“Wish you all a Happy 4th July!” [This blog post is part of Crypto Exponentials DeFi Educational Series]. Regardless of what stats you look at, it’s clear that decentralized perpetuals contracts are the most popular trading product in crypto. As a refresher, a perpetual contract is a special type of futures contract (futures are a contract between two parties to buy or sell an underlying asset at a specific date for a predetermined price in the future). As the name suggests, perpetual contracts go on “forever” and do not come with an expiry date. Instead, perpetual swaps allow traders to take highly leveraged positions with minimal upfront capital. Pioneered by Bitmex in 2016, Bitcoin perpetual contracts are now traded on every centralized derivatives exchange. It’s been a long time coming…but this week, decentralized perpetual contracts were finally introduced to the market.

Why is this DeFi Perps are important? For a few different reasons. Centralized alternatives often require often require KYC, rely on a counterparty for trades to be processed, as well as need collateral to be custodied. However, with decentralized apps like GMX, dYdX etc. – this whole process can now be automated via smart contracts. As always, decentralization comes with its trade-offs, however, the benefits it provides for perpetual markets are noteworthy. Finally, these markets will be fully transparent and auditable. 

In this blog post I get into the weeds of GMX exchange and offer insights on getting passive income from Decentralized Perpetuals.

Decentralized Perpetuals Exchange GMX Overview

GMX is a decentralized perpetual and spot exchange that allows you to trade assets on-chain, without an account, KYC, geographic restrictions or high centralised exchange fees.

The exchange initially launched as Gambit Financial on the Binance smart chain (BSC) but later rebranded to GMX when it launched on Arbitrum. The exchange now operates on both the Avalanche network and on Arbitrum, a layer 2
scaling solution built on Ethereum, and has plans to expand to new chains in the future.

Users can long or short assets in the GLP pool, on up to 30x leverage and complete swaps. The pool is composed of high quality crypto-assets, which vary depending on network.

Since it’s launch on Arbitrum (31.08.21), GMX has processed a total volume of $16,870,364,343. On the 6th of January 2022, GMX launched on the Avalanche exchange and has since processed a total volume of 5,090,570,247, bringing the cumulative total volume to over $21.5 Billion.

Protocol Mechanics

Traders on the GMX platform on the Arbitrum network can perform asset swaps on ETH, BTC, LINK and UNI and a variety of stable coins. They can also leverage trade these assets in both directions by utilising the assets in the pool.

When entering a long on Bitcoin for example, a trader is ‘renting out’ the upside in Bitcoin, from the Arbitrum GLP pool. When entering a short on Bitcoin, a trader is ‘renting out’ the upside of the Stablecoins versus Bitcoin, from the Arbitrum GLP pool.

Traders on the GMX platform on the Avalanche network can perform asset swaps on ETH, BTC and AVAX and a variety of stable coins. They can also leverage trade these assets in both directions by utilising the assets in the pool.

When entering a long on Bitcoin for example, a trader is ‘renting out’ the upside in Bitcoin, from the Avalanche GLP pool. When entering a short on Bitcoin, a trader is ‘renting out’ the upside of the Stablecoins versus Bitcoin, from the Avalanche GLP pool.

What is GLP Pool?

The GLP pool is a multi-asset pool that supports trading and allows users to long/short and perform swaps. This pool earns liquidity provider (LP) fees from market making, swap fees and leverage trading and these fees are distributed back to both GMX and GLP holders.

LP’s can ‘mint’ GLP tokens, which represent shares in the GLP pool, by deploying any of the index assets to the pool. They can redeem any index asset by burning their GLP holdings. The fees associated with buying GLP vary depending on which of the index assets are currently underweight/overweight. If any index is underweight the fees for minting GLP by depositing this asset is lower and hence incentivised.

The token weights in the pool are adjusted to help hedge the holders of GLP against the open positions traders have. So, if a large number of traders are long Bitcoin on the Arbitrum exchange, the GLP pool would have a higher Bitcoin weight and vice versa with stable coins if a large proportion are short.

