Yesterday, I participated in the official competition of the beginner's class, and the theme this time (Derivatives DEX & New DeFi – Where is the future of on-chain liquidity?) was very profound, and it also touched on some of my knowledge blind spots. I learned a lot and organized a Q&A document for everyone to study together!

Basic concepts and current market landscape

Q1: What are the essential differences between derivatives DEX and spot DEX (like Uniswap) in terms of liquidity pools, trade matching, and risk management?

1. Liquidity pools: Spot DEX requires the deposit of base asset pairs, while derivatives DEX typically use single-sided asset pools (like GLP/USDC) as counterparties.

2. Trade matching: Spot is an AMM curve, while derivatives DEX often use VAMM or L2 order books for leveraged trading.

3. Risk management: Derivatives DEX must handle more complex risks such as liquidation, under-collateralization, and funding rates.

Q2: What liquidity mechanisms are currently adopted by mainstream derivatives DEX? What are their respective advantages and disadvantages?

* L2 order book (e.g., dYdX v3): The advantage is high capital efficiency and a trading experience close to CEX; the disadvantage is a higher level of centralization (order book is off-chain) and cross-chain complexity.

* Unilateral LP pools (e.g., GMX): The advantages are simple liquidity provision and LP earns real yield; the disadvantage is that LP bears the net profit and loss risk of traders (counterparty risk).

* VAMM (e.g., Perpetual Protocol): The advantage is being purely on-chain with no counterparty risk; the disadvantage is higher slippage and relatively low capital efficiency.

Q3: What is the definition of 'on-chain liquidity'? What are the key factors affecting its quality?

Definition: Refers to the tradability and depth of assets within DeFi protocols. That is, the ability of assets to be bought and sold at low slippage, quickly and at stable prices on a decentralized network.

Key factors: TVL (Total Value Locked), Gas fees/latency, smart contract security, oracle accuracy.

Q4: What is the current market share of derivatives DEX in the entire crypto derivatives market? What are the main bottlenecks hindering its growth?

Market share remains relatively small (usually below 10%). Main bottlenecks: trading speed and costs (although L2 improves, still not as good as CEX), insufficient liquidity depth, lack of institutional-grade compliance/risk control tools.

Key technologies and liquidity mechanisms

Q1: Explain the application of order book models and AMM models in derivatives DEX. Why do many derivatives DEX tend to prefer hybrid models or L2/sidechain order books?

Order book: Users place orders, matching buy and sell, suitable for derivatives requiring high frequency and precise trading.

AMM: Uses mathematical formulas for pricing.

Tendency towards mixed/L2: Because on-chain order book Gas costs are too high and speed is slow, making it difficult to support high-frequency, leveraged trading. L2 order books provide a CEX experience, and on-chain settlement ensures decentralization.

Q2: What is a virtual AMM (VAMM)? How does it address impermanent loss and capital efficiency issues in derivatives trading?

VAMM: An AMM without actual assets, used solely for price discovery. It uses the formula $x * y = k to calculate contract prices and does not hold underlying assets.

Solution: Because it does not store trading assets, there is no impermanent loss. At the same time, due to its virtual nature, it can support high leverage, thus enhancing capital efficiency.

Q3: How does GMX's GLP/VLPs model work? What innovations does it offer in providing liquidity, sharing risk, and capturing fees?

How it works: GLP is a multi-asset index liquidity pool (including ETH, BTC, stablecoins, etc.). LPs deposit assets to obtain GLP tokens, becoming the counterpart to traders' net profit and loss.

Innovative points:

1. Real Yield: LP earns trading fees and liquidation profits.

2. Risk sharing: Risk is indexed (rather than single asset), and the risks borne by liquidity providers are more diversified.

3. Delta neutral: LP can hedge, seeking returns closer to Delta neutrality.

Q4: How do derivatives DEX handle the **liquidation** mechanism? How do on-chain liquidations compare with centralized liquidations in terms of efficiency and security?

Liquidation mechanism: When a trader's margin falls below a certain threshold, the liquidator intervenes to close or partially close positions. Comparison: * Centralized liquidation: Extremely efficient, very low latency.

* On-chain liquidation: High security (executed by smart contracts), resistant to censorship. However, efficiency depends on L1/L2 block speed and may involve risks of **'liquidation front-running' (MEV) and 'liquidation gaps'**.

Innovations and breakthroughs in new DeFi

Q1: What is the **'Real Yield'** movement? How does it fundamentally differ from past high APY (like liquidity mining)? Which new DeFi protocols are representative?

Real yield: Refers to the protocol's revenue coming from actual business activities (such as trading fees, lending interest, liquidation profits), rather than through high inflation or issuance subsidies of the protocol's own tokens.

Essential difference: Real Yield is sustainable, driven by intrinsic value; high APY is often an unsustainable external incentive.

Representatives: GMX, MakerDAO, Curve/Convex (partially).

