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Deep dive into Perpetual Protocol v2

Weiting Chen

4 months ago ·

4 min read

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Since day 1, Perpetual Protocol aims to be the Uniswap equivalent for perpetual futures trading - allowing anyone to create new perpetual markets, accessible to anyone in the world, and fully composable with other protocols.

However, due to the unsustainable nature of Perp v1 and the fact that Perp v1 was only available on Gnosis Chain, a less popular EVM-compatible chain, we haven’t achieved the goal so far. That being said, Perp v1 occupied the no.1 spot as the largest decentralized derivative platform by trading volume for a long time before DyDx started liquidity mining.

With the experience Perp Protocol gained from Perp v1 and months of research and development came Perp v2, which we believe is the right approach to build the dominant derivative exchange in DeFi.

But before explaining the reasons, we need to understand the perpetual contract and what makes it the most popular derivative in the crypto space. If you’re already familiar with perpetual contracts, please jump straight to “How does Perp v2 Work?”.

What is a Perpetual Contract?

A perpetual contract is a derivative, or a financial tool, that lets you speculate on the price movement of an asset with leverage.

Expect the price of an asset to go up? You can open a long position with an asset (usually a stablecoin) as the collateral. If the price of the said asset indeed goes up, you can close your position and get more money back than the amount you put in. If it goes the opposite way, you will receive less collateral in return.

The ease of use, the capital efficiency (no need to hold the underlying asset), and the liquidity, thanks to the leverage, make perpetual contracts the most traded derivative in the crypto space.

You can learn more about perpetual contracts in this article, including how they are priced, how perpetuals compare to other financial instruments, and a lot more.

How does Perp v2 work?

On a high level, Perp v2 is a derivative-enabler for Uniswap v3, making perpetual contracts trading possible.

V1 vs V2 Guest Post - Traders.png

As the first step, users need to deposit their USDC into Clearing House, a smart contract on Perp v2 that mints and burns virtual tokens and keeps a record of trading activities (more on this later). Once the deposit is made, Clearing House will credit the depositor with 10x the amount of virtual USD, or vUSD, on its balance sheet than the amount of USDC that the user deposited.

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The 10x amount of vUSD is the maximum leverage that Perp v2 provides to users, who can but don’t need to use their entire leverage all at once.

Now, users can then instruct the Clearing House to use their vUSD credits to trade or provide liquidity on the markets of the protocol. Since Perp v2 is built on top of Uniswap v3, each perpetual market is a market on Uniswap v3. For instance, the ETH perpetual market on Perp v2 is a Uniswap vUSD/vETH pool where both vUSD and vETH are minted by the Clearing House.

So when you open a long order on ETH perpetual market, under the hood, you’re instructing the Clearing House to use your vUSD credit and mint vUSD tokens, then send them to the vUSD-vETH pool on Uniswap v3 and get vETH from the said pool (pictured in the diagram above).

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But who is the counterparty of this trade, and why are they taking the opposite side of your bet?

On Perp v2, the counterparty of each trade are the liquidity providers, or “makers” as we call them. To compensate Liquidity providers for the risks, they can earn transaction fees whenever a trade happens in the price range they set.

V1 vs V2 Guest Post - Makers.png

Similar to traders, the first step for makers is to deposit their USDC into the Clearing House. Then they can instruct the Clearing House to use their credit and mint virtual tokens to provide liquidity on the perpetual markets on Uniswap v3. Makers can specify which markets they want to provide to and in which price range.

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To simplify the liquidity provision for makers, Perp protocol works with managed liquidity protocols such as Teahouse Finance, Visor Finance, or Popsicle Finance, where users can simply deposit their stable coins, and the said platforms will do the heavy lifting.

What makes Perp v2 unique?

Permissionless To create a new perpetual market, the only thing Perp v2 needs is a price feed from an Oracle provider. Perp works with multiple Oracle providers. This flexibility paves the way for one of our ultimate goals - letting anyone create new markets permissionless. While we’re still working on this feature, the community (or token listing DAO) can vote to decide which markets the protocol should list.

Accessible Currently, the primary way to access Perp v2 is through app.perp.com. But anyone can interact with its smart contracts on-chain. To make it easier for people to access the protocol, we have partnered with multiple protocols and wallets such as dHEDGE, Frontier, StakeDAO, and a lot more! In the following months, they’ll integrate Perp v2 into their applications.

Composable Because Perp v2 is entirely on-chain, other protocols can integrate it to build up their services without starting from scratch. For example, our partner Indexzoo is building leveraged tokens and index funds using Perp v2’s perpetual contracts as the underlying.

Additionally, Perp v2 itself is built on top of Uniswap v3, making it easier to tap into the ecosystem of the latter. As mentioned previously, managed liquidity protocols can support Perp v2’s markets without that much modification of their existing Uniswap v3 strategies.

Closing

Hopefully, this short introduction gave you a good overview of how Perp v2 works and what makes it unique!

Perp v2 is available on Optimism as of December 2021, and will expand to other L2 or (side)chains in the future. You can try out the testnet here without any risks to get familiar with the platform using play money. Once you feel ready, you can trade on the mainnet here.

Weiting Chen

4 months ago ·

4 min read


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