Challenges and Developments of Decentralized Perpetual Futures Trading Exchange

Recently, an event that attracted attention occurred in the cryptocurrency market. A large holder went long on ETH with 50x leverage on a certain Perptual Futures trading platform, with floating profits exceeding $2 million at one point. Due to the massive position size and the transparent nature of the blockchain, the entire crypto market is closely monitoring the movements of this "whale".

However, the trader's subsequent actions were unexpected. He did not choose to continue to increase his position or close it for profit, but instead adopted a unique strategy: by withdrawing part of the margin to secure profits, which led to the system raising the liquidation price of the long position. Ultimately, this operation triggered a liquidation, resulting in a profit of approximately 1.8 million dollars.

This practice has had a significant impact on the platform's liquidity. The platform adopts an active market-making mechanism to maintain the liquidity pool by charging funding fees and clearing profits. Due to the excessive profits made by this large trader, a normal liquidation could lead to insufficient liquidity. The active liquidation strategy he chose has caused the losses to be borne by the liquidity pool. On March 12 alone, the platform's liquidity pool decreased by approximately $4 million.

This event highlights the severe challenges faced by decentralized exchanges for perpetual futures (Perp Dex), particularly the urgent need for innovation in liquidity pool mechanisms. Let us take this opportunity to compare the mechanisms used by current mainstream Perp Dex and discuss how to prevent similar attacks from happening again.

Comparison of Mainstream Perpetual Futures DEX Mechanisms

A proprietary chain platform

1. Liquidity Provision:

   • Community liquidity pools provide funding
   • Users can deposit assets such as USDC to participate in market making.
   • Allow users to create their own "Vault" to share in market-making profits

2. Market Making Model:

   • Utilizing a high-performance on-chain order book matching
   • The liquidity pool acts as a market maker, providing depth and handling unmatched orders.
   • Use external oracles to ensure price accuracy

3. Clearing Mechanism:

   • Liquidation triggered when margin falls below minimum requirement
   • Any sufficiently funded user can participate in the liquidation.
   • The liquidity pool also serves as a clearing insurance fund

4. Risk Management:

   • Multi-exchange price oracle, regularly updated
   • Increase the minimum margin requirement for large positions
   • Open clearing participation, but there is a risk issue of a single treasury bearing the risk.

5. Funding Rate and Position Cost:

   • Calculate long and short funding rates every hour
   • Adjust the deviation of contract prices from spot prices through funding fees.
   • May dynamically adjust funding rates to control risks

a Solana ecosystem platform

1. Liquidity Provision:

   • Multi-asset liquidity pools provide liquidity
   • Users participate in liquidity provision by swapping assets

2. Market Making Model:

   • Innovative LP-to-Trader mechanism
   • Achieve near-zero slippage trading through oracle pricing

3. Clearing Mechanism:

   • Automatic Liquidation System
   • Liquidation is triggered when the margin rate falls below the maintenance requirement
   • The liquidity pool acts as a counterparty to bear gains and losses.

4. Risk Management:

   • Use oracles to keep contract prices close to spot.
   • A limit can be set on the total position of a single asset
   • The borrowing rate increases with the utilization rate of assets.

5. Funding Rate and Position Cost:

   • No traditional funding fees, using a lending fee mechanism
   • The borrowing fee is calculated hourly based on the asset ratio.
   • The longer the holding period, the more interest accumulated.

a multi-chain platform

1. Liquidity Provision:

   • Multi-Asset Index Pools provide liquidity
   • Users deposit assets to obtain liquidity tokens

2. Market Making Mode:

   • No traditional order book, using oracle pricing
   • The liquidity pool automatically acts as a counterparty.

3. Clearing Mechanism:

   • Automatic Liquidation System
   • Use decentralized oracles to calculate position value
   • The liquidity pool directly bears the liquidation profit and loss.

4. Risk Management:

   • Use multi-source oracles to reduce manipulation risks
   • Set a maximum position limit for easily manipulated assets
   • Limit leverage risk through a dynamic fee rate mechanism

5. Funding Rate and Position Cost:

   • No traditional funding fees, using a lending fee mechanism
   • The lending fee is paid directly to the liquidity pool
   • The higher the asset utilization rate, the higher the annualized borrowing fee rate.

Future Development Direction

The challenges faced by decentralized futures trading exchanges stem from their transparency and code-defined rules. Future preventive measures may include:

1. Reduce user position size:

   • Adjust the maximum leverage multiplier
   • Increase margin requirements

2. Implement automatic reduction mechanism (ADL):

   • Activate when the risk reserve cannot bear the liquidation loss
   • Hedging losing positions with profitable or high-leverage positions

3. Multi-account monitoring:

   • Track Address Relevance
   • Preventing Witch Attacks

However, excessive restrictions may contradict the core principles of DeFi. The ideal solution is to gradually increase liquidity depth as the market matures, raising the cost of attacks until such operations become unprofitable. The current challenge is an inevitable stage in the development of decentralized Perptual Futures trading exchanges. It is believed that over time and with technological advancements, these issues will eventually be resolved.