The Optimist Twitter Spaces - Derivatives on Base

In The Optimist’s Twitter Spaces which took place on January 18, 2024, Charlie from The Optimist hosted Sehaj from Avantis, Burt Rock from Kwenta, and Kamel Aouane from Contango to discuss DeFi trading evolution, Avantis, Kwenta, and Contango on launch strategies, liquidity models, cross-platform integration on the Base platform, and more! Read our notes below to learn more.

Background

Charlie (Host) – Co-Leader at The Optimist

Sehaj (Guest) – Co-Founder of Avantis

Burt Rock (Guest) – Head of Blockchain at Kwenta

Kamel Aouane (Guest) – Co-Founder of Contango

Avantis – an on-chain perpetuals for crypto & real assets

Kwenta – a decentralized derivatives trading platform offering perpetual futures and options trading on Optimism

Contango – a unique decentralized market offering cPerps (Contango perps)

Launch Strategies of Avantis, Kwenta, and Contango on Base Platform

Sehaj introduces himself as one of the founders of Avantis, noting they have been building for a few months and are launching on Base soon.
Burt describes his involvement with Kwenta, focusing on communications, marketing, and providing liquidity. He explains that Kwenta is a perps exchange with around 80 markets on Optimism, deep liquidity, and plans to roll out their V3 launch on Base.
Kamel talks about Contango’s focus on leverage positions or perps using money markets. He mentions that Contango is live on six chains, including Base, and has 12 money markets on Base.
Charlie asks why Base is a choice for their protocols, what excites them about Base, and its potential for Optimism users.
Sehaj explains Avantis’ early interest in Base and its native bridge feature for seamless liquidity transfer across chains. He appreciates the governance and process involved in Base’s grant system, highlighting its alignment with decentralization principles. Sehaj is bullish on Base due to Coinbase distribution and its potential as an institutionalized chain.
Burt comments on the importance of connected liquidity for trading protocols and the seamless user experience offered by the Optimism Superchain, expressing excitement about its prospects.
Burt explains that the decision to expand V3 with base originated from the Synthetix side, particularly for Kwenta. The use of Cannon by the Synthetix team allows quick deployment on EVM chains. Base’s connection to Coinbase offers an opportunity to attract less DeFi-savvy users through Coinbase routes. This expansion is seen as the first step into the wider EVM ecosystem, focusing on the Optimism stack.
Burt highlights that the Base’s advantage lies in its ability to use $USDC, despite some in the Synthetix community opposing it due to its centralization. This move aims to improve the reliability of the protocol and ease user access to collateral.
Kamel mentions that deploying on any EVM-compatible chain is straightforward for them, with Optimism being Contango’s third biggest trade chain. The choice of Base was influenced by the desire to expose the $CBETH and launch protocols with rewarding opportunities. Kamel expresses curiosity about the future direction of Coinbase and Base, considering institutional involvement in DeFi.

Strategies and Challenges in Enhancing Trading Volume on Optimism and Base

Charlie asks about the challenges of increasing user and trading volume on Optimism and Base, seeking insights on what could enhance trading volume and future bullish prospects.
Sehaj points out the challenges faced by the Base and Optimism, including Base’s denial of having a token and Optimism’s focus on governance. He says that competing in a fragmented liquidity market requires incentives, like those offered by Arbitrum.
Sehaj proposes that Base needs to utilize its advantage, similar to Binance with BNB, to increase adoption and volumes. He addresses the contentious issue of institutionalization in DeFi, suggesting that increased trust from institutions in Base could bring more capital, benefiting the entire DeFi space.
Charlie acknowledges the importance of both short-term and long-term strategies in fostering chain activity. He highlights that while short-term tactics like focusing on key opinion leaders and narratives are effective initially, long-term success depends on solid fundamentals, such as reliable protocols and beneficial conditions for users. Charlie summarizes that a balance of both approaches is crucial for sustained growth.
Burt discusses the dominance of Arbitrum in the L2 space, driven primarily by the success of the GMX protocol. He mentions Kwenta’s competitive performance in terms of volume, although with slightly fewer users.
Burt notes the temporary impact of STIP rewards on user attraction to Arbitrum but remains unbothered, highlighting the uniqueness of some protocols on Arbitrum. He also praises the innovative approaches of Dopex and Lyra in designing financial products.
Burt contrasts Arbitrum’s influencer-driven marketing with Optimism’s grassroots approach, suggesting that Optimism’s steady growth might lead to a more significant, long-lasting impact, especially with the potential of the Optimism Superchain.
Kamel says that trading behaviors on chains like Optimism and Arbitrum are quite similar, with a focus on correlated and non-correlated asset trading. He observes a concentration of trading on Aave V3 and mentions different trading strategies like the $stETH loop.
Kamel points out the differences in rewards across protocols, with newer protocols on Base offering more lucrative opportunities. He acknowledges the varying interest rates and trading patterns across different chains.