Q2: How do on-chain structured products introduce more complex risk layering and yield strategies for DeFi?

Structured products (e.g., Tranches, Vaults) layer underlying assets or income streams (for example, senior layers bear low risk for low yield, while junior layers bear high risk for high yield). This allows LPs to choose investment tiers based on their risk preferences and creates diverse secondary market liquidity.

Q3: What impact does RWA (Real World Assets) tokenization have on on-chain liquidity? How does it attract traditional financial institutions into DeFi?

Impact:

1. Expands the range of collateral in DeFi, improving capital efficiency.

2. Introduced low volatility and non-crypto correlated returns. Attracting institutions: RWA (e.g., US Treasuries, notes) provide compliance targets and stable returns familiar to institutions, backed by legal frameworks, serving as a compliance bridge for traditional financial institutions to enter DeFi.

Q4: What are the latest developments in cross-chain/full-chain liquidity aggregation? How to ensure depth and efficiency for users trading across different chains?

Latest developments: Intent-centric protocols and full-chain interoperability protocols (e.g., LayerZero, Axelar).

Guarantee: They route users' trading needs to the most liquid chains through a unified messaging layer or aggregator, making users feel like they're operating on a single chain, enhancing capital utilization and trading depth.

Challenges and risks

Q1: How do L2/Rollup technologies address the delays and Gas costs in derivatives trading? What areas still have room for improvement?

L2 moves the execution layer off-chain (e.g., Optimistic/ZK Rollup), batching a large number of transactions and only submitting the compressed data to L1, thus greatly reducing Gas costs and increasing throughput.

Room for improvement: The cost of data availability (DA), communication latency between Rollups (e.g., cross-L2 bridging), and the degree of decentralization of L2.

Q2: How do derivatives DEX ensure the decentralization of oracles, resistance to witch attacks, and minimum latency? How to prevent oracle manipulation?

1. Use decentralized oracle networks (e.g., Chainlink) to provide price feeds from multiple independent nodes.

2. Use time-weighted average price (TWAP) or VWAP instead of a single time point price to prevent flash loan attacks.

3. Use low-latency price feeds on L2, combined with a high-frequency checking mechanism.

Q3: In the face of increasingly stringent global regulation, what challenges do derivatives DEX face regarding KYC/AML and jurisdiction?

Challenges:

1. KYC/AML: Pure DEX cannot enforce KYC and can easily be used for illegal activities.

2. Jurisdiction: Its borderless nature makes it difficult to determine which country's laws apply. Balance: Introduce **'permissioned pools' or on-chain identity proofs** (such as Soulbound Tokens), providing specific services or products only to users who pass KYC.

Q4: Why do some derivatives DEX choose to adopt a hybrid architecture of centralized order books + decentralized settlement? Will this 'degree of decentralization' hinder its development?

Reason: Sacrificing some decentralization for extremely high trading speed and capital efficiency to compete with CEX and meet the needs of professional traders.

Impact: It will not hinder its development but may instead become a mainstream trend. The market's tolerance for 'decentralization' is shifting towards **'key function decentralization'** (i.e., decentralization of settlement and fund custody, with more efficient trade matching).

The core trend is a combination of both: aggregation solves fragmentation issues, while specialized pools address capital efficiency issues. Future liquidity will:

1. Achieve cross-chain deep aggregation through intent/full-chain aggregators.

2. Highly customized inflows, providing real yield and risk-hedged specialized pools (such as Delta-neutral or RWA collateral pools).

Q2: What areas need breakthrough innovations to attract traditional financial institutions to participate in derivatives DEX on a large scale?

Breakthrough point:

1. Institutional-level identity verification: On-chain KYC/AML and whitelisting mechanisms.

2. Risk hedging tools: Allow institutions to implement Delta-neutral strategies and credit risk hedging.

3. Operational efficiency: Provides high throughput and low-latency L2/Rollup solutions.

4. Compliance structure: Establish specialized permissioned liquidity pools.

Q3: Besides perpetual contracts and basic options, what new types of on-chain derivatives will become new drivers of liquidity growth in the future?

1. Interest Rate Swaps: Hedge against floating interest rate risks in DeFi lending.

2. Volatility index products: Hedge or speculate on the volatility of the entire crypto market.

3. Credit derivatives (Credit Default Swaps, CDS): Hedge specific protocol or token default risks. These will make the DeFi market more mature and complete.

Q4: What potential impacts does the narrative of modular blockchains have on DeFi's liquidity and the trading efficiency of derivatives DEX?

The potential impact is huge: Modularity (separating execution, settlement, data availability, and consensus) makes:

1. Trading efficiency: Higher data throughput (through cheaper DA layers), greatly reducing L2 Gas fees and improving trading speed of derivatives DEX.

2. Liquidity: Allows specialized chains (e.g., application chains) to emerge, customized to meet the high-performance needs of derivatives trading, further optimizing liquidity.