Instead of the standard Automated Market Maker model (AMM) (x*y=k), GMX uses the GLP pool in combination with dynamic aggregated oracle price feeds provided by Chainlink (sourced from Binance & FTX) to determine the ‘true price’ of an asset. This allows GMX to achieve the true price of an asset with far less liquidity and means trades can be executed with zero slippage. Furthermore, LP’s are protected against impermanent loss as the traditional AMM model isn’t utilised.

The value of the GLP token is determined by the changing value of the index tokens inside of it, making it in a way, a diversified index of high quality crypto assets. In fact, GMX’s vision for GLP is to be “ a diversified index of top and upcoming cryptocurrencies all being used in a highly capital-efficient way while generating yield for holders”.

The GLP pool is essentially a liquidity pool that acts as the
counterparty to traders on the GMX exchange. This means that if traders on GMX make a profit, GLP holders make a loss and vice versa.

Analysis of the cumulative Profit and Loss statement of traders on the GMX Arbitrum exchange shows that traders have lost money and thus GLP holders have benefitted.

The GMX protocol generates revenue by charging fees on the opening and closing of trades and also a “borrow fee” that is deducted every hour a leveraged position is open.

There is a trading fee of 0.1% of your position size when incurred when opening a position and closing a position. The borrow fee is the fee that is paid to the counter-party (GLP pool) of your trade at the start of every hour. This fee varies based on utilisation of assets in the GLP pool and is calculated as follows:

The Fees generated by the exchange are distributed entirely back to GMX and GLP holders. 70% of these platform fees will be distributed to GLP holders and 30% of them will distributed to staked GMX holders. Staked GMX holders receive 30% of the fees generated from both Arbitrum and Avalanche exchange.

However, since the GLP token is unique on each of these networks, holders of the Arbitrum GLP token will receive 70% of the GMX (Arbitrum) platform fees in ETH and holders of the Avalanche GLP token will receive 70% of the GMX (Avalanche) platform fees in AVAX.

GMX Token Utility

The GMX token is the platform’s utility and governance token and staking the token unlocks a few benefits. The GMX token will be used to vote on governance and determine future rules and goals of the protocol, such as esGMX emissions.

Staked GMX receives three rewards:

1. Escrowed GMX
2. Multiplier Points
3. ETH rewards – 30% of platform fees generated are distributed to staked GMX holders in ETH

These rewards provide long-term incentives for GMX holders to stake their coins and compound rewards. GMX have also talked about the possibility of GMX holders receiving fees discounts on trading, depending on how much GMX they hold. See here.

GMX on Arbitrum

GMX is chain agnostic and the aim is to expand to all chains that gain network adoption and a consistent user base.
GMX launched on Arbitrum on July 14th 2021. Arbitrum is a layer 2 scaling solution built on top of Ethereum, thus benefiting from the low transaction fees of an L2 but also the security of Ethereum’s main chain. Arbitrum is an Optimistic Rollup and processes transactions off-chain before bundling them up and sending back to the Ethereum main chain. The validity of those transactions are then checked using fraud proof’s. This enables GMX transactions to be cheap and fast, creating a great user experience.

Currently, Arbitrum is the largest L2 scaling solution by Total Value Locked (TVL) with $1.94 Bn (as of 4th July 2022), and boasts a 52.62% market share according to L2beat. This network has seen an uptick in usage and TVL as Ethereum users have migrated to avoid the high transactions fees of the main chain. Data from Arbiscan estimates that there are 87.3 K unique active addresses on the Arbitrum network in the last 30 days, with the number of daily transactions growing from 0 in May 2021 to more than 200k on 29 Jun 2022.

The overall trend therefore suggests that the Arbitrum network is the dominant L2 scaling solution and it currently being adopted as Ethereum users wish to migrate to cheaper chains (or L2’s), whilst preserving the security of their transactions. As Ethereum moves to Proof-of-Stake and with their plans to make Rollups a large part of their scaling solution, I expect Arbitrum’s network to continue to grow.

GMX On Avalanche

The Avalanche network is an alternative Layer 1 solution which is EVM compatible. Having launched in 2020 by Ava labs, the platform has gained a significant amount of monthly active users and has locked up $2.71 billion in TVL (as of 4th July 2022 and peaked at ~$11 billion during the bull run) . Again, the high fees of the Ethereum main chain and their inability to scale has led users to cheaper, faster chains and Avalanche was well positioned to onboard users.

