Can you short NFT with leverage?Inventory of NFT perpetual contract track from nftperp

introduction

For a long time, the NFT market has been committed to solving the problem of “insufficient liquidity”. Starting from the valuation and pricing of NFT, matching methods, etc., many excellent products and innovative mechanisms have continuously emerged to promote the continuous development of NFT financialization. A healthy financial market needs to allow market participants to play the role of long and short sides at any time, in order to achieve the purpose of hedging transaction risks, increasing profit opportunities, and enriching trading strategies. However, NFT traders can only profit by buying low and selling high on NFT spot at present. The trading method is very single. NFT traders have the demand for long/short NFT with leverage. The price of blue-chip NFT is high, and retail investors want to participate in the transaction but are unwilling powerless. In response to these questions, people look forward to the answers to NFT derivatives transactions found in traditional financial markets and DeFi markets.

The traditional financial futures market once had an inherent limitation, that is, it has a settlement date and limited leverage trading capabilities, and cannot adapt to this 724-hour trading encryption market. As a result, BitMEX launched the perpetual contract on May 13, 2016, using an innovative funding rate to control the price of the spot and the contract as much as possible, unlocking the opportunity to go long/short with up to 100 times leverage. Its birth changed the cryptocurrency and the entire financial field forever.

In fact, many NFTFi innovations are inspired by DeFi: for example, sudoswap, the first NFT AMM project, refers to the centralized liquidity solution of uniswap v3 AMM, and the leading peer-to-pool lending agreement refers to the lending agreement Aave.

With the perpetual contracts in the DeFi market as a reference, nftperp, a perpetual contract platform that can leverage long/short NFTs, is here.

Introduction to nftperp

What is nftperp?

As the name suggests, nftperp is a perpetual contract decentralized exchange for NFT:

• Built on Arbitrum

• Users can use ETH as collateral to conduct perpetual contract transactions with blue-chip NFT projects such as BAYC and CryptoPunk with a leverage of up to 10 times

• The agreement uses the NFT price evaluation protocol Upshot on the basis of the floor price of blue-chip NFT to integrate Chainlink oracles to feed real-time NFT price data on the chain

• Does not require a real liquidity provider, does not use an order book, but improves the vAMM (Virtual Automated Market Maker) mechanism pioneered by Perpetual Protocol to match NFT perpetual contract transactions

Team and financing information

At present, there is little team information released, only the founder of the team is Joseph Liu. In addition, a number of investment analysts and researchers Mckenna, Nick Chong, Ben Roy and Ben Lakoff serve as team advisors.

On November 25, nftperp, an NFT perpetual contract trading platform, announced the completion of a $1.7 million seed round of financing at a valuation of $17 million. This round of financing was funded by Dialectic, Maven 11, Flow Ventures, DCV Capital, Gagra Ventures, AscendEX Ventures, Perridon Ventures , Caballeros Capital, Cogitent Ventures, Nothing Research, Apollo Capital, Tykhe Block Ventures, OP Crypto and other institutions participated in the investment.

Platform Usage

On November 25, 2022, nftperp launched the beta mainnet. According to Dune Analytics data, as of the publication date of the platform:

• Cumulative trading volume exceeds $70 million

• 1,381 users made a total of 21,150 transactions

• Currently the platform only supports perpetual contract transactions for five series of BAYC, Azuki, MAYC, CryptoPunks, and Milady

• The most traded NFT collection is Bored Ape Yacht Club with a 32.4% share, followed by Azuki with a 29.6% share

route map

According to the official roadmap, the follow-up plans for 2023 are:

• V1 public mainnet launch

• Mafia Nuts bundle sale

• L2 solution reassessment

• nftperp token distribution

• NFT index derivatives

• License-free market

• Structured product launches and more

Transaction mechanism of nftperp

Use vAMM to match transactions

Original Static vAMM

In 2018, Perpetual Protocol, a decentralized perpetual trading platform, launched the vAMM (Virtual Automated Market Makers) mechanism.

Like ordinary AMM, vAMM also uses x * y = k for automatic price discovery. The difference is that vAMM does not require real liquidity providers. Users will mint virtual assets after depositing real assets as collateral in the smart contract vault , and then trade and quote in the liquidity pool according to x * y = k, which also provides the functions of short selling and leveraged trading, and avoids impermanent losses.

vAMM is an independent settlement market, all profits and losses are settled directly in the guarantee vault, that is, a trader’s profit in vAMM is the loss of other traders.

