Decentralized crypto asset spot swap and margin trading
GMX has been a stand-out performer amongst crypto applications in the rough year of 2022. Launched on BSC, re-branded and moved towards Arbitrum and Avalanche, it has found a great product-market fit on the blockchain by offering spot swapping and margin trading straight from your crypto wallet. Where many have failed to also do this, GMX has utilized novel techniques to bootstrap liquidity, attract traders and have a token model that rewards both liquidity providers and the GMX project itself. Let's take a look at why it became one of the stand-out performers for Fourstack as well as the crypto market as a whole in the rough year of 2022.
Novel way of liquidity provision
Users can provide liquidity through the use of a ‘target liquidity’ basket of assets. With target liquidity, we mean that there are certain target weights the basket of assets wants to achieve. Bitcoin for example consists of a target weight of 15% and distance between the target weight and actual weight dictates the fee percentage when depositing or cashing out in that particular asset. Spots swap fees vary between 0-80 bps (0 - 0.8%) depending on whether an asset moves towards or away from their target weights within GLP.
The main benefit to this model, akin to a decentralized clearinghouse, is that liquidity providers suffer no impermanent loss like with Uniswap. This makes providing passive liquidity a lot easier. Something the application has benefited a lot from as liquidity begets liquidity, growing the asset base on which can be traded with. GLP also does not need to re-balance, incurring slippage costs and gas fees as the target weights act like an ‘invisible hand’’ in bringing the pool back in balance. The downside is of course that the weights can be out of balance for the short to medium term, causing over and or under-exposure to certain assets in the basket compared to what you as an LP assumed.
These assets in the basket can in turn be lent out to traders that want to trade a certain asset on leverage. In GMX’s model, the counterparty to positions on the platform is always the GLP basket. If a user wishes to enter a levered long on ETH, it can be described as “renting out” the upside of ETH in GLP to the trader. For this, the trader pays a fee, similar to other decentralized and centralized models.
Beyond this, possibly the most exciting part about GMX is its economics of the token (tokenomics), which made it a big stand out in 2022. Good tokenomics are important because it turns a protocol in an investable asset and users into a community. GMX in its design has made a focal point to reward long-term users.
GLP gets 70% of total platform fees that is calculated on a weekly basis. GMX gets 30% of the platform fees (next to being a governance token for the protocol) while also being rewarded with additional yield the longer they stake. This causes stickiness in the platform and favours a longer-term view.
Yield is paid in real-time, block for block based on the fees generated in the week before. Bootstrapping with protocol native tokens (GMX) has been done through the form of esGMX tokens. This prevents mercenary capital from dumping additional promotional rewards straight away, something which has plagued poorer tokenomics designs of other protocols.
You can use these esGMX rewards to stake in the protocol, or let them vest for a year in which it will unlock in a driplike fashion. Finally, multiplier points are rewarded based on how long you stake, letting you earn a bigger piece of the total fees generated if you indeed have a longer term view. These multiplier points are subsequently burned once an investor decides to unstake their GMX. The model, copied often since its inception, has proven to effectively bootstrap a protocol and attract liquidity without causing strain on the token price.
There are some risks and challenges that GMX will need to overcome with subsequent updates in 2023.
The prices for the assets that are traded are being sourced from oracles as there is no price discovery taking place on the platform itself. This means that the prices are sourced elsewhere which can be viewed as a positive and a negative. The positive is that scam wicks where only the asset on your platform falls or rises heavily in contrast to the wider market cannot happen since the prices are sources from a decentralized collection of price points delivered by Chainlink node operators. The downside is that for opening your position, it currently uses a centralized oracle to provide very high latency updates, needed for leveraged trading. It is expected though that GMX will implement Chainlinks new solution for this, outlined in this blog.
Additionally, since there is no slippage in an oracle design, and thus no slippage, the trade could be ‘too’ good for the trader on the platform because he does not incur slippage like on other venues. To mitigate this, the slightly higher fees on GMX are there to prevent this from happening, and in the future some form of synthetic/oracle-based slippage could be introduced. For the current model, focusing on highly liquid crypto assets has worked well.
Another potential risk is that GLP providers assume the counterparty risk of traders which could lead to the edge case of 1. crypto assets falling dramatically and very quickly, 2. the platform being heavily net-short, accelerating the losses that liquidity providers could make since traders would heavily profit from their position while the basket loses value from both these wins and the asset prices going down. Historically though, traders have lost a decent amount of money even when you exclude all the funding fees that have been paid.
We at Fourstack are excited to see the progression of derivatives projects on the blockchain with GMX being a stand-out. Currently, we are an investor and a liquidity provider in GMX and are actively looking for enticing projects that build on top of the GMX protocol. While some challenges and risks lay ahead, we are curious to see what the future brings and what new roll-outs will mean for overcoming these challenges and offering a wider range of products.