Perennial provides a basic framework for a derivatives market, allowing you to set your own parameters to build a market.
Written by Babywhale, Foresight News
On December 7, the DeFi derivatives protocol Perennial announced that it had completed a $12 million financing round, with investors including well-known institutions such as Polychain Capital and Coinbase Ventures. With centralized institutions frequently facing financial crises and decentralized DeFi protocols as numerous as stars, why are these institutions still willing to make such a big bet?
Perennial operation mechanism
Perennial essentially provides a tool for establishing a derivatives market without permission, rather than simply providing a trading market. Perennial sets a set of trading rules for derivatives and allows anyone to set the key parameters to establish their own market.
Perennial provides a trading model called peer-to-peer pools. Each public derivatives market includes three roles: market builders, liquidity providers, and traders. According to the project documentation, the current Long-SQTH pool is operated by Opyn's multi-signature address. The other two markets: Ethereum's long and short markets are both managed by Perennial's multi-signature address.
First, as a market builder, only a portion of the derivatives market fees will be collected as income, and there will be no mandatory requirement to provide liquidity. There are only two roles in the market: liquidity providers and traders. For the Ethereum long market, the trader is the party that is long on Ethereum, and the trader's counterparty is the liquidity provider. Therefore, if a user chooses to provide liquidity for the long market, he is short on Ethereum, while if he provides liquidity for the short market, he is long on Ethereum.
Perennial calls it a peer-to-pool trading model. Because there are only two parties involved in the market, the profit of either party comes from the loss of the other party. When a user opens a position, closes a position, or is liquidated, the opening, closing, and liquidation transactions will be executed according to the new price feed when the oracle feeds the price next time. Perennial said that this move is intended to prevent front-running transactions caused by a large deviation between the oracle price and the actual price when the market fluctuates violently.
For market builders, the parameters they need to set include utilization curve, fee structure, leverage and maximum liquidity. Among them, fee structure (opening and closing positions) and maximum liquidity are relatively easy to understand, and the key is the utilization curve and leverage parameters.
The utilization curve is the functional relationship between market utilization and funding rate. Perennial said that this parameter refers to the relationship between Aave and Compound regarding lending utilization and interest rates. In Perennial, traders need to pay funding fees to liquidity providers, and the level of this fee depends on the funding utilization rate (that is, the ratio of the nominal value of the trader's opening position to the nominal value of the liquidity provider's opening position). The higher the utilization rate, the higher the funding fee, but it maintains a low growth rate before 80%. After reaching 80%, in order to balance the liquidity on both sides of the market, the funding fee will increase significantly.
As a market builder, you need to set four parameters: minimum and maximum funding rates, target utilization rate, and target funding rate that matches the target utilization rate to form a utilization curve.
At the time of writing, the utilization rates for the long and short markets were 3.413% and 17.947%, respectively, with funding rates at 0.007% and 0.019%, respectively.
Leverage represents the maximum leverage that liquidity providers and traders can use. In the market, this parameter is called "Maintenance", which is the minimum ratio between the user's nominal position and margin. For example, if Maintenance is set to 20%, the maximum leverage is 5 times.
In Perennial, liquidity providers and traders are called Makers and Takers respectively, and both parties can use leverage to open positions. The token used to open a position is the USDC wrapped token DSU. Users only need to use USDC to open a position, and the protocol will automatically convert USDC into a wrapped token. When liquidation occurs, 20% of the collateral will be used to reward the liquidator. Perennial said that it currently only supports overall liquidation, and may add a partial liquidation mode in the future.
In actual use, the actual liquidation price is not calculated entirely according to the leverage multiple, but a separate calculation method is used. The leverage multiple only represents the magnification of the profit, and when the market goes against the user's position, the liquidation price will have a certain buffer space on this basis.
Taking the bullish Ethereum market as an example, when the highest leverage of 5x is selected, the user's collateral value is 20% of the nominal position, which will directly trigger liquidation, so the liquidation price is the opening price. When the leverage is set to 2x, the price drops by about 37.5% to trigger liquidation. This number is still some distance away from 50%, and the risk is relatively high in actual use.
Summarize
Perennial provides a basic framework for the derivatives market, allowing you to set your own parameters to establish the market. The trading model is not much more noteworthy than the order book and AMM models, but its value, in my opinion, is to provide an underlying protocol for derivatives, on which other protocols can set up derivatives markets with specific parameters, or develop structured products based on existing derivatives markets. Compared with the existing derivatives market with restricted rules, customizability and platformization may be important reasons for capital to choose to bet.