However, the original static vAMM will have problems in the unilateral market: if the spot price soars during the bull market, to keep the contract price consistent with the spot price, it is necessary to establish a large number of long positions, so the funding rate is likely to be paid to the long positions. Some, short sellers have no incentive to pay these funding rates, that is, the funding rate creates an imbalance in the interests of long and short, and the price will deviate far from the bonding curve. At this time, the agreement will face systemic risks.

In order to solve this problem, Perpetual Protocol v2 integrates the vAMM mechanism and the centralized liquidity of Uniswap v3, while providing PERP liquidity incentives and online limit order functions. Solana’s perpetual contract agreement Drift developed Dynamic vAMM through “re-pegging” and “adjusting liquidity” based on it.

nftperp introduces dynamic vAMM

nftperp borrows from Drift’s dynamic vAMM and adopts DVL (Dynamic Virtual Liquidity, dynamic virtual liquidity), so that the virtual assets x and y in the x * y = k equation can be dynamically adjusted according to the following two situations ( Refer to nftperp documentation):

• Convergence event: When the perpetual contract price deviates from the oracle price by more than 5% for more than 8 hours, it is determined that a convergence event has occurred. The system will adjust the y value to match the oracle price using the following formula. Once the convergence event is triggered, the virtual liquidity is reset to the center of the bonding curve.

In addition, nftperp currently provides convergence rewards indefinitely. When the vAMM price deviates from the index price by more than 2.5%, users are encouraged to narrow the price deviation with $vNFTP. The convergence rewards are distributed according to the nominal value of the converged transaction (opening time exceeds 30 minutes).

• Dynamic expansion/contraction of liquidity factor k: Since the protocol cannot predict the long/short position of the platform, the dynamic k is very important. k represents the depth of virtual liquidity. The larger k is, the smaller the slippage when the transaction is executed. The protocol can withstand any market condition (high open interest vs low open interest) as long as the process of k expansion/contraction does not affect the ratio between x and y.

Through the above model, nftperp ensures that the price is always traded in the part of the curve with the deepest liquidity of vAMM, and the available virtual liquidity corresponds to the transaction demand, so that traders can obtain the best slippage and available liquidity.

In addition, in order to ensure that nftperp vAMM remains highly available in abnormal market conditions, the following two optimizations have been made:

• Dynamic Funding Rates: Standard funding rates take into account position size, contract mark price, and oracle price, while nftperp takes into account the overall ratio between longs and shorts to better balance open interest. In addition, the funding rate is updated every hour to ensure that the contract price does not deviate too much from the floor price of the NFT trading market.

• Volatility Limits: A ±2% change limit is set for the contract price per block to protect the protocol from manipulation by flash loan attacks and loss of insurance funds during periods of high volatility. Drift v1 has experienced this situation, where large fluctuations in LUNA prices lead to unrealized losses and unbalanced gains within the system, and excess returns can be withdrawn from the insurance fund without restriction.

Pricing using robust, tamper-proof “true floor prices”

According to the nftperp official document, due to the non-homogeneous nature of NFT, it is very difficult to price/valuate NFT. In the current NFT-related agreements, most of them use the floor price as a pricing/valuation indicator.

However, directly using the floor price of NFT as the price feed data of the oracle will cause some problems:

• Price manipulation

• A single NFT pending order (becoming a floor price) does not represent a broad consensus for that NFT series

• Lowest selling price represents the seller only and not fair value (the price that both bid and ask agree on)

Among them, price manipulation is the most obvious problem, and even blue-chip NFTs such as BAYC with high unit prices are not immune to it. For example, in November last year, Franklin, the seventh largest holder of BAYC, “manipulated” the floor price to trigger BendDAO to trigger auction liquidation to realize his “smashing and arbitrage” strategy.

