In this article, we will explore the current token economic landscape of decentralized perpetual contract exchanges, analyze the different mechanisms utilized by these protocols, and discuss possible future developments.
Why are tokenomics important?
Token economics are critical to the growth and stability of the protocol. The experience of “DeFi Summer”, liquidity mining successfully led to the launch of yield protocols in the early stages, but was ultimately unsustainable in the long run. This mechanism attracts mercenary capital that seeks short-term high returns and is ready to transfer at any time, and promotes a vicious cycle of "mining and dumping". Farmers are constantly looking for the next agreement that provides higher returns, and the agreement that leaves is suffering. to serious damage.
One example is Sushiswap’s vampire attack on Uniswap, which initially succeeded in attracting significant TVL, but was also ultimately unsustainable. At the same time, protocols like Aave and Uniswap have successfully attracted and retained their users through product-oriented and sustainable tokenomics strategies, which has helped them solidify their position as market leaders and remain the remain so to this day.
(Data source: DeFiLlama)
While product-led growth is important, token economics are a differentiating factor for decentralized perpetual contracts exchanges in a highly competitive market. Tokens represent users’ assessment of the value of a protocol based on its activity, similar to how stocks reflect a company’s expected performance. Unlike traditional markets, token prices often precede widespread awareness and growth of crypto projects.
Therefore, it is important to have a tokenomics system that accumulates value as the protocol grows. Ensuring there is a sustainable token economy that provides adequate incentives for new users is equally important. Overall, good token economics are key to achieving long-term growth and preserving the value of the protocol.
Review: The competitive landscape of decentralized perpetual contract exchanges
dYdX was one of the first protocols to introduce perpetual contracts on-chain in 2020 and launched its token in September 2021. The token is widely known for high inflation from staking, liquidity provider, and trading rewards, offering little utility to holders aside from trading fee discounts.
In response to the unsustainability of emissions, GMX entered the market in September 2021. GMX was one of the first platforms to introduce a peer-to-pool model and provide users with a revenue distribution mechanism that generates revenue through transaction fees, paid in major and native tokens. Its success also led to the creation of more peer-to-pool model systems, such as Gains Network. It differs in the staking model and revenue sharing parameters, with users taking lower risks but generating lower returns.
Synthetix is another established DeFi protocol in the field, supporting the front ends of multiple perpetual and options exchanges, such as Kwenta, Polynomial, Lyra, dHEDGE, etc. It uses a synthetic model where users must stake their SNX tokens as collateral to lend out sUSD for trading. Stakers receive sUSD fees generated from all front-end transactions.
Tokenomics compared in on-chain perpetual contract exchanges
The table below shows how different protocols compare on their token economics:
Creating good tokenomics: factors to consider
Well-designed token economics require careful consideration of various factors to create a system that aligns the incentives of participants and ensures the long-term sustainability of the token. We discuss various factors below based on the current landscape of decentralized perpetual contract exchange token economics.
1. Incentives and Rewards
Incentives and rewards play an important role in encouraging desired behavior. This includes staking, trading, or other mechanisms that encourage users to contribute to the protocol.
1a. Staking
Staking is a mechanism for depositing native tokens into the protocol in exchange for rewards. Benefits gained by users can be obtained through revenue sharing from fees, which can be larger market cap tokens/stablecoins, or emissions from the native token. Depending on the protocol we analyzed, there are 3 main types of staking:
(1) Fee sharing for major tokens or stablecoins
(2) Fee sharing of native tokens
(3) Emission sharing of native tokens
period capital, no vesting period, etc.) may attract mercenary users, which dilutes rewards for active users (active traders, long-term stakers, etc.).
Our view is that staking is a common method of reducing the circulating supply of a token in most protocols. This is a good way to align with the interests of the user, especially if staking is required as collateral (such as SNX), it can reduce the volatility of the user's position through yields. If rewards were distributed as a share of fees and in the form of major tokens/stablecoins, then the effects of staking would be more positive and long-term, and this would also apply to most decentralized perpetual contract exchanges with decent trading volumes.
1b. Liquidity Providers (LPs)
Liquidity providers (LPs) are crucial for decentralized perpetual contract exchanges, especially for peer-to-pool models, as they are able to support higher trading volumes on the platform. In the peer-to-pool model, LPs become counterparties to traders on the platform. Therefore, the revenue sharing from fees must be sufficient to offset the trader's risk of loss.
For order book models like dYdX, LPs serve as a way for users to earn rewards. However, the majority of TVL still comes from market makers, and the rewards issued in DYDX are purely inflationary. As a result, the LP module will be deprecated in October 2022. One exception is Synthetix, where stakers are technically LPs on the platform they are integrated with (Kwenta, Polynomial, dHEDGE, etc.) and earn fees from trading volume.
Both GMX and Gains Network use peer-to-pool models that require LPs as counterparties. Compare these two protocols:
(1) GLP’s TVL is significantly higher than gDAI – possibly due to higher returns
(2) gDAI users face a lower risk of loss because traders’ profits are supported by GNS casting, while GMX uses user funds in GLP to pay users
(3) For users with strong risk aversion, higher returns will attract them to choose GLP, while for users with strong risk tolerance, they may choose to deposit gDAI despite lower returns.