DeFi Trading Dynamics and Risk Management in Decentralized Protocols

Charlie asks if users on different chains have distinct focuses or if they are generally chain agnostic. He asks whether the culture on each chain fosters specific types of users.
Kamel explains that trading behavior is similar across chains like Optimism or Arbitrum, with a significant focus on Aave V3 and strategies involving correlated and non-correlated assets.
Kamel highlights the role of rewards in different protocols and how they influence trading, with newer protocols offering more attractive rewards. He mentions specific trading strategies and the comparative lack of interest in certain trades on Base compared to others.
Charlie asks about the fundamentals of Contango and the criteria used for supporting new lending markets, highlighting the importance of incentivized markets, and the research process involved.
Kamel explains the concept of looping in DeFi trading, where one can leverage $ETH/$USD by depositing and borrowing $USD repeatedly, or use a flash loan to achieve the same result. This mechanism leverages the liquidity of spot and money markets, ensuring no insolvency risk to the protocol and utilizing large money market liquidity. He mentions a construction similar to perpetual protocols with funding fees based on borrowing and lending rates.
Charlie expresses excitement about Contango, sharing his experience as a manual looper and his preference for minimal leverage. He finds Contango’s one-click solution appealing for managing his portfolio and hedges.
Kamel highlights the depth of money market liquidity in DeFi, noting that protocols like Contango are not subject to the same restrictions as perpetual protocols, which impacts their open interest limits.
Burt reflects on his experience with manual looping and the evolution of decentralized perpetual protocols. He explains how protocols like Kwenta and Synthetix manage liquidity by balancing open interest, reducing LP risks, and allowing greater exposure. Burt observes the rapid advancements in the usability and liquidity of decentralized perpetual protocols, foreseeing a future challenge in reducing trading fees while managing risk.
Burt expects the next challenge in DeFi will be reducing fees while controlling risk, noting the difference between order book DEXs/CEXs and AMMs in risk management. He says that liquidity issues are becoming less significant for most traders, with ample open interest available for large trades in decentralized protocols like Kwenta.
Burt discusses the risk management strategies in AMMs, mentioning the use of simulated or real slippage based on position size. He points out the limitations of current models where slippage is linear and does not adapt to varying market conditions, emphasizing the need for more aggressive parameters.
Burt predicts future improvements in AMM models with the development of high-speed oracles providing extensive data. He expects these advancements will enable more complex liquidity provision and slippage calculations, potentially reducing fees.

