Limitations of the GMX v1 operating model
The highlight of the GMX operating model is the design of the GLP. By design, it is based on the "casino game" philosophy, where liquidity providers (LPs) are casino owners and traders are players.
Read more: GMX Operating Model: Unique Design and “Ponzi Scheme” Token Economic Model
The project applied the "casino owners always win" mentality to designing its current operating model, and in this way, GMX has been moderately successful in attracting approximately $600 million in TVL and hundreds of millions in transaction fees ( GMX’s TVL reaches an all-time high of over $700 million).
However, the current model has some limitations. First, the cryptocurrency market is characterized by unidirectional trends (traders tend to either buy in large quantities or sell in large quantities), so open interest on GMX is usually quite high.
Additionally, GMX v1 has no funding rate mechanism to regulate trader activity, so liquidity providers will suffer losses when the market moves in line with their bets. Therefore, GMX is at risk of the following negative feedback loop:
Additionally, to avoid liquidity fragmentation, all liquidity sources on GMX are kept in GLP. This design helps traders with large trading positions obtain sufficient liquidity to trade. However, this limits GMX’s scalability in terms of trading assets.
Learn more: Risks of GMX operating model
Indeed, GMX currently only supports trading of 5 volatile assets, including BTC, ETH, AVAX, LINK and UNI.
Scaling to more assets requires a huge liquidity pool that includes a variety of tokens, as well as a complex GLP portfolio reorganization process. This could pose a risk to GLP holders since there are so many different tokens in the portfolio.
Overall, GMX currently has two main problems with its operating model:
Liquidity provider risk when traders make profits
Limited expansion issues
Additionally, high transaction fees on GMX are also a hindrance. Depending on the situation, for small traders, the fee for opening a long/short order is 0.1% (much higher than Binance).
GMX’s synthetic minting mechanism allows traders with large positions to profit with zero slippage (as their slippage is typically much larger than trading fees). However, for small traders, the issue of transaction fees is more important.
Therefore, GMX is not attractive to small traders compared to other platforms or centralized exchanges.
What's new in GMX v2
Changed the liquidity supply mechanism
GMX v2 splits the source of liquidity for each trading pair into many different liquidity pools, rather than all trading pairs sharing the same liquidity from GLP like v1.
Liquidity providers (LPs) are free to choose a pool that suits their risk appetite.
Each independent liquidity pool will act as a GLP in the old model. Therefore, each perpetual trading pair, such as BTC/USD, requires a mini-GLP pool containing BTC and stablecoins (such as USDT, USDC, DAI, etc.).
For example, if a trader wants to trade Ethereum's perpetual contracts, the liquidity source will come from all pools containing Ethereum and any stablecoin (for example, the liquidity source can come from v2 containing ETH-USDC, ETH-DAI, ETH -3 separate pools from FRAX), not just from the GLP pool in v1.
This makes GMX v2’s model similar to AMM DEX or Perpetual Protocol.
When scaling up to many assets, this model still has certain limitations in terms of scaling, as it still requires the participation of many LPs and different types of assets in each pool.
However, GMX v2 proposes a solution, for lower liquidity and higher risk trading pairs (such as DOGE), the mini-GLP pool will be composed of Ethereum and another stablecoin.
For example, when traders continue to trade the DOGE asset, liquidity will come from the ETH-USDC pool dedicated to trading the DOGE/USD trading pair. Liquidity from this pool will not be used to trade the ETH/USD trading pair.
For these trading pairs, it sometimes happens that the price of the tokens in the trading pair fluctuates too much compared to the ETH in the pool, which will result in insufficient liquidity in these independent pools to pay traders.
To solve this situation, GMX v2 applies automatic position liquidation. When traders' profits reach a level that threatens the entire pool, the platform will automatically partially liquidate (partially gain) their positions to ensure the safety of the entire pool.
Price Impact and Funding Rates
GMX v2 uses price impact and funding rate tools to solve two problems:
Price Impact: To avoid large traders manipulating the price of low-liquidity tokens in subsequent transactions supporting multiple asset classes.
Funding Rates: Addresses the situation where Open Interest (OI) often skews to one side, negatively impacting liquidity providers and potentially exposing traders to significant losses if they bet in the right direction.
Although GMX v2’s trading mechanism is still synthetic minting based on oracle prices, the project will apply price shocks based on users’ different trading positions. Therefore, traders with larger trading positions will experience slippage when placing orders, while the opposite is true for traders with smaller trading positions.