Data form Nansen and Avalanche show that the monthly active addresses on the network has grown from almost 0 in Jan 2021 to between 590,000– 667,000 currently. This trend in combination with the increase in TVL and number of transactions on the network show real signs of network adoption and network effects. Another interesting and potential catalyst for GMX could be the introduction of Avalanche subnets that drastically improve scalability of the protocol, leading to low transaction fees and sub-second finality.

GMX will be able to benefit from the large user base on Avalanche, whilst also enjoying the low fees and high throughput (higher than Ethereum) offered.

GMX Decentralized Perpetuals Fundamental Analysis

Need For GMX

believe the Digital Asset space needs an on-chain spot and perpetual exchange in order to help facilitate a thriving ecosystem through enhanced liquidity, price discovery and consumer choice. The Decentralized Perpetuals futures market is currently the largest source of liquidity and trading activity in the digital asset space and since the overall liquidity of a market greatly affects the growth of that market, it is vital that the digital asset space has an efficient perpetual future market.

However, there have been significant regulatory concerns regarding CEX perp trading in 2021 and we have seen exchanges such as Huobi forced to shut down operations in China because of this. Furthermore, we have seen exchanges such as Binance and FTX forced to clamp down on KYC, whilst also reducing the leverage they are able to offer customers. It therefore makes sense that the digital asset ecosystem has a viable alternative in case of regulatory crackdowns.

GMX, a decentralized perpetuals futures and spot exchange, fulfils this need well with their fully pseudonymous team. Users of the exchange can trade spot and perp markets directly on-chain, with no KYC or account, from any location in the world.

• Decentralized Perpetuals and Spot Exchange: The need for a fully decentralised DEX for both Spot swap and Perpetual futures is becoming evident with the regulatory concerns surrounding CEX trading. A non-KYC exchange that is completely on-chain will allow the thriving Perp market to continue being the main source of liquidity to the digital asset ecosystem in case of CEX regulations.
• Multi-Chain Future: The future is that of a multi-chain one. Different blockchains have positioned themselves at different positions along the blockchain trilemma scale and in doing so each chain will excel at certain use cases and underperform at others. GMX is chain agnostic and plans to expand to new chains and become the leading spot and perp DEX there.
• Great User Experience: GMX has a sleek UI without the need to KYC or even create an account. Moreover, the use of the GLP pool and price feeds provided from Oracles, enables trades to be executed with no price impact. The resultant effect is a great user experience when trading both Spot and Perpetual markets.

An Impressive Roadmap

The future for GMX is bright, with the proliferation to new chains and the adding of new tradeable assets, GMX looks set to increase volume and fee generation.

An unknown is the plans for “X4”, which Xdev describes as a new type of AMM that will allow for the invention of new DeFi products and protocols.

Scalability

GMX, being chain agnostic, has plans to scale horizontally by deploying their contracts onto more chains and becoming a multi-chain Spot and Perp exchange. With the rise of alt-L1’s in 2021, there are plenty of chains to expand to with a large user base and GMX can instantly tap into this base on deployment. The focus will be on low transaction fee chains, that have high throughput.

GMX plans to scale vertically by continuing to increase market share on both Arbitrum and Avalanche. I reached out to a team member and they said the main priority right now is “to consolidate current work on Avax and Arbitrum”. One initiative the GMX team has voted on is the introduction of a referral program, similar to FTX and Binance’s referral programs. 10,000 esGMX per month of the marketing and floor price fund allocation is going to be dedicated to rewarding the referrers.

I believe GMX will also scale with the base chains they are already on. As mentioned, we are seeing high network adoption rates of both the Arbitrum and Avalanche chains and if these chains continue to grow, GMX will benefit. Furthermore, the trend is firmly in the favour of DEX trades vs CEX trades, as DEX’s increased their market share of total trading by 441% in 2021. I expect this trend to continue for the foreseeable future and as such GMX will scale nicely.

