Synthetix Makes a Big Leap Forward

Virtual liquidity and virtual pricing designs are really interesting DEX models. They give you an easy way to price assets. The virtual liquidity model has no real asset backing and tries to mimic liquidity depth to create healthy market dynamics. The virtual pricing model has real liquidity but attempts to price these assets via external feeds instead of native price discovery.

In my opinion, the virtual liquidity model is all but dead for vanilla perpetuals. Perpetual Protocol v1 was one of the first to launch on this design and its market dynamics were incredibly dislocated, leading to an eventual re-design that hasn’t really found strong traction either. Drift Protocol also ran into problems with a pure vAMM and launched v2 with a hybrid design.

Virtual pricing includes the likes of GMX, Gains Network, and Synthetix. And we know they’ve been all the rage and have found strong PMF. Specifically GMX.

But there’s one lingering issue, and that’s managing the long-short skew on the exchange — something that caused massive issues for vAMMs. Open interest on the GMX model is almost intentionally designed to skew to the long side, owing to a historically large allocation to volatile assets (that margin traders can rent to long) and relatively low allocation to stablecoins (that margin traders can rent to short).

Synthetix using dynamic fees and a funding rate to manage open interest and balance the long-short skew is actually a big win for this entire design space. SNX stakers, who cumulatively are counterparties to all traders on the platform, do not have to manage their delta risk as much. Until fairly recently, managing an SNX staking position was nightmarish. When you stake SNX, you can mint sUSD against it. If you just held the sUSD and didn’t mimic the exposure traders on the platform had, you would end up net losing when traders won (your debt in the pool is now more than the sUSD you hold). This was a result of being the counterparty to traders *and* not hedging your exposure to offset losses.

It’s great to see how far Synthetix and the virtual pricing model have come. And while this design can never be an end-game for DEX design (more on this next week), it certainly moves the needle in terms of helping users overcome UX barriers in DeFi.

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