The mechanics of Gains Network are similar to GMX’s predecessor – Gambit Financial on BNB. Gambit generated considerable volume and TVL upon launch. Although Gambit and GMX share similar features in their peer-to-peer pool model and revenue sharing mechanism, their parameters are different.
(1) Incentive trading volume in the short term
a. With dYdX v3 rewards, traders are essentially being paid to trade, which helps drive trading volume up.
Factors to consider:
(1) The type of users the protocol wants to attract
a. For dYdX, the simple conditions for obtaining rewards and the lack of vesting conditions may attract many short-term users who will dilute the rewards from real users;
b. For Kwenta, the upfront capital requirements and vesting conditions may make it unattractive to short-term users - this may reduce the dilution of rewards to long-term users.
Our thinking: Transaction rewards can be an effective way to kick-start a protocol at the beginning, but should not be used indefinitely given that ongoing emissions/issuance reduce the value of the token. It should also not account for a significant percentage of supply and monthly inflation, while vesting is important for the protocol to spread selling pressure over time.
1d. Value is aggregated on the chain
Case study: dYdX
The launch of the dYdX chain marks a new milestone for the protocol. On January 18, the dYdX chain even surpassed Uniswap and became the largest DEX by trading volume.
Going forward, we may see more decentralized perpetual contract exchanges follow this pace. The main changes to the token economics after the dYdX chain update include:
(1) Staking to support chain security, not just to generate revenue
a. In v3: Rewards in the security pool were sent in the form of DYDX token emissions, but were eventually stopped after the community voted in favor with DIP 17;
b. In v4: The dYdX chain requires dYdX tokens to be staked in order for validators to run and secure the chain. Delegation (staking) is an important process in which stakers entrust validators to perform network verification and block creation.
(2) 100% of transaction fees will be allocated to delegators and validators
a. In v3: all fees incurred are collected by the dYdX team, which is a concern for some in the community;
b. In v4: All fees, including transaction fees and gas fees, will be distributed to delegators (stakers) and validators. This new mechanism is more decentralized and aligned with the interests of network participants.
c. PoS stakers (delegators) can select validators to stake their dYdX tokens and, in turn, receive a share of revenue from their validators. Commissions to delegators (stakers) range from a minimum of 5% to a maximum of 100%. Currently, the average validator commission rate on the dYdX chain is 6.82%, according to Mintscan data.
(Data source: https://dydx.forum/t/dydx-v3-vs-v4-new-trader-rewards-overview/881)
On top of these changes, new transaction incentives also ensure that rewards do not exceed the fees paid. This is an important factor as many of the concerns surrounding v3 were about inflation and unsustainable token economics, and although this was updated along the way, it had little impact on the token's performance. Xenophon Labs and other community members have raised the issue of being able to "manipulate" rewards, which has also been discussed a few times in the past.
In v4, users can only earn transaction rewards up to 90% of the net transaction fees paid by the network. This will lead to an improved balance of demand (fees) and supply (rewards) and control token inflation. Rewards are capped at 50k DYDX per day and will last for 6 months, ensuring inflation is not significant.
Our Thoughts: The dYdX chain is at the forefront of the industry’s move toward greater decentralization. The verification process plays several key roles in the new chain: securing the network, voting on on-chain proposals, and distributing staking rewards to stakers. Combined with 100% of fees being distributed back to stakers and validators, it ensures that rewards are aligned with the interests of network participants.
1e. Value is concentrated in the liquidity center
Case Study: Synthetix
Synthetix plays an important role as a liquidity center for multiple perpetual contracts and options exchanges such as Kwenta, Polynomial, Lyra, dHEDGE. These integrators create their own custom functionality, build their own communities, and provide users with a trading front-end.
Among all integrators, Kwenta is the leading decentralized perpetual contracts exchange directing the majority of trading volume and fees to the entire Synthetix platform. Synthetix’s ability to capture the value brought by Kwenta and other exchanges is due to Synthetix’s tokenomics. Key reasons include:
(1) The first step of trading on the integrator requires staking SNX
a. Even with its own governance token, Kwenta only quotes its asset price against sUSD, which can only be minted by staking SNX tokens;
b. In addition to Kwenta, other integrators such as Lyra and 1inch & Curve (atomic swaps) also use sUSD and therefore the SNX token. Therefore, Synthetix's front-end integrator allows for the imputation of value in SNX tokens.
(2) Liquidity Center’s reward distribution to integrators
a. In April 2023, Synthetix announced the exciting news of distributing its massive Optimism token to traders. For 20 weeks, Synthetix is giving out 300k OP per week, while Kwenta is giving out 30k OP per week.
b. Synthetix is able to attract higher transaction volumes and fees from Q2 to Q3 2023. This has been a major catalyst for Synthetix's price growth.
c. Through these mechanisms, Synthetix not only provides users with a platform to trade synthetic assets, but also creates value for SNX token holders and the entire ecosystem through its token economics strategy, promoting its healthy development and growth.
a. Without a stable income stream, the mechanism will be unsustainable, and its reduced impact may cause users to lose the motivation to continue holding tokens.