Decentralization

GMX is a dApp built on top of multiple blockchains and therefore it will inherit the decentralisation of the blockchain it
is running on. Currently, GMX is operating on the Arbitrum and Avalanche network.

Arbitrum
As discussed, the Arbitrum network is an optimistic Rollup layer 2 scaling solution for Ethereum. This means GMX inherits the decentralisation of the Ethereum main chain and is therefore secured by a widely distributed network of miners (or Validators when Proof-of-Stake). Ethereum is widely considered to be one of the most, if not the most decentralised smart contract platform.

Avalanche
The Avalanche network is a Proof-of-Stake blockchain that is secured by 1,284 Validators. Interestingly, the number of messages each node has to handle per decision remains constant as the validator set grows. Therefore, there is a clear path for greater decentralisation, as validators scale. On the scale of decentralisation, Avalanche is less decentralised than Ethereum (and by extension the Arbitrum network), but its remains sufficiently decentralised in my opinion.

Binance Smart Chain (BSC)
Although GMX is not technically on the BSC, Gambit is. Before rebranding to GMX, Gambit was the first iteration of GMX, hosted on the BSC. The Binance smart chain is arguably the most centralised of the large chains. Utilising Proof-of-Stake Authority, the BSC has only 21 validators.

Innovation

GMX’s dual use of the GLP pool as the counterparty to traders and the oracle pricing system represents a huge innovation in the execution of trades. Firstly, trades are executed with zero slippage/ market impact as the traditional Automated market maker (AMM)/ Order book model is not used. This also represents an innovation for LPs as they are not subjected to Impermanent loss due to the oracle pricing system (not subjecting the LPs to the cost of price
discovery via arbitrage).

Furthermore, the aggregated oracle pricing system GMX uses pulls price feeds directly from Binance and FTX. By aggregating these feeds, there is a reduction in the risk of liquidation from temporary wicks. Looking at the intraday wicks on the December 4th Bitcoin sell-off, we can see the GMX wick bottomed out 3.94% higher than FTX and 3.45% higher than Binance.

The dual use of capital and the oracle pricing system also enables the GLP to be one of the most efficient pools in the entire digital asset space. More on this later.

DEX Aggregator Integration

GMX is both a decentralised derivative platform and spot platform. The elegant design of the GLP pool, a multi-asset liquidity pool, in combination with the oracle pricing method allows for digital asset swaps to be completed with no market impact, akin to an OTC trade. This trade execution design was so efficient on the BSC chain (with Gambit), that at its peak Gambit was handling roughly 20% of all 1inch exchange’s (aggregator) traffic with just under $2.5 million in liquidity and only a few assets swappable. Furthermore, GMX was added as a new route on YieldYak (21.01.22) and has since routed >35% of the total volume in USD, beating Platypus finance, Curve, Sushiswap and Traderjoe.

A huge catalyst for GMX would be its integration into aggregators such as Matcha, Paraswap and 1inch (on Arbitrum and Avalanche). Since GMX is one of the most liquid places to trade assets in the GLP pool, an aggregator integration would result in a large share of the volume from trading these assets to be routed through GMX. This in turn would increase the number of users of GMX and the fees generated and distributed to GMX stakers.

Certain trade sizes would almost always be routed through GMX instead of through the typical AMM models of Uniswap, Sushiswap and Curve and this represents a large vertical that GMX can exploit to gain market share. Taking a look at trade execution on the Avalanche network, we can see that GMX already offers the best execution of USDC to AVAX, with only $75,146,457 in the GLP pool.

Investment Thesis

The Market Opportunity and DEX Adoption

The perpetual futures (Perps) market is the main source of liquidity and trading volume in the digital asset space and GMX is positioned well to serve a proportion of this demand for perps. In 2021, perp volume in the digital asset space was around $57 trillion, accounting for 52.8% of all trading volume. The perp market was also witnessed the largest growth of all the derivatives, growing by an estimated 358% in comparison to derivative trading volumes.

Analysis of the decentralised perp exchange volume vs the centralised perp volume shows there is a clear trend toward DeFi perps (DEXs accounted for only 2% of the total derivatives market). This share looks set to continue in 2022 as advances in layer 2 solutions and faster chains have made perp trades viable. Moreover, another key catalyst for further growth of DeFi perps is regulator concerns surrounding CEX’s.

