Challenges and Strategies for Decentralized Exchanges of Perpetual Futures

Recently, a trader used 50x leverage to go long on ETH on a certain Perptual Futures trading platform, with unrealized profits exceeding $2 million at one point. Due to the massive size of the position and the transparent nature of Decentralization finance, the entire crypto market is closely watching the movements of this "whale".

Unexpectedly, the trader chose not to continue increasing their position or to close it for profit, but instead adopted a unique strategy: by withdrawing part of the margin to realize profits, while triggering the system's mechanism to automatically raise the liquidation price of the long position. Ultimately, the trader successfully triggered the liquidation, making a profit of 1.8 million dollars.

This operational method has significantly impacted the platform's liquidity. The platform's liquidity pool is responsible for actively market-making, maintaining operations by charging funding fees and clearing profits. Due to the high profits of this ETH whale, a normal one-time liquidation could lead to insufficient counterparty liquidity. However, he chose to actively trigger the liquidation, resulting in the related losses being borne by the liquidity pool. In just one day on March 12, the platform's liquidity pool reduced its funds by approximately $4 million.

This incident highlights the severe challenges faced by decentralized exchanges (DEX) for perpetual futures, particularly the urgent need for innovation in liquidity pool mechanisms. We will conduct a comparative analysis of several mainstream DEX for perpetual futures, including Hyperliquid, Jupiter Perp, and GMX, and discuss how to prevent similar attacks from occurring.

Hyperliquid

Liquidity Provision:

• Community Liquidity Pool HLP (Hyperliquid Pool) provides funding
• Users can deposit assets such as USDC into the HLP Vault to participate in market making.
• Support users to create their own "Vault" to participate in market-making profit sharing.

Market Making Model:

• Adopting a high-performance on-chain order book matching, providing an experience similar to a Centralized Exchange.
• The HLP treasury acts as a market maker, providing depth on the order book.
• Use external oracles to ensure that order prices are close to the global market.

Clearing Mechanism:

• Liquidation is triggered when the margin falls below the minimum requirement (usually starting from 20%)
• Any user with sufficient funds can participate in liquidation.
• The HLP Vault also serves as a clearing insurance fund, bearing the losses caused by clearing.

Risk Management:

• Use multiple exchange price oracles, updated every 3 seconds, to prevent manipulation of single market prices.
• For large positions, increase the minimum margin requirement to 20% and reduce the impact of liquidation on the liquidity pool.
• Open clearing participation rights to enhance decentralization
• As an emerging proprietary chain, it has not yet been tested over the long term and has previously experienced the risk of substantial liquidation losses.

Funding rate and position cost:

• Calculate long and short funding rates every hour to anchor contract prices close to the spot.
• When bulls dominate, bulls pay funding fees to bears (and vice versa)
• For net positions exceeding the HLP's capacity, risks may be managed by increasing margin requirements and adjusting funding rates.
• Holding positions overnight incurs no additional interest, but high leverage may lead to higher funding fee expenses.

Jupiter

Liquidity Provision:

• Multi-asset JLP (Jupiter Liquidity Pool) provides liquidity
• The pool includes index assets such as SOL, ETH, WBTC, USDC, and USDT.
• Users mint JLP by swapping assets, with JLP assuming the risk as the counterparty.

Market Making Mode:

• Adopt an innovative LP-to-Trader mechanism, abandoning the traditional order book.
• Traders can trade directly with JLP through oracle pricing, enjoying an almost zero slippage experience.
• Supports advanced features like limit orders, but actual trades are executed by the pool at oracle prices.

Clearing mechanism:

• Automatic liquidation will be triggered when the margin rate falls below the maintenance requirement (e.g., <6.25%).
• Smart contracts automatically close positions based on oracle prices
• JLP absorbs the profit and loss of positions as the counterparty, and the remaining margin upon liquidation belongs to the pool.
• Users can adjust collateral during the holding period, but excessive withdrawals may lead to easier triggering of liquidation.