Referring to the DropsDAO NFT oracle model, nftperp uses the NFT price evaluation protocol Upshot to integrate Chainlink oracle data, and finally calculates a robust and tamper-proof “True Floor Price” (True Floor Price) and feeds it to the platform.

calculation method

1. Collection and analysis: collect and analyze on-chain/off-chain NFT transaction events on top NFT markets

2. Detect data eligibility: Determine whether data is eligible based on transaction event type, Token ID, and wash trading detection

3. Filter outlier data: filter extreme outliers and possible outliers using statistical methods and volatility scores

4. Calculation: Use the time-weighted average price algorithm to calculate the filtered data to get the “true floor price”

The data involved in the calculation of the “true floor price” is the transaction data extracted from the APIs of Opensea, LooksRare and X2Y2 through the oracle machine operated by nftperp. The calculated price is updated every time a qualifying public transaction occurs, ensuring that prices are up to date while protecting users from price manipulation. This process has been back-tested on a real dataset of blue-chip NFT transactions to demonstrate its effectiveness, as shown in the figure below.

When traders establish leveraged positions, they use collateral to borrow money from the protocol to buy and sell assets. When the market moves against them and the value of the trader’s position is close to the value of the initial collateral by a certain threshold, the protocol will liquidate the position to maintain its solvency.

When that trader’s position value moves against them, their losses are rolled over to their margin, the initial collateral. The protocol is now at risk, with sudden price movements that could make a trader’s position worth less than their original collateral. When the value of a trader’s position gets too close to the value of the original collateral, the protocol will liquidate the position in order to maintain its solvency.

nftperp adopts the traditional Keeper bots liquidation mechanism, earning 1.25% of the nominal position size during liquidation, and the rest enters the insurance fund of the agreement.

The insurance fund is used to ensure the solvency of the agreement on bad debts, and the funds in the fund pool are composed of clearing and transaction fee income (0.15% transaction fee of the agreement). The size of the insurance fund will grow with the adoption of the protocol and will be able to allow more open positions to be paid out in the future.

The protocol’s base transaction fee is set at 0.3%, but this figure is also dynamically adjusted as the mark price deviates to incentivize a balance between shorts and longs. The fee adjustment mechanism is shown in the figure above. The official document also mentions that token pledgers will receive a portion of transaction fees, but no information has been released yet.

What problems can NFT perpetual contracts solve in the current NFT market?

Drawbacks of the current NFT market:

• Unable to hedge risk

• Expensive blue-chip NFTs are out of reach of most people

• There is no easy and capital efficient way to trade with leverage

• Secondary market fees and royalties reduce traders’ profits

In response to these problems, nftperp provides solutions for seven specific scenarios.

1. Hedge your NFT positions

Holding NFT means holding the spot. After the price of NFT rises, many traders/collectors want to hedge the risk of potential decline while continuing to hold it. In this case, there is an option to open a short position with an exposure equal to the price of the NFT being hedged. This hedging strategy helps protect yield while retaining ownership of the NFT, so holders still get all associated benefits such as whitelisting opportunities, airdrop opportunities, and community access.

2. Can’t afford expensive NFTs

Notoriously expensive for blue chip NFTs, nftperp has lowered the barrier to entry, making it possible to create positions on Punks, BAYC, MAYC, Squiggles, Azuki, and Moonbirds with as little as $1 in collateral.

Not only will this flexibility cater to existing NFT traders, but it will also make onboarding NFT transactions more user-friendly, which is significant for future mass adoption of NFTs.

3. Expand profit margins and improve transaction liquidity

For example, when a trader buys BAYC from 70 ETH to 75 ETH, and there is a floating profit of 5 ETH, he decides to take a profit. However, after deducting OpenSea’s 2.5% handling fee + BAYC’s 2.5% royalty + Gas Fee, the profit is less than 2 ETH. nftperp believes that the layer-by-layer increase of platforms and project parties not only reduces the profits of traders, but also reduces the liquidity of the NFT market.

Nftperp offers a better option for optimizing trading profits with a base fee set at 0.3% for opening/closing positions. The fee does adjust for open interest in order to incentivize a balance between shorts and longs, but extremes are required to achieve a fee close to OpenSea’s level. Additionally, the protocol is based on Arbitrum, which has a much lower Gas Fee than Ethereum.

In addition to lower fees, perpetual contracts are more liquid than NFT spot. Because there is no need to find a specific buyer for the NFT being sold, positions on nftperp can be closed at any time. Liquidity is king in financial markets, especially for institutional trading, but the benefits apply equally to all traders.

