There are many ways to trade financial assets. The simplest form of trading involves buying and selling assets, relying on price variability to attempt to drive profit. However, in the traditional finance world there are also many types of derivatives, which are instruments that derive their value from an underlying asset like a stock or commodity. Traders often use derivatives to obtain leveraged exposure to the underlying asset which amplifies gains and losses compared to trading the underlying asset directly. Examples of derivatives include: options, swaps, forwards, and futures.
With a traditional futures contract, the buyer and seller agree to exchange an asset at a pre-specified price at some future date (hence the name). Unlike traditional futures markets that emerged prior to the creation of perpetual futures, cryptocurrency markets lacked deep and liquid regular futures markets. Consequently, liquidity swiftly shifted towards perpetuals, finding a niche among cryptocurrency speculators, leading to a new type of futures trading: perpetual futures. These leveraged tools do not have expiration dates—like traditional futures—and this makes them more efficient and intuitive.
Perpetual Protocol offers the trading of perpetual futures on a decentralized exchange (DEX) via the Ethereum-based Optimism layer 2 scaling solution (L2). Traders use Perpetual Protocol to increase their exposure to crypto assets, potentially reaping more profits at the risk of increased losses. This feature is also offered by projects like dYdX.
Perpetual’s PERP token is native to Ethereum and is used to earn rewards through locking tokens in a smart contract, and it is also used for community governance through a decentralized autonomous organization (DAO).
How was Perpetual Protocol developed?
Perpetual Protocol was co-founded by Yenwen Feng and Shao-Kang Lee in 2020. The Taiwan-based pair previously co-founded another decentralized derivatives protocol called Cinch Network, which focused on options trading (rather than futures), as well as a company that offered accounting software for crypto companies.
Feng and Lee began to develop Perpetual Protocol as a part of the Binance incubator. When it was first announced in 2020, their project went by the name “Strike Protocol.” Inspired by protocols such as Synthetix and Uniswap, Perpetual was designed to offer 20x leverage in perpetual contracts, support synthetic assets, and guarantee liquidity by using a virtual automated market maker (vAMM). Within months, Strike was renamed to Perpetual Protocol and Strike’s SKE token was renamed PERP. This was partially to avoid confusion with the Bitcoin lightning wallet also named Strike.
The first version of Perpetual Protocol was released in 2020, and the next year the platform saw around $36 million in trading volume, according to Feng. The developers announced a second, updated version of the protocol called “Curie” that launched on Optimism (an Ethereum L2 network) in November 2021. This new version adjusted original vAMM model and more closely tied itself to Uniswap’s traditional AMM.
Unfortunately, as the platform was transitioning from v1 to v2, a large trader of the CREAM token was liquidated which put Perpetual’s insurance fund in jeopardy. This resulted in the team temporarily halting all trading on the platform, and, through community governance, the platform distributed remaining funds across its userbase. After this turmoil, only Perpetual v2 (Curie) was live for trading.
How does Perpetual Protocol work?
Perpetual Protocol is a non-custodial, smart contract-powered platform that operates on Optimism’s layer 2 blockchain. That means that when users place a leveraged trade on Perpetual, they deposit their funds into a smart contract with pre-specified functionality, allowing them full control of their funds.
Perpetual futures
Traditional futures contracts allow traders to increase their leverage in the market. However, since they expire on a given date, traders must “roll over” their positions (close the old one and open a new one with a later expiration date) if they want to continue to have exposure to the asset. This introduces complexity and results in inefficiency for traders wanting to maintain longer term price exposure to the asset. Therefore, perpetual futures (perps) were proposed as financial tools that don’t require this periodic buying/selling to maintain a position.
However, it took around 20 years for this idea to become a reality. Perpetual futures are now a relatively common offering in the cryptocurrency space, although they still haven’t been adopted in traditional finance. Perpetual Protocol was one of the first of these crypto platforms to offer perps. They allow platform users to trade crypto with 10x leverage or more. Although this can be very profitable when traders speculate correctly, it also comes with the risk of significant losses and even liquidation of whole positions.
Automated market maker
Perpetual uses Uniswap’s automated market maker (AMM) to execute trades made on its platform. Uniswap was the first major project to successfully implement an AMM to run its decentralized exchange (DEX). Using Uniswap allows Perpetual to access the advanced features of this well-established DEX, such as concentrated liquidity.
Users of Perpetual Protocol can deposit funds and provide liquidity to different markets such as BTC, ETH, and others. In doing so, they earn a portion of platform fees for the service of “deepening” that market’s liquidity. When performing this function, the user chooses a range in the asset’s price in which they will earn rewards. Therefore, they can choose if they are more bullish or more bearish on the asset. As long as the asset stays within the pre-specified range, they earn rewards without the risk of impermanent loss.
How is the PERP token used?
PERP is an Ethereum-based token that conforms to the ERC-20 token standard. Its primary uses are in platform rewards and community governance. Token holders can lock PERP in a smart contract, allowing them to collect protocol rewards and portions of trading fees. When holders lock their PERP, they receive voting escrow PERP (vePERP) tokens in return. This process is based on the standard for “veTokenomics” originally set by Curve. In general, more vePERP are returned to users who lock more of their tokens for longer amounts of time.
By holding vePERP, users are eligible to receive rewards (in the form of USDC) for fees generated by traders using the platform. They are additionally able to participate in community governance in Perpetual Protocol’s decentralized autonomous organization (DAO).
Token distribution and economics
PERP was launched around the time of the mainnet launch in September 2020 using a feature of the Balancer DEX’s platform called the Liquidity Bootstrapping Pool (LBP). Through this process, a small percentage of the total supply of PERP tokens were sold to raise funds for the project.
Of the maximum supply of 150 million PERP, 54.8% are reserved for to support the Perpetual ecosystem (through the DAO) and platform rewards, 21% are allocated to the development team and advisors, 19.2% were distributed to investors, and 5% were distributed through the Balancer LBP.
Conclusion
- Perpetual Protocol is a decentralized finance (DeFi) protocol that offers leveraged trading through the use of perpetual futures.
- By integrating with Uniswap v3’s automated market maker (AMM), Perpetual offers its users the benefits of concentrated liquidity while also attempting to minimize impermanent loss.
- The PERP token can be deposited into Perpetual’s smart contracts to earn platform rewards and is also used for community governance.