Risk Management:

• Use oracles to ensure contract prices closely follow spot prices, avoiding internal price manipulation.
• High TPS on the Solana chain helps reduce clearing lag risks, but instability in the underlying network may affect trading and clearing.
• Limits can be set on the total position of a single asset to prevent malicious manipulation.
• Borrowing rates increase with asset utilization, suppressing long-term unilateral positions.
• Currently, traders are in an overall net loss state, while JLP funds are relatively stable and growing.

Funding Rate and Position Cost:

• Does not use the traditional long-short mutual funding fee mechanism
• Introduce Borrow Fee, which is calculated hourly based on the ratio of borrowed assets to the pool.
• The longer the position is held or the higher the asset utilization rate, the more interest accumulates, and the liquidation price gradually approaches the market price.
• This mechanism serves as a cost constraint for long-term unilateral positions, preventing the long-term imbalance of funding fees.

GMX

Liquidity Provision:

• Multi-Asset Index Pool GLP (GMX Liquidity Pool) provides liquidity
• Includes assets such as BTC, ETH, USDC, DAI
• Users deposit assets to mint GLP, which becomes the counterparty for all trades.

Market Making Model:

• No traditional order book, using oracle quotes and pool assets to automatically act as counterparty.
• Use Chainlink DEX to obtain market prices
• "Zero Slippage" execution trading, the GLP asset pool is equivalent to a unified market maker.
• Adjust the assets in the pool through a price-impact fee mechanism to ensure liquidity depth.

Clearing Mechanism:

• Automatic liquidation, using Chainlink index prices to calculate position value
• Liquidation is triggered when the margin ratio falls below the maintenance level (approximately 1.25 times the initial margin).
• The contract automatically closes the position, with the margin first used to cover the losses in the pool, and the remaining amount returned or included in the insurance.
• The GLP asset pool directly bears losses or earns liquidation margin revenue as the counterparty.

Risk Management:

• Use multi-source authoritative oracles to reduce price manipulation risks.
• Set a maximum opening position limit for easily manipulated assets (e.g., AVAX limit of $2 million position)
• Limit leverage risk through position limits and dynamic fee rate mechanisms
• 70% of the trading fee rewards are given to GLP, enhancing the motivation for LPs to bear losses.

Funding rate and position cost:

• GMX V1 does not have long and short funding fees.
• Borrowing fees are charged at 0.01% per hour based on the proportion of the borrowed assets.
• Fees are paid directly to the GLP pool, and all holders are required to pay holding interest.
• The higher the asset utilization rate, the higher the annualized borrowing fee rate (which can exceed 50%), penalizing long-term one-sided crowded positions.
• Perpetual prices are always close to the spot, but the pool must bear the profits and losses during severe price fluctuations.

Conclusion: The Development Path of Decentralized Exchange for Contracts

This incident exposed the challenges brought by the decentralized nature of Perp Dex: high transparency, with rules determined by code. Attackers took advantage of these characteristics, profiting from large positions while impacting the internal liquidity of the exchange.

To prevent similar attacks, the platform can take the following measures:

1. Reduce user position size:

   • Adjust leverage multiplier and margin requirements
   • Announced a reduction in the maximum leverage multiples for BTC and ETH (40x and 25x respectively)
   • Increase margin transfer ratio (increase by 20%)

2. Implement Automatic Deductions (ADL) Mechanism:

   • Start when the risk reserve cannot bear the liquidation losses.
   • Hedge losing positions with profitable or high leverage positions, closing both positions simultaneously.
   • Limit risk reserve loss, but may force liquidation of profitable positions

3. Strengthen address association tracking:

   • Prevent multi-account attacks and witch attacks
   • But it may contradict the core idea of DeFi's permissionless use.

In the long term, the Perptual Futures DEX protocol needs to develop along with market maturity, gradually thickening liquidity and increasing attack costs until such attacks become unprofitable. The challenges faced currently are an inevitable path for the development of decentralized finance, requiring the industry to work together to explore safer and more efficient operational models.