4. Degen and Leverage for Advanced Traders

Leverage is a powerful tool and nftperp offers up to 10x long and short leverage, but this magnifies all gains and losses. Therefore, typically the use of leverage requires expertise in the dynamics of the NFT market and a catalyst for the particular set of NFTs being traded. For traders with a higher risk tolerance or a strong belief in a trade, leverage can provide greater capital efficiency.

5. Delta neutral liquidity mining strategy

NFT-collateralized lending protocols such as BendDAO and Jpeg’d allow users to deposit their NFTs into a vault to lend out funds. Users can bring these loaned funds into the wider DeFi ecosystem to earn income, and repay the loan after making a profit to get back the deposited NFT. The main risk for borrowers is that their NFTs will be liquidated if their value falls and their collateralization ratio falls below a certain threshold. In this case, short hedging will be a useful tool. In the event that the deposited NFT loses value, shorts will profit, providing depositors with additional capital to pay back enough loans and avoid liquidation.

6. Hedging with options trading risks

Options can be used as another form of NFT financial derivatives. Another common downside protection strategy for holders is to buy put options that grant them the right to sell the NFT at a predetermined price within a set period of time. The seller who trades a put option takes on this downside risk in exchange for a gain in the form of a premium paid by the buyer. To hedge this risk using nftperp, put option sellers will short on the same collection of NFTs to protect them when the option is exercised. vice versa.

You can refer to the recent cooperation between nftperp and the NFT option agreement Hook Protocol on Delta neutrality.

7. Market maker hedging

Users of NFT market makers and NFT AMMs can also benefit from hedging. As platforms such as Sudoswap introduce liquidity pool-based trading to the NFT market, liquidity providers can now deposit their NFT/FT into these pools and specify their bid/ask prices for buying/selling NFTs. Traders can then buy and sell NFTs in the pool, with prices determined by the pool’s bonding curve.

When LPs can hedge via nftperp, bid-ask spreads should tighten as bidders can reduce downside risk by shorting in the event of a falling price. This will improve liquidity within the pool and potentially improve capital utilization for traders.

How big is the market for NFT perpetual contracts?

First look at the situation in the cryptocurrency derivatives market

Consistent with traditional financial markets, the market size of derivatives transactions in the encrypted market is larger than that of spot transactions. According to TokenInsight, the transaction volume of Q2 perpetual contracts in 21 was 19 trillion US dollars, equivalent to a daily transaction volume of more than 200 billion US dollars, which has surpassed the spot market. If the total market value of cryptocurrencies reaches 10 trillion US dollars within 5 years, the accompanying derivatives trading volume may reach 70-100 trillion US dollars.

According to Switcheo Labs data, cryptocurrency derivatives transactions on centralized exchanges account for an average of 69% of the total cryptocurrency trading volume. For example, 76.6% of Binance’s daily trading volume comes from derivatives ($49.52 billion out of $64.65 billion), while FTX generates 78.9% of its daily derivatives volume ($6.22 billion out of $7.88 billion).

In terms of decentralized exchanges, let’s compare the trading volume of Uniswap and dYdX, as they are the largest spot and derivatives markets in this space. Uniswap has a daily trading volume of $1.09 billion, while dYdX’s derivatives average daily trading volume is $1.33 billion. This amounts to 45.2% and 54.8%, respectively.

Bloomberg also previously reported that the trading volume of BTC perpetual contracts accounted for 93% of the total futures trading volume.

It can be seen that whether it is a traditional financial market, a centralized exchange in an encrypted market, or a decentralized exchange, the scale of the derivatives trading market is larger than that of spot trading. As the first and unique derivatives market in the encryption market, the perpetual contract has great trading flexibility compared with other financial products and is favored by the market.

Estimated NFT sustainable market size

According to DappRadar data, the NFT platform with the largest trading volume in the last month is Blur, with a total trading volume of 442 million US dollars and an average daily trading volume of 14.73 million US dollars. By comparing the top NFT spot trading platforms, it is possible to estimate the market share of nftperp when it is gradually adopted by more traders.

