Perpetual swaps that track the price of ether (ETH) are coming to dYdX, the company announced Tuesday.
“The main reason people like trading these contracts is because people can trade them with pretty high leverage,” dYdX founder Antonio Juliano told CoinDesk in a phone call.
The decentralized finance (DeFi) firm was founded three years ago to contribute to the stack of financial products available in the crypto industry. It started with enabling margin trading on Ethereum and has now expanded to providing synthetic assets that enable traders to make bigger bets. This follows its launch of bitcoin perpetual swaps in April.
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“The types of people who trade derivatives are really institutions and some sophisticated retail-type traders,” Juliano explained. “It basically helps people to express more complicated opinions on price, and this really helps to stabilize the underlying markets.”
As an example, with swaps, if people in the market see something they see as very unhealthy for ETH’s price, they can go onto dYdX and take out a 10x short position against the price of ETH, planning to profit $10 for ever $1 ETH’s price falls. This is a very dangerous play, because if the price goes up instead they lose $10 for every $1 it rises.
Such a position can very quickly eat all the trader’s collateral.
However, precisely because of that, it sends a strong signal to the market. If one trader takes that kind of position others will start looking to see if they should be scared, too. Obviously if someone sells their ETH that sends a signal to the market as well, but it’s a less weighty signal than a leveraged short position.
So theoretically, as the derivatives market gets bigger and more sophisticated it should help ETH itself become less volatile, as warnings come in earlier and sound more loudly.
“We’re not there yet,” Juliano cautioned. “With the rise of more derivatives products it should help.”
How it works
A leveraged derivative allows traders to magnify gains and losses on an asset without anyone involved holding the asset itself.
Popularized on the centralized exchange BitMEX, perpetual swaps are unique to the crypto market. They create a synthetic asset that, when working properly, roughly tracks the price of the underlying asset, while allowing more leverage. Market makers in the system make it feasible for traders to find buyers for their positions.
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A user’s losses are limited by the collateral they put up to back their bet. So if a user took a leveraged bet against the price of ETH, but the ETH price rose, they would get liquidated once their losses started approaching their total collateral. So for example, $300 ETH in collateral would only tolerate a bit less than $300 ETH in losses before the collateral was sold to cover the loss.
Juliano argued that dYdX’s product enables more leverage more easily than other DeFi alternatives, such as using Instadapp to take out multiple loans at once on Compound. Its users also won’t pay gas though they will pay trading fees.
Juliano said that trades on dYdX are among the largest for decentralized exchanges (DEXs), at around $10,000 on average.
In the traditional market, any derivatives market always dwarfs the underlying market it tracks, and Juliano noted that we’re starting to see that in crypto over the last year, with derivatives markets outpacing the spot market for the first time. However, in traditional finance, perpetual markets don’t exist. Derivatives usually come with an expiration date.
Juliano said he believes this is because there are so many traders who want to be able to magnify their bets with a product that’s roughly as simple to trade as the underlying asset.
“The crypto market is very dominated in terms of volume by retail traders, particularly international crypto traders,” he said.