You are reading an excerpt from our free but shortened abridged report! While still packed with incredible research and data, for just $20/month you can upgrade to our FULL library of 50+ reports (including this one) and complete industry-leading analysis on the top crypto assets. 

Becoming a Premium member means enjoying all the perks of a Basic membership PLUS:

• Full-length CORE Reports: More technical, in-depth research, actionable insights, and potential market alpha for serious crypto users
• Early access to future CORE ratings: Being early is sometimes just as important as being right!
• Premium Member CORE+ Reports: Coverage on the top issues pertaining to crypto users like bridge security, layer two solutions, DeFi plays, and more
• CORE report Audio playback: Don’t want to read? No problem! Listen on the go.

Perps

Decentralized perpetual exchanges, known as perp DEXs, have emerged as platforms that enable investors to trade perpetual swaps. Unlike centralized exchanges like Binance, perp DEXs allow traders to trade against community liquidity, making liquidity providers the counterparty. Additionally, perp DEXs offer self-custody of assets, providing users with full control over their funds.

The growth of perp DEXs has been closely tied to the development of Layer 2 scaling solutions. The scalability provided by Layer 2 networks has allowed perp DEXs to flourish by facilitating faster and more cost-effective transactions. This scalability has been crucial in enabling the explosive growth and increasing popularity of perp DEXs.

Perpetual swaps resemble traditional futures contracts but with some notable differences. Perpetual swaps have no expiry date and track the spot market price through a funding mechanism where longs pay shorts or vice versa. These swaps enable crypto traders to speculate on price movements without owning the underlying asset and leverage their positions, amplifying their market exposure.

The structure of a perp DEX typically includes a trading interface where traders can access charts, analysis tools, and observe price action. Open interest, which represents the number of outstanding positions, provides insights into market sentiment. Funding is a mechanism that ensures the convergence of perp and spot prices, with traders paying or receiving funding based on market demand. Collateral is the crypto deposited by traders to open leveraged positions, and governance tokens entitle users to platform revenue and act as a liquidity efficiency tool. Liquidity tokens allow retail investors to participate in market-making activities and earn fees.

The success of perp DEXs relies on community-funded liquidity pools that serve as the counterparty for trades. These liquidity providers supply funds with the expectation that losses will outweigh gains. Perp DEXs direct a significant portion of platform rewards to liquidity providers, creating a mutually beneficial ecosystem.

Leverage is a significant feature of perp DEXs, allowing traders to amplify their returns by using borrowed capital. Leverage is a common practice in modern economies, and its application extends beyond the crypto market. The use of leverage has become ingrained in financial systems, offering opportunities for wealth creation and economic growth.

The growth of perp DEXs has been remarkable, with platforms like ApolloX leading the way on the BNB Smart Chain before the emergence of Layer 2 solutions. Perp DEXs on Layer 2 networks, particularly the Arbitrum network, have gained prominence due to their scalability and performance advantages.

The reasons for the rapid expansion of perp DEXs are multifaceted. The maturing crypto market demands a more robust derivatives market, and leverage trading pairs well with the volatility in the space. The shift toward self-custody and the increasing adoption of decentralized exchanges have contributed to the growth of perp DEXs. The permissionless nature of these platforms enables users in jurisdictions where crypto derivatives may be restricted to access them. Furthermore, perp DEXs cater to traders seeking opportunities to test their market knowledge and capitalize on fast money and high leverage.

Looking ahead, the derivatives market in DeFi is poised for further growth. The estimated size of the traditional finance derivatives market exceeds $1 quadrillion, and crypto is no exception to this trend. As more funds flow into DeFi and on-chain trading increases, the propensity for users to utilize decentralized derivatives platforms grows. The real test for perp DEXs will be whether community liquidity can support the increased trading volume and activity during a bullish market. The ability of liquidity providers to remain profitable in such conditions will be a crucial factor in the long-term success of perp DEXs.