There are some weaknesses in GMX's operating model. What are these shortcomings, and will they affect GMX's long-term growth?
GMX traders are trending profitable again
GMX is a decentralized derivatives exchange that uses the GLP Pool model to provide traders with zero slippage.
However, the limit to the development of GMX lies with the liquidity providers (in this case the GLP pool). Therefore, as the trading volume on GMX becomes larger and larger, the size of the GLP Pool (or project TVL) needs to be correspondingly large to meet the demand.
The design of this model is that liquidity providers are symmetrical to traders. Therefore, the trader's losses will correspond to the profits of the liquidity provider (GLP holder). In addition, GLP stakers will receive a portion of the exchange’s trading fees.
Therefore, GMX will operate under the assumption that most traders in the market will lose money. At that time, GLP stakers will receive both the profit of transaction fees and the losses of traders. The high yield of GLP will attract more liquidity to serve GMX to ensure that users' trading needs are met.
However, from the beginning of 2023 to now, the trend of traders losing money on the GMX exchange has reversed.
Specifically, traders on GMX went from a net loss of about $45 million since the beginning of the year to about $12 million (on the Arbitrum system).
In addition, GMX's AUM Daily Usage index is on a downward trend.
Therefore, the source of yield for GLP is decreasing (as traders are once again taking profits, TVL is increasing, but AUM daily usage is not increasing accordingly). This will reduce the incentive to hold GLP.
At this point, the risk of GMX entering a negative feedback loop will increase.
Risk of GMX entering a negative feedback loop?
When GLP holders suffer too much loss or the returns are not attractive enough, they tend to withdraw from GMX. At this time, TVL will decrease, and traders' liquidity needs will not be met, resulting in a decline in trading volume. From then on, the returns will decrease and will cause GLP to withdraw more capital.
In addition, since there is no funding rate mechanism, traders on GMX usually tend to support one way, Long or Short, within a certain period of time.
Therefore, in the period from early 2023 to now, when BTC grew by more than 70%, traders once again made profits.
If traders bet on the correct trend of the GLP market, they will lose and gain less, and if the loss exceeds the ability of transaction fees to cover, the risk of GMX will enter a negative feedback loop and increase.
Since its official launch, GMX has collected over $193 million in transaction fees (across both ecosystems).
Of this, 70% of the equivalent of $135.4 million has been allocated to GLP. Therefore, the $4.5 billion loss figure of the above traders has made a significant contribution to the income of GLP holders.
Therefore, GMX needs to adjust its project design to balance long/short trading volumes to maintain stable income for GLP holders (possibly achieved through funding rates).
However, at present, the transaction fees allocated by GMX to GLP can still offset the risk of profitable traders. However, if the current model continues, GMX will face huge risks when the market grows strongly and traders hold long positions (historically, 99% of the open profits on GMX are long positions).
Furthermore, when GMX enters a negative feedback loop, the token price will also be severely affected due to the project’s staking mechanism.
Currently, the number of GMX tokens participating in staking has reached about 6.7 million tokens (accounting for more than 50% of the total supply). Among them, only 3% of GMX tokens are in the liquidity pool (according to the table above). Therefore, when the above risks occur, GMX tokens will also face huge selling pressure relative to liquidity.
GMX's risks will become opportunities for other sustainable platforms
Currently, the decentralized perpetual market is dominated by a few major names (in terms of trading volume), namely Dydx, GMX, Gains Network, Kwenta, and Mux Protocol.
Among these platforms, GMX has the highest average daily trading volume (fluctuating between $130 million and $350 million on a 30-day average since the beginning of 2023).
Typically, GMX's trading volume often exceeds that of other exchanges.
For Dydx, average daily trading volume typically exceeds $1 billion.
When the above risks occur in GMX, it will become an opportunity for other decentralized perpetual exchanges to dominate the market.
If the majority of GMX’s trading volume (average around $250 million in 2023) flows to exchanges such as Kwenta or Dydx, it will bring a significant increase in the revenue of these projects.
For some exchanges with similar operating models to GMX, such as Gains Network, Level Finance, and Mux Protocol, we also need to pay special attention to this risk when making investment decisions.
For Dydx and Kwenta (exchanges with different operating models than GMX), there are several advantages:
Kwenta: Uses synthetic mint, so also has zero slippage.
Dydx: A self-developed application chain with large transaction volume and more supported assets than GMX.
Additionally, the two exchanges could offer greater scalability than if GMX relied solely on a common liquidity pool for trading.
Overall, if GMX can quickly find a solution to the risk of entering a negative feedback loop, the project may continue to maintain market share in the future. However, there are still many questions about the scalability of trading various assets on GMX.
If the above risks are not fully overcome, other permanent DEX projects will be able to rise and develop in the future.
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