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A Deep Dive on Decentralized Derivatives Trading
By: Rahul Nambiampurath •defiant
The FTX crash has created a void in the derivatives trading market, leaving many retailers searching for a trustworthy platform that is not based on fraudulent schemes. Fortunately, the answer may lie in decentralized networks that prioritize self-custody. One such platform is the Gains Network.
Before we delve into the platform itself, what benefits can traders get from the derivatives market?
Why Trade Derivatives?
Any economy is driven by production and trade, but both are layered with a heavy coat of speculation. Among the most popular speculative instruments to consider is the perpetual futures. These contracts speculate on the price movements of an underlying asset but without owning the asset itself.
They are what’s known as derivatives, and they are among the highest-risk instruments in the markets, typically traded by experienced professionals but also retail investors.
Perpetual futures are settled in cash, instead of delivering the underlying asset. Let’s say that you have an eye for a hypothetical crypto token, BitBoost. You have reasons to believe its value will skyrocket in the upcoming weeks for a number of possible reasons:
- A major company may adopt BitBoost, which would level up its legitimacy.
- An upcoming partnership or collaboration could spike the token’s visibility and trading uptick.
- The token’s network could undergo a major upgrade.
- The overall media hype could snowball into excitement, leading to increased demand.
- The token may be listed on a major exchange, also increasing demand.
Armed with one of these reasons, you buy a perpetual futures contract for 1 BitBoost coin with 10 times leverage. You use $100 as your own capital to start with as margin, while the price of the hypothetical token itself is $100. Therefore, your total investment, or position, in BitBoost perpetual would be $1,000, as 10 BitBoost times $100 per coin.
What Happens Next?
If BitBoost goes up to $110, your leveraged position would then be $1,100, a 10 BitBoost times $110 per coin.
At this point, you could sell the perpetual futures contract and pocket a profit of $100, which is the difference between your initial investment of $1,000 and its present value of $1,100.
If BitBoost drops from $100 to $90, you will lose $100. It is up to you to decide in which direction to place the bet.
If you think that BitBoost price will decrease, you could sell a perpetual futures contract for 1 BitBoost with ten times leverage. By doing this, you would borrow 1 BitBoost from the exchange and sell it for its current market price of $100.
Then, if it goes down to $90, you could buy back the leveraged tokens at a lower price and return it to the lender — the exchange. The difference would make you a $10 realized profit or $100 if leveraged by 10 times.
This kind of downward price betting is called shorting. It allows you to profit from the token’s depreciation. In contrast, when you expect the token to go up, you will be making long positions.
Of course, you may also lose money if the token’s price unexpectedly rises for a prolonged time period. Likewise, you could suffer losses from a drop in value when you go for longs.
Finally, where does the “perpetual” come into play? Whether you bet on the price movement to go up or down, these futures contracts have no expiry date. This means that you can hold your position as long as you are able to maintain the required margin, and the rollover fees, giving you much greater flexibility over your trading strategies.
Now that we have cleared up the basics on perpetual futures, the most important question is, which trading platform to pick?
Gains Network Explained
In the wake of the failure of the crypto exchange FTX last year, investors have lost confidence in centralized platforms. Instead, people are seeking decentralized protocols, which allow trustless access to users who have their own self-custodial wallets.
In the last year, the decentralized Gains Network has surged to 10,000 traders from 800. The trading platform is available on Ethereum’s top scaling networks, Arbitrum and Polygon, with negligible gas fees. Arbitrum has increasingly become Ethereum’s scalability solution of choice for veteran traders.
Arbitrum Gas Price. Source: CoinTool
Thanks to these drivers, gTrade had already settled over 700,000 trades.
But how does a decentralized protocol handle derivatives trading? Wouldn’t you need a centralized exchange with deep liquidity like Binance?
Gains Network has a trick up its sleeve that makes even 1000x leverage possible. And not only for crypto tokens, but also for certain stocks, commodities, indices, and forex pairs. The demand for either asset class shifts, but is still mainly crypto-centered, as shown in the chart below.
Weekly Volume. Source: Dune
As with any decentralized application (dApp), you can access gTrade with a self-custodial wallet, such as MetaMask, without having to sign up. But before we get into opening your first perpetual futures trade, how exactly does gTrade maintain liquidity?
First, you should keep in mind that leveraged trading is a high-risk, high-reward venture. Case in point, if we take a look at gTrade’s profit vs. losses statistics, we see that PNL of closed positions is cumulatively in the negative range at nearly -$7 million.
gTrade Trade Stats. Source: Dune
Just like a traditional exchange, gTrade is built with an assumption that most traders lose money on average. In turn, the losers fill the protocol’s liquidity coffers. Specifically, by depositing DAI stablecoin as collateral for investment positions. This is gTrade’s first line of defense against liquidation when margin-called.
But what happens when traders have positive PnL in excess of their collateral? This is when the second line of defense comes in, an overcollateralized layer in the form of a $5 million liquidity pool owned by the protocol.
Lastly, gTrade has a third line of liquidation defense in the form of gDAI vault. In this liquidity pool, anyone can deposit DAI stablecoins as counterparty balance. In exchange, they receive a cut from trading fees. Incentivized by these yields, liquidity providers bolster the protocol’s liquidity.
Trading fees organically incentivize LPs, as their yield fluctuates based on trading demand. Presently, the vault pays a 20% annual percentage yield (APY) while holding over $30 million worth of DAI stablecoins, or $45 million if we take into account Polygon and Arbitrum.
