized exchange like DYDX, it means you are relying on market makers like Wintermute to keep your orders flowing.
Pricing via oracles. Peer-to-Pool protocols run into the problem of toxic flow, because they do not automatically adjust market prices they are offering traders. Rather, they rely on traders to arbitrage the difference between their venue and other venues in order to close the price.
In other words, you as a liquidity provider, are paying the cost of price discovery to smart traders. This is why the flow is “toxic”. GMX does not face this problem as prices are fetched and updated via oracles
These, amongst many other things, allowed GMX to provide superior execution as well as a flywheel for attracting protocol liquidity. And also many seemingly attractive features such as cross-margining and zero-slippage trades (though there are some consequences of this which I will not discuss).
In the ethos of decentralized finance, GMX maintains the spirit of composability, as the GLP token could be used as collateral in money markets, stablecoin issues, and yield managers.
Today, I am excited to back KTX, a decentralized derivatives protocol inspired by GMX’s architecture. The KTX team is led by Kevin, a PhD in Computer Science from the National University in Singapore. Kevin co-founded the world’s first BTC options Exchange and also held senior roles at Southeast-Asian (SEA) unicorns like Grab and Garena.
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Theses for KTX
Thesis 1: Validated model — GMX’s shared liquidity model has been battle tested on a high throughput chain.
As aforementioned, incentivizing public liquidity through a shared pool vis a vis fragmented ones have allowed for better capital efficiency and also portfolio margining features, relative to order-book style or peer-to-pool models
Thesis 2: A rising tide to lift all boats: we are likely hitting an inflection point for decentralized derivatives
FTX had over a million users and its collapse has cast a shadow on exchanges, shown in falling daily exchange volumes across all CEXes.
Regulatory scrutiny of CEXes, furthermore derivatives products, has become more severe – Australia has recently cancelled Binance’s Derivatives License for example.
On the contrast, trading volume of almost all decentralized margin DEXes has risen since the past year.
There is also a secular argument for the growth of derivatives DEXes by all “ratios”. Derivatives to spot trading volume on crypto DEXes far lower than traditional asset classes
Within crypto itself, DEX derivatives account for less than 1% of CEX derivatives volume, while the share is closer to 8% for spot volume between DEXes and CEXes. Binance does 19B in futures trading volume daily, while GMX only does ~100M. Futures is a massive pie.
Thesis 3: Not just a fork. BNB chain’s competitive environment is uniquely different from Ethereum/L2s, and KTX’s team is well positioned to bring GMX to BNB.
BNB chain’s user base skews towards retail. It has the 2nd largest protocol by TVL after Ethereum (4.4B vs 28B) yet has 4 times the number of daily active addresses (1.2M vs 0.3M). This requires a different value proposition that is reflected in the dominant DeFi protocols on BNB today.
Pancakeswap, for example, focuses on gamifying aspects of trading and continually introduces novel campaigns (“Syrup Pools”) and lottery-like systems to keep users engaged. In line with this, KTX will expand on social features such as copy trading vaults and growth campaigns like trading competitions
BNB’s user base is asian centric. SimilarWeb shows that while ~25% of Uniswap’s visitors are from US/UK, only 14% of Pancakeswap’s visitors are from the West. Users from the asian region have differing user behaviors, may not speak English, and are acquired via different discovery channels. The success of localized Asian projects such as Coin98 Wallet is evidence of this segmentation.
KTX’s team is based in Southeast Asia and fluent in Mandarin, and so is well positioned to penetrate the Asian-centric crowd on BNB
Being adaptive to BNB Chain’s environment is a moat in itself:
It is unlikely that GMX will go into BNB: GMX DAO has indicated little interest (even objection) to integrating with BNB due to dilution of product focus, brand image, and the ethos of decentralization.
It is difficult for a second-mover from another chain to win over the BNB market without dedicated focus: Uniswap V3 deployed on BNB just this year but only attracted 10M worth of TVL. A tailored GTM approach is needed – even Sushiswap that deployed on BNB early on in April of 2022 never secured above 2M in TVL.
A recurrent theme in Internet history is the juxtaposition between products built for the West, and products built for Southeast-Asia. From Uber and Gojek, to Amazon and Shoppee, verticalization by geography is commonplace for applications that require repeat user interaction, more so in futures trading, which demands more attention than spot trading.
The KTX engineering team each have at least 8 years of experience in the SEA tech scene, spanning Shoppee, Garena, and Google. I am excited by how KTX can stand on the shoulders of giants and push the derivatives space forward!
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