In addition to the above effects, this will also help GMX serve more users and reduce risks to the liquidity of the trading pool, especially when liquidity is more fragmented compared to v1.
Therefore, this mechanism prevents traders who are too large (compared to the trading pool) from placing orders to occupy all the liquidity of the pool, thus avoiding systemic risk.
Additionally, when open interest (OI) skews to one side (whether long or short), GMX v2 will apply funding rates to facilitate trading demand in the opposite direction to ensure a more balanced OI on GMX.
The goal is to minimize risk so that the "casino owner always wins" philosophy will work more effectively in this model.
However, when projects apply price shocks and funding rates, traders may incur more costs than in v1.
Change the transaction fee allocation mechanism
To ensure balance with the two new mechanisms mentioned above (price impact and funding rate), GMX v2 will reduce the trading fee for opening long/short positions on the exchange from 0.1% to 0.05%.
Therefore, compared to the old model, traders will incur two additional costs (in addition to opening/closing fees and borrowing fees) when trading: price impact and funding rate:
GMX v1: Trading fees for opening and closing orders are 0.1% (based on volume) + margin borrowing fees.
GMX v2: The transaction fee for each open and close order is 0.05% (calculated by volume) + margin lending fee + price impact + funding rate (may exist).
In addition, GMX v2 also adopts a different fee allocation mechanism compared with v1. Specifically, in v2, transaction fees will be distributed to 4 participants: Oracle, liquidity provider (LP), GMX pledgers and project funds (GMX Treasury), instead of just LP and GMX Treasury as in v1 GMX stakers.
This will ensure that the project has a stable source of long-term development revenue (rather than relying solely on venture capital from previous stages).
Are GMX's trade-offs appropriate?
Through the above design, GMX has overcome OI imbalance, transaction fees and scalability limitations (for liquidity providers providing risky assets).
However, GMX will face some new limitations:
Trading costs increase for traders with large positions (due to price impact).
Liquidity fragmentation is even more severe, as current liquidity is split into many independent pools.
Although GMX’s total value locked (TVL) has been growing recently, the trend in trading volume is not in a good direction.
In addition, the number of GMX users is also currently showing a downward trend, although trading volume and TVL remain stable.
Additionally, the Open Interest/TVL ratio, which shows GMX utilization, also shows that trader demand often does not exceed the GLP pool’s supply capacity.
In most cases, OI/TVL is below 0.5.
Therefore, if the new model divides liquidity between pools based on market demand, it will be possible to utilize funds more optimally and strike a balance between expansion needs and liquidity.
However, according to data from Dune Analytics (source), trades with a volume of $100,000 currently account for about 44% of the average daily total trading volume (usually fluctuating between 40% and 60%).
Therefore, the application of price impact may affect the group of traders who account for more than half of GMX’s daily trading volume. This could be a potential reason for them to leave GMX or choose another trading platform.
However, we still don’t have concrete data to accurately calculate whether lower transaction fees can offset the price impact of large traders.
In short, GMX v2 is balancing scalability across different asset classes, reducing liquidity provider risk through a more complex design, and the potential risk of customer churn.
However, against the backdrop of centralized exchanges (CEX) struggling under the influence of legislators, this strategy may be a suitable option for GMX to attract users.
Read more: Binance’s Regret or SEC’s Mistake?
In fact, spot trading volume on decentralized exchanges (DEX) is growing compared to centralized exchanges (CEX).
Therefore, the application of price impact may affect the group of traders who account for more than half of GMX’s daily trading volume. This could be a potential reason for them to leave GMX or choose another trading platform.
However, we still don’t have concrete data to accurately calculate whether lower transaction fees can offset the price impact of large traders.
In short, GMX v2 is balancing scalability across different asset classes, reducing liquidity provider risk through a more complex design, and the potential risk of customer churn.
However, against the backdrop of centralized exchanges (CEX) struggling under the influence of legislators, this strategy may be a suitable option for GMX to attract users.
Read more: Binance’s Regret or SEC’s Mistake?
In fact, spot trading volume on decentralized exchanges (DEX) is growing compared to centralized exchanges (CEX).
This proves that users have gradually become accustomed to the trading experience on decentralized exchanges (DEX), laying a good foundation for future development. Furthermore, futures trading on DEXs and centralized exchanges (CEXs) have yet to show signs of growth compared to spot trading.
So this may be the basis of the trade-off for GMX v2.