Therefore, the total addressable market for GMX perp’s is staggering and if they could capture just a small percentage of total perp volume, the GMX token will accrue massive value to holders, through revenue share. With the expansion of GMX to multiple chains, the addition of new assets to the GLP pool (to become tradeable) and the continued growth of the protocol on Arbitrum and Avalanche, it is likely that volume processed by the platform will continue to increase.

Product Market-Fit and Network Effects

Since it’s launch on the Arbitrum network at the end of August, GMX has gathered a peak 19019 users on 28th Jun 2022 and this trend shows no sign of slowing down. Even more impressive is the launch of GMX on Avalanche, with a higher user base on the underlying network, GMX has managed to reach 5,691 total users in just 52 days.

It is clear to see that in the short time GMX has been operating, it has found product-market fit as users desire an on-chain perpetual futures exchange. The plans for a GMX referral program will be a great way to increase network effects and expand vertically. Furthermore, the expansion to new chains and the integration of GMX into aggregators will ultimately lead to an increase in total users of the platform and hence, increased network effects.

Bullish Tokenomics

A large part of my investment thesis is based on the bullish token utility and tokenomics of GMX. We have already spoken about the utility through revenue generation, so I will now focus on the supply and demand aspect of the token. Firstly, GMX had what is referred to as a “fair launch” – no Venture Capital or private sales to kickstart the project. This means all holders have acquired their GMX from the open market (such as Blocktower). Thus, there are no VC’s selling tokens after purchasing in private rounds, for a fraction of the market price. Moreover, the team allocation of GMX was small, with just 250,000 GMX (1.88% of total supply), unlocked linearly over 2 years.

Supply

The total supply of GMX is 13.25 million coins, however, it is very unlikely that all of these coins will ever be circulating on the market. Firstly, the price floor fund (2 million GMX) tokens have no plan to hit the market as the team don’t want to dilute holders. Secondly, the 2 million GMX that are allocated to esGMX emissions are only liquid if token holders lock the average number of GMX or GLP tokens that earned them their esGMX for a whole year. It is therefore very likely that a large proportion of these 2 million GMX will never circulate on the open market, as people forget to vest/don’t want to. The total realistic supply for GMX is therefore much smaller than 13.25 million and makes GMX extremely scarce.

Demand

The token utility creates a large demand for GMX as 30% of protocol revenues accrue to GMX stakers. As such, 82.5% of the circulating supply is currently staked. This staked GMX is currently yielding a 27.41% APR and hence there is a high demand for the token. Token holders are further incentivised to hold through the multiplier points system and due to the clever vesting procedure of esGMX, GMX tokens cannot be farmed and instantly sold (like a number of high APR farming projects). Furthermore, the introduction of a GMX fee reduction for GMX holders will further incentivise holding a position if you are an active trader or a protocol that utilises the exchange. In a way this is similar to the Curve ve tokenomics, as protocols integrating GMX will be incentivised to accumulate GMX. There are already a couple of examples of protocols acquiring GMX for their treasuries – KeeperDAO and Thorus.

Fee Generation

GMX is kind of a DeFi cash cow, generating an annualised $117.2 million in protocol revenue*, which is completely distributed back to token holders. Since the beginning of 2022, GMX has generated $46.5 million in fees on Arbitrum and $16.5 million on Avalanche

Competition Analysis

The mail vertical GMC competing is in the decentralized perpetuals futures market, however, it also competes in the spot market alongside other DEXs. The following diagram represents the primary competitive landscape.

