Inside GMX v2: A Closer Look at Its Innovative Mechanics

Introduction

GMX has emerged as a highly successful perpetuals protocol since its inception. In 2023, It generates an estimated annual revenue of approximately $15 million and annual fees of around $50 million. With over 300,000 users on board, GMX has proven to be a protocol that effectively meets market demands. However, there is one aspect that poses limitations, and that is the architecture associated with $GLP and the incentives structure in GMX v1.

GLP and GM

GLP is a token that combines various crypto assets, similar to an index. It is affected by market changes and mainly comprises of volatile assets. GLP serves as a counterparty, where GLP holders engage in trades with other parties (traders). However, there are certain limitations to keep in mind with this mechanism:

1. Imbalance of Open Interest (OI) and higher risk to LPs

   The GLP model has no funding fees, but there are borrow fees. These fees are charged to traders who open/ close trades, whether they are long or short positions. The problem is that there are no incentives for arbitrageurs to balance the Open Interest, resulting in higher risk for LPs. This exposes them to the performance of traders, leading to suboptimal profit and loss (PnL).

2. Higher Fees for Small/ Medium Size Trades

   The fees to open or close a trade are 0.1%, which is considered high compared to competitors, despite the existence of a zero-slippage function.

3. General exposure basket for LPs

   The GLP architecture does not separate the assets within its basket. This means that LPs can be exposed to other volatile assets that they might not want to have exposure to.

4. Low Capital Efficiency

   Due to the way GLP operates, a significant portion of liquidity remains unused and idle. This is because the protocol imposes caps (40-50%) and avoids overexposure to one side of the market. As a result, the liquidity within GMX v1 is not fully utilized.

GMX v2 sought to overcome the mentioned limitation and bring in new innovations, including updated incentives, fee structure, and liquidity model. Now, let's see how GMX v2 distinguishes itself through GM and new mechanics:

• Isolated markets, liquidity providers have the freedom to select the assets they wish to provide liquidity for. Consequently, they become exclusively exposed to those particular assets.

• To maintain a balance between short positions and long positions and mitigate the risk of price manipulation, measures such as price impact and funding fees to the less dominant side have been implemented.

• The spot and perpetual fees were decreased from 0.1% to 0.05% - 0.07%

• Tradable pairs can be added without the need for liquidity providers to have exposure to the asset (synthetic market), as some markets will be collateralized with ETH and stables instead of the traded assets, while others will fully collateralized by the traded assets (ARB/USDC will be backed by ARB but LTC/USDC will be backed by ETH)

• GMX V2’s oracle system will price each block, ensuring orders are executed at the latest possible prices, resulting in faster execution speeds and lower slippage.

The New Frontiers for GM

The new structure and mechanics open up exciting possibilities for building products using GMX v2 as a foundation. Here are some potential use cases:

• LP Management

  The objective is to actively manage LP positions by taking trading volume and activity into account, similar to LP management protocol in Uniswap v3, with the aim of optimizing yield in a efficient and effective manner.

• Yield Protocols that Focused on The Farming Funding Fees

  The implementation of funding fees in GMX v2 will allow for the extraction of funding fees and arbitrage opportunities with other perpetual decentralized exchanges (DEX) that have a similar mechanism, like dydx and Kwenta. For example, a protocol can open a long position in perp DEX 1 and earn a 20% annual percentage rate (APR), while simultaneously opening a short position in perp DEX 2 and gaining a 10% APR.

• Derivatives and Other Structured Products

  The use of GM, similar to GLP in structured products, can act as a primitives for different DeFi instruments. By including GM as a key element, decentralized options and structured products can be created and used for hedging or to develop more complex financial products.

Chainlink Low-Latency Oracles Integration

GMX v2 will use low-latency oracles from Chainlink to improve execution speed and reduce front-running risk. These oracles provide real-time updates for each block, resulting in a smoother validation process and increased gas efficiency.

Compared to Chainlink Price Feeds, this new oracle solution uses a pull-based approach. It generates oracle reports per block, which users can retrieve off-chain. Users can then validate these reports atomically with their on-chain transactions.

*More on this: https://blog.chain.link/low-latency-oracle-solution/

Conclusion

The launch of GMX v2 addresses architectural limitations in GMX v1's GLP model. This new version improves the balance of risk exposure, liquidity, incentives, and fee structure. It also expands the range of tradable assets, introduces coin-margined positions, and enhances the overall user interface (UI), user experience (UX), and security. It opens up new possibilities for DeFi users to participate and explore.

However, there may be some challenges in the initial phase, such as fragmented liquidity due to isolated markets for each asset. GMX should also consider risks like attracting liquidity, competition with other Perp Dex platforms, and possible security threats. These factors need to be carefully navigated in the complex DeFi landscape.

References:

• Special Thanks to 0xAtomist, DeFiMann and Castle_Cap for creating amazing summary of GMX v2 in here.

• LD Capital - Changes and Impacts of GMX V2

Snapsh(x)t is the latest visual guide by @eli5_defi. It offers concise and essential information about DeFi protocols, including the latest developments. This guide is designed to complement HomeBrew, which provides a more detailed breakdown.

Disclaimer & Disclosure:

None of the content in this post should be interpreted as financial or tax advice