DeFi: CDPs, Liquidity Models, and Cross-Platform Strategies

Charlie asks Kamel about his work with money markets and lending protocols, specifically asking if Kamel supports Collateralized Debt Positions (CDPs) and if he has considered a liquidity-based model.
Kamel explains the feasibility of integrating CDPs but notes the limitation of only being able to operate on one side of the market, such as in Maker‘s use case. He mentions the integration of Spark protocol in Contango, allowing for more diverse operations.
Kamel acknowledges the potential of liquidity-based protocols but points out the current limitation of only being able to use $ETH as collateral and borrow $LUSD. He says this is an area they could integrate into their platform, though they haven’t seen significant demand for it yet.
Kamel compares Contango and Kwenta, highlighting differences in leverage and maintenance margin. He notes the increased leverage and liquidation mechanics in Kwenta, and the benefits of relying on Oracle and not needing to swap.
Kamel remarks on the evolution of DeFi the potential for tighter loan-to-value ratios in money markets, and the impact of blockchain evolution on execution speed and risk reduction.
Sehaj explains Avantis focuses on commodities, forex, and crypto with up to 75x leverage. He explains their approach to liquidity provision risk management, offering higher returns for long-term LPs and a unique skew balancing mechanism that compensates traders for helping to balance open interest.
Charlie asks about Avantis junior and senior vault mechanisms. Sehaj explains that junior vault LPs face higher risks and rewards, while senior vaults offer less risk and reward, creating a risk management balance.
Charlie discusses the idea of locking up liquidity to boost APR in the context of skew and funding rates, and their relation to open interest (OI).
Bert expresses amazement at the loss protection mechanism being different from Kwenta’s model of premium and discount. He says this mechanism could lead to instant wins in trading if one balances the skew between Kwenta and Avantis, potentially offering free money.
Bert explains Kwenta’s unique funding rate mechanism, which is based on funding rate velocity rather than a balanced skew. This approach aims to identify the market rate of funding when the skew is balanced, thereby creating tighter arbitrage opportunities.
Charlie asks about the use of $USDC as collateral on Base and considering an integration with Synthetix given its V3 launch.
Sehaj speaks about Synthetix V3, noting the expanded opportunities it offers. He explains the choice of $USDC as a starting point for collateral due to its universal applicability in Synthetix operations.
Kamel reveals a short-term plan involving a point system to be rolled out soon for Contango, indicating it’s a precursor to a proper token launch happening within the year.

Contango and Avantis: Zero Fees, LP Rewards, and New Asset Integrations

Charlie asks about the fee structure and revenue generation methods for Contango. Kamel says that they aim to drive fees towards zero, hence they have zero fees.
Sehaj explains that Avantis aims to distribute 80% of revenue to Liquidity Providers (LPs), the highest in the industry, to bootstrap liquidity, with the remaining 20% going to the protocol treasury.
Charlie asks about the upcoming focuses, specifically regarding testnet, mainnet launch timelines, and new integrations.
Sehaj says a mainnet launch in the next couple of weeks for Avantis, highlighting responsible and secure scaling. He also hints at introducing new trading pairs like crude oil and other roadmap items, stressing the importance of security and efficient operations, especially with Avantis being heavily reliant on on-chain code.
Charlie asks about the trading of Forex and commodities on Avantis, curious about the liquidity management and how it differs from standard crypto pairs.
Sehaj explains that all assets, including crypto, Forex, and crude oil, have virtual caps on their $USDC allocation, which can be adjusted based on demand. He highlights the importance of setting parameters for protecting liquidity providers and satisfying traders, focusing on secure price feeds, reasonable fees, and effective risk management.
Sehaj says that Real-World Assets (RWAs) on their platform currently refer to stablecoin treasuries like Savings $DAI, with most RWAs being synthetic, offering price exposure without actual on-chain custody. He says that this eliminates custody risk, with the primary concern being the security of smart contracts and the reliability of platforms like Avantis or Gains Network.
Charlie expresses surprise at the significant volume of non-crypto assets, like commodities, in trading platforms, acknowledging his oversight in not considering such assets in the RWA space.
Kamel mentions a shift in money markets to offer these assets, and talks about the possibility of integrating tokenized short-term T-Bills. He highlights the challenge of balancing permissioned and permissionless systems in DeFi, aiming for a future where Contango and money markets can offer products on tokenized RWA assets in a KYC-compliant, yet open, system.

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Show Information

Medium: Twitter (Audio)
Show: The Optimist Twitter Space
Show Title: 🔵Derivatives on Base <> 🔴The Optimist
Show Date: January 18, 2024