Risks

1. Long-tail asset risks – due to the oracle pricing nature of assets in the GLP pool traders can avoid market impact. This works fine for assets which are liquid such as Bitcoin or Ethereum, but for illiquid assets (long-tail assets) there are risks. Traders could potentially execute trades with no slippage on smaller cap coins.
2. GLP as the counterparty to traders – Since GLP is the counterparty to traders, if traders are very profitable the GLP pool is depleted. The data shows that traders are at a loss so far and GMX expect the traders to cumulatively have 0 PnL in the long-term.
3. Bear Market short skew – In a bear market it is likely there will be a significant short skew on open interest. Whilst the GLP pool works well in a bull market as traders are long skewed and the GLP pool will just pay out this upside to traders (whilst the assets in the GLP pool rise). However, in a bear market with traders short skewed and making money, GLP will be paying out Stablecoins to these traders as profits whilst the index assets in the GLP decrease. This would make the GLP an unattractive place to LP and we may see a decrease in the AUM. An interesting idea, akin to funding rates could solve this risk and it can be found here.
4. GMX team pseudonymous – The entire GMX team is pseudonymous and this makes walking away from the project/stopping shipping that much easier for the team. We are yet to see how the team works in a bear market.
5. Adoption risks – currently the GMX platform doesn’t allow traders to exit their position unless price has moved at least 1.5% away from their entry and this minimum price movement duration is 3 hours. This is to limit rbitrage bots taking advantage of lagged oracle price feeds, however, these features dampen the user experience. Furthermore, large players like HFT firms will not be able to use this protocol and hence adoption could be limited.
6. Smart contract risks – Since GMX operates on Arbitrum, an L2, it carries significant smart contract risks. Tokens within a rollup are locked into a smart contract, meaning a smart contract bug / hack could result in those funds getting stolen or frozen. However, GMX has had an audit from ABDK consulting and currently has a bug bounty listed on ImmuneFi which is a good sign.
7. Competition – GMX has competition from both CEXs and DEXs. Binance currently dominates the perp market and Decentralised perp exchanges only make up less than 3% of total pep volume. In the decentralised perp exchange space, dYdX currently dominates and has a significant head start on GMX.

Final Thoughts

GMX is a decentralised perpetual futures and spot exchange looking to fulfil the market demand for on-chain trading. Its innovative design allows it to execute trades with zero market impact, making it a very desirable place to trade. The central investment thesis is that GMX is a grassroots DeFi cash cow that distributes all trading revenue back to holders of GMX and GLP, and as such the GMX token accrues value from an increase in volume (and thus fees) on the platform.

Therefore, the question is, how will volume increase? – GMX has plans to scale both horizontally and vertically. Firstly, GMX will consolidate market share on Arbitrum and Avalanche and scale horizontally with the introduction of the trading referral program and the addition of new assets to the GLP pool. Then, GMX will increase volume by scaling horizontally; expanding to new chains, integrating as a new route in aggregators and with the launch of X4. GMX is also positioned well to benefit from the growth in demand for perpetual futures contracts, DeFi applications and from the transition from CEX’s to DEX’s, in light of regulatory concerns.

Exit Strategy

The investment strategy for GMX would be defined by a long-term investment horizon, making up one of the key holdings in the DeFi investment theme. I would suggest staking this position to benefit from the esGMX rewards and multiplier points. If the investment is successful we would look to trim the position in 10% tranches for every 100% of returns. After a 300% return from current prices, selling 10% of the initial position at each 100% would result in a total return of 145%, with 60% of the initial position still invested. Each take profit level is labelled on the chart. The remainder of the position will be exited based on exit catalysts and on the maturation of the project. Possible exit catalysts would include: expansion to new chains, introduction of X4 , a DeFi sub-sector bull market or a market wide bull market.

A key metric to track whilst determining the adoption and maturation of GMX would be the volume processed by the platform. Since we expect both the Perp market volume and the share that DeFi serves to grow, we will look to exit based on examining trends in this sector. By using the revenue generation model on slide 50 what the expected market cap of GMX will be dependent on the volume the platform processes (keeping P/E constant). We would therefore look to exit positions when GMX has fulfilled its potential in terms of perp market volume share.

Recommended Reading: Food For Thought on Crypto “Overleveraged”

Disclaimer: Past performance is not indicative of future results, you could lose some or all of your money. Buying/selling digital currencies is extremely volatile and may not be suitable for all people as the price can change drastically in a short amount of time. Never risk more than you are 100% comfortable losing. Anyone wishing to buy/sell digital currencies should seek his or her own independent financial or professional advice.

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