December 8, 2023

The Pool 2 Peer Mechanism

A brief overview on the pool 2 peer model and comparing it with exciting models.

Why Modern Exchanges Play a Dual Role

Contemporary centralized exchanges have a dual responsibility: matching buyers with sellers and providing the necessary liquidity, which is pivotal. However, when it comes to perpetuals (perps), a distinctive set of challenges arises. Unlike spot assets, perps are perpetual contracts that lack an expiry date and the obligation to be redeemed for their base spot asset. Furthermore, these contracts can be generated without involving the specific spot asset and can be settled with any kind of collateral. This intricacy exposes users to the liquidity provision architecture of perp exchanges not only when opening a trade but also throughout the holding period. If there is no one to take the opposite side of your trade when you want to open or close, then you simply will be unable to open or close your position

A recent example highlighting this overlooked aspect occurred in the ecosystem here.

Comparing Liquidity Provision Models on DEX

Liquidity provision models on decentralized exchanges (DEX) fall along a spectrum. At one extreme, the peer-to-peer model of Central Limit Order Books (CLOBs) offshores liquidity to individuals. While advantageous for fine control, it poses a steep learning curve and isn’t feasible for regular individuals.

In the middle lies a hybrid system that combines a CLOB with a backup pool for “Just in Time” liquidity. In this model, when the individuals are not providing liquidity for any reason then there is a pool of capital that quotes widely but at least gives a way for users to close or open positions in dire moments. This system, though functional, inherits drawbacks from both mechanisms.

At the other end of the spectrum is the Pool-to-Peer model, where anyone can contribute to liquidity provision. This model ensures deep liquidity with minimal slippage, prevents toxic flow through use of oracles, and empowers regular individuals to provide liquidity and earn passive yield.

How a Pool-to-Peer Model Addresses Challenges

Enter the pool-to-peer model: a solution that diverges from the peer-to-peer model’s dependence on perpetuals liquidity provision. In this innovative approach, all positions are backed by their spot asset within a unified pool, ensuring 24×7 liquidity availability backed by the spot asset in the pool.

In this system an oracle determines the futures contract’s price, and traders borrow the exposure from the pool for their trades. Unlike traditional models, users no longer depend on external liquidity, especially if the pool has a portion of the pool locked up through protocol-owned liquidity. This model facilitates the ability to trade large positions with minimal spread.

The system also excels in liquidation, as the pool, with its constant liquidity and locked collateral, can absorb liquidations without relying on external factors.

Blockchain Dynamics and the Ideology Behind Pool-to-Peer

Blockchains differ fundamentally from traditional infrastructure and as such demands products that understand and balance their advantages and limitations. While centralized CLOBs dominate traditional finance, blockchain calls for native novel ideas. The Pool-to-Peer model allows for high leverage, deep liquidity, and at the same time it is accessible for a regular individual to provide the liquidity and earn yield passively. This open and fair ideology behind the Pool-to-Peer model is Flash Trade’s approach.

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