Although in the double-digit range, the APY comes from trading fees. Gains Network also has its own GNS token that allows users to earn a share of protocol revenue. Whenever you deposit DAI in the vault, you receive a liquid gDAI ERC-20 token, which represents your ownership of the stake.
The withdrawal system consists of epochs. Within the first two days of each epoch, you can withdraw the funds. However, there is a timelock between the withdrawal request and when it is executed. This timelock delay is dependent on the collateralization ratio of the vault:
- Vault is 120% or more collateralized = 1 epoch timelock (3 days)
- Vault is 110%-120% collateralized = 2 epoch timelock (6 days)
- Vault collateralization is below 110% = 3 epoch timelock (9 days)
The purpose of the timelock is to cover for leveraged trades. With high-risk, high-reward in mind, let’s get started on your first gTrade.
How To Start Using gTrade?
Gain Network has two types of access:
The regular one in which you connect your wallet and select the network, either Arbitrum or Polygon. For example, if you have MetaMask, the wallet would automatically set the network settings for Arbitrum when switching to it.
The other way is to enable gTrade’s own proprietary One-Click Trading (1CT) wallet. If you are tired of clicking on MetaMask’s approvals for every transaction, 1CT wallet provides extra convenience. You would then be able to trade seamlessly as if you were on a centralized exchange.
After clicking on “Let’s go,” a short 4-step process is required to generate the 1CT wallet:
- Create a PIN
- Sign the message
- Approve the new 1CT wallet
- Fund the 1CT wallet with ETH for gas fees.
Just like MetaMask, 1CT is a self-custodial wallet, which means that you hold your private key, not gTrade, or, heaven forbid, FTX. As for your original wallet, the most convenient way to fund it would be to transfer the funds from a centralized exchange like Binance or Coinbase.
That’s because they make it the easiest to convert fiat to crypto.
Your 1CT wallet comes into play as a delegation wallet. As its name suggests, it’s a type of wallet that allows you to delegate crypto funds to a third party for trading purposes, in this case, the Gains Network.
Given that your 1CT wallet is tied to your original wallet address, which holds your collateral and Profit-and-Loss (PnL) balance, 1CT wallet only needs gas funds for submitting transactions. This way, you can engage in a more seamless trading experience, while still maintaining full control over your funds.
With wallet-funding and 1CT creation out of the way, how do you open your first gTrade position?
The first thing you will notice is that gTrade has all options available at a glance. The major being you are betting on token appreciation (LONG) or betting on token depreciation (SHORT). For example, let’s take Cardano as your perpetual futures target.
The blockchain’s native currency is ADA, so the token trading pair will be ADA/USD, which you can manually search for by typing in the first few letters.
Once you have selected the trading pair, you will have to decide on your trading position — LONG or SHORT. Next, select your leverage. The minimum one is 2x, ranging all the way to 150x. On Polygon, the minimum position size is 1,500 DAI, accounting for the collateral plus leverage.
Therefore, if you had selected a 2x leverage on 800 DAI, your position would be 1,600 DAI, excluding the protocol’s fee charge.
With position type and size set, you have the conditions under which the position is closed. You will have three options:
- Set limit order: set the specific price at which to buy or sell ADA. For example, if you believe ADA will go up to $0.5, and you want to buy it, you would set that limit. Likewise, for selling at a specific price point.
- Take profit order: automatically sell ADA when it reaches the price point you set.
- Stop loss: automatically sell ADA when it reaches a specific price point, in order to limit your losses. For example, if you bought ADA at $0.35, but you set a stop loss order at $0.30, your ADA will be auto-sold when its price drops under $0.30.
With order combos, you can manage your risk with greater flexibility.
How Does Gains Network Know the Accurate Price of Tokens?
Borrowing from ancient Greek mythology, an oracle was an intermediary between humans and the gods. Applied to crypto space, oracle networks are intermediary systems that feed off-chain data to on-chain smart contracts. This is how dApps gain their capacity to execute their logic based on real-world data.
Typically, this real-world data is the price of cryptocurrencies. The most popular such oracle network is Chainlink (LINK), which uses a decentralized verification system to make sure the data is correct.
In contrast, Gains Network uses its own customized Chainlink oracle to guarantee price accuracy.
Gains initially launched on the Polygon blockchain, but a deployment on Arbitrum, a Layer 2 scaling solution for Ethereum, on Dec. 31, proved to be a catalyst for its recent growth.
Ishan Bhaidani, a Gains contributor, said that the protocol’s oracle network also played a significant role in the recent momentum. The project uses customized Chainlink oracles, which provide pricing data for on and off-chain assets.
When traders rely on rapid decision-making to ensure gains or stop losses, they must be confident that the oracle feeding is flawless. But sometimes, “scam wicks” can occur. This is the thin vertical line on a price chart that represents the asset’s low or high point given a particular time period.
As such, wicks show the range of prices. But a scam wick happens when a cryptocurrency is manipulated to create an illusion of market activity. This typically happens when whales place large volume orders that are drastically high above or below the asset’s current market price.
Consequently, they manifest as scam wicks to trigger stop-loss orders or artificially drive up the price, enabling the whale to sell at a higher price. gTrade’s customized Chainlink oracle is specifically tuned to filter scam wicks to prevent that form of market manipulation.
Note: This explainer was sponsored by Gains Network
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.