Our thinking: The burning mechanism may not directly affect the price, but it can contribute to the narrative of buying deflationary tokens. This works well for protocols that generate strong revenue and already have a large portion of the total supply in circulation (e.g. RLB). Therefore, using this mechanism would be ideal for protocols like Synthetix that are already established and don’t have much supply inflation.
3. Token distribution and vesting plan
It is important to keep an eye on token distribution and vesting plans for different stakeholders to ensure parameters are not biased in favor of certain stakeholders. For most protocols, the main split between stakeholders is investors, team, and community. For community tokens, this includes airdrops, public sales, rewards and DAO tokens, etc.
(1) Investors: Usually receive token allocations early in the project, and vesting plans can help prevent them from selling all their tokens at once, causing pressure on the market.
(2) Team: Tokens earned by team members usually have a long vesting period, which encourages the team’s long-term commitment to the project and its success.
(3) Community: Community tokens can be distributed in a variety of ways, including but not limited to airdrops, public sales, and reward programs. A community’s ownership program should be designed to encourage long-term ownership and participation.
(4) DAO tokens: DAO tokens are used for governance voting and may be distributed to community members based on participation or other criteria.
Ensuring fair and transparent token distribution and vesting plans is critical to building investor and community trust. A transparent vesting plan reduces the risk of market manipulation and ensures the long-term health of the protocol. Token allocation and vesting plans should be open and transparent so that all stakeholders understand their entitlements and expectations.
Investors sell large amounts of tokens in the early stages of the project to stabilize the market.
(4) Discharges/issuances should be spread out over time and include some form of vesting to prevent significant selling pressure at any point in time. This helps keep the token supply stable while encouraging long-term holding and participation.
Through such a strategy, the protocol can better balance the interests of all parties while encouraging long-term ecosystem development and token value growth. Ensuring that token economics are fair and sustainable is critical to building the trust of investors and community members, as well as ensuring the long-term success of the project.
4. Governance and Voting
Governance is very important for decentralized perpetual contracts because it gives token holders the power to participate in the decision-making process and influence the direction of the protocol. Some of the decisions that can be made through governance include:
(1) Protocol upgrade and maintenance
a. Decentralized perpetual contracts often require upgrades and improvements to enhance functionality, scalability, and growth. This ensures the protocol remains up to date and competitive
b. For example, in GMX’s most recent snapshot, governance approved proposals to create a BNB market on GMX V2 (Arbitrum) and GMX v2 fee splitting
(2) Risk management and safety
a. Token holders can collectively decide on collateral requirements, liquidation mechanisms, bug bounties, or emergency measures in the event of a security breach or exploit. This helps protect user funds and build trust in the protocol
b. The recent incident that Synthetix encountered due to TRB price fluctuations resulted in stakers losing $2 million. This highlights the importance of ongoing review of parameters – increasing volatility circuit breakers and increasing sensitivity to deviation parameters for pricing volatility spikes
(3) Liquidity and user incentives
a. Token holders can propose and vote on strategies to incentivize liquidity providers, adjust fee structures, or introduce mechanisms to enhance liquidity provision.
b. For example, dYdX’s governance passed the v4 launch incentive proposal
(4) Establish a decentralized and transparent community
a. Governance aims to build a decentralized, transparent and accountable community. Publicly accessible governance processes and on-chain voting mechanisms provide transparency into decision-making
b. For example, DEXs like dYdX, Synthetix, and GMX adopt on-chain voting mechanisms to promote decentralization
Our thinking: Having governance in place helps create a robust and inclusive community for stakeholders participating in decentralized perpetual contracts exchanges. Having an on-chain voting mechanism and transparency in the decision-making process builds trust between stakeholders and the protocol because the process is fair and accountable to the public. Therefore, governance is a key feature of most cryptographic protocols.
Try new mechanics
除上述因素外，我们认为还有许多其他创新方法可以引入额外效用并激励代币需求。各协议在引入新机制时，需要根据其针对的利益相关者以及什么对他们最重要来确定优先顺序。下表显示了主要利益相关者及其主要关注点：
Given the breadth of concerns, it is unlikely that the protocol will meet the needs of all stakeholders. Therefore, it is very important for a protocol to reward the right group of users to ensure continued growth. We believe there is room to introduce new mechanisms to better balance the interests of different stakeholders.
in conclusion
In conclusion, token economics are a core part of any crypto protocol. Because there are so many factors that affect performance, including factors outside a project’s control, there is no clear formula for determining a successful token economy. Regardless, the cryptocurrency market is rapidly evolving and constantly changing, which highlights the importance of the ability to react and adapt based on the market. As you can see from the examples above, trying new mechanisms can also be very effective in achieving exponential growth.