According to Dune Analytics data, since November 25, nftperp has accumulated a total transaction volume of 71 million US dollars, and the average daily transaction volume is 1.01 million US dollars. Analogous to the ratio of spot transactions to derivatives transactions on decentralized trading platforms, it is conservatively estimated that the average daily trading volume of nftperp can also reach the same level as the largest NFT spot trading platform. nftperp charges a 0.3% transaction fee for all positions on the platform, and part of the proceeds will be distributed to pledgers of its platform token $NFTP.

In addition, according to NFTGO data, the total trading volume of the NFT market in the past year was 17.06 billion US dollars, and the average daily trading volume was 46.74 million US dollars. Similar to the cryptocurrency market, the NFT derivatives market has great potential.

What challenges does the NFT perpetual contract market still face?

Possibility of price manipulation still exists

There is a possibility of price manipulation in any financial market. Due to the small size of the NFT market, spot prices are relatively easy to be manipulated. When spot price manipulation occurs, violent price fluctuations may lead to a large number of liquidation events in the derivatives market, and the agreement’s insurance fund may not be sufficient to repay bad debts, and the agreement will face systemic risks.

It is foreseeable that the market share of NFT derivatives will gradually increase. When the profit opportunities from the derivatives market are greater than the cost of manipulating the spot market, price manipulation events will definitely occur. Therefore, how to avoid or minimize the probability of such an event needs to be considered in advance.

The robustness of vAMM, the “true floor price” mechanism, and whether it can cooperate with the funding rate to maintain the normal operation of the system have yet to be tested by the market.

The demand for perpetual contracts of long-tail NFT assets still needs to be met

In 2004, Chris Anderson, editor-in-chief of the American “Wired” magazine, proposed the famous “long tail theory” (The long tail), believing that the Internet will empower the long tail of the niche market, and the long tail niche market The scale will even exceed the economies of scale of the short head.

The NFT market also has its own “long tail” version, which refers to those NFT projects with small market value, low transaction volume, and low popularity. Currently, there are tens of thousands of NFT projects in the NFT market, but only a few can enter the top 50. Become the so-called “blue chip” and “quasi-blue chip”, and other projects constitute the “long tail”. The same is true for the cryptocurrency market.

Therefore, platforms/services for the long-tail niche market of NFT and cryptocurrency may have greater value space in the future.

Referring to the decentralized trading platform, the spot DEX Uniswap provides liquidity for many long-tail assets by listing coins without permission, but few decentralized perpetual contracts can achieve the function of listing coins without permission (CoinFLEX, Mycelium, etc. platform has been implemented), the reason is that perpetual contract transactions are more complex than spot transactions, and have higher requirements for matching transaction mechanisms, on-chain response speed, and on-chain liquidation. At the same time, the threshold for creating a perpetual contract pool is high. For example, if the decentralized perpetual contract protocol TracerDAO (now Mycelium) wants to deploy a Token perpetual contract pool, many parameters need to be configured: leverage function, update interval, minting/ Burn fees and more.

For the NFT market, the demand for perpetual contracts of long-tail NFT assets is still there, but products that can realize functions such as lending and derivatives transactions of non-blue-chip NFT projects have not appeared for a long time, which is caused by multiple reasons.

Taking nftperp as an example, its “true floor price” has high requirements for data quality and calculation methods. There are a lot of unreliable data in the NFT market (such as wash transactions), which makes it only applicable to blue-chip NFTs with high liquidity. series. Taking BendDAO as an example, even the top blue-chip BAYC will be manipulated by big investors to “liquidate arbitrage”, let alone long-tail NFT assets with smaller market value?

In the final analysis, upstream problems such as poor liquidity of NFT and difficulty in valuation and pricing of NFT have not been well resolved, which restricts the development of downstream NFTFi products and cannot release the potential of NFT long-tail assets.

epilogue

Focusing on DeFi, NFT and even the entire encryption field, continuous financial innovation has pushed the market to a higher level. The improvement of composability between products in different segments will further stimulate market innovation, NFT-specific derivative products will provide more trading strategies for the market, and the nascent NFT market will gain more depth, just like options and futures contracts play an important role in mature financial markets.

As the NFT infrastructure becomes more and more perfect, it is believed that the financialization of NFT at the upper level will continue to accelerate. NFT will not just be a small picture, it will become an important part of the encryption field and even the financial world together with NFTFi.