This SIP proposes a redesign of the Synthetix perpetual futures mechanism to enable (1) unconstrained open interest limits, (2) broader asset compatibility, and (3) low fee execution.
This SIP proposes upgrades to the Synthetix perps implementation. Core upgrades include a premium/discount pricing function that is zero-sum and path invariant in skew space, as well as a funding rate velocity-based that is also zero-sum and path invariant in funding rate space. Oracle latency challenges are also putatively mitigated through a decentralized off-chain oracle network implementation with on-chain validation.
The current Synthetix perps market design is constrained in terms of scalability and efficiency. The most notable limitations are capital inefficiency (restrictive open interest limits), funding rate volatility, and high fees / wide spreads.
There are three high level improvements proposed here: (1) premium/discount pricing function, (2) funding rate velocity model, and (3) an on/off-chain hybrid oracle. Item (1) can be implemented through a simple change to how exchanges are priced. Instead of quoting a pure oracle price, markets would instead quote
oracle_price + premium where
premium is directly proportional to fractionalized skew. Item (2) can be implemented with a modification to funding rate calculations where fractionalized skew dictates funding rate velocity (instead of instantaneous funding rate). Item (3) requires relatively minimal contract changes, but is dependent on external infrastructure considerations.
Restrictive open interest limits are a symptom of inefficient risk management. While proportional skew funding provides a non-zero incentive to balance debt pool risk, it has proven generally ineffective. Notably, there are two primary limitations of this model. One is that while the intention is optimize for balanced open interest, there is no incentive to completely offset debt pool exposure as funding would instantaneously disappear. Additionally as Synthetix perps markets reach equilibrium with external markets, risk does not converge to zero (e.g. hard-to-borrow assets with perpetually negative funding for an extreme illustration). As an aside, funding rates that are instantaneously proportional to skew also present UX challenges in the form of volatile/unpredictable funding rates.
This SIP proposes a layered approach to risk management. Rather than leaning exclusively on funding payments for risk management, this mechanism applies a skew premium to prices quoted by the market (premium for long skew, discount for short skew). By storing premium from takers (expanding skew) to later distribute to makers (compressing skew), this mechanism creates a high frequency rebalancing incentive while also placing soft limits on maximum exposure held by the debt pool (without the need for restrictive OI limit). Simulating price impact in this way also increases compatibility for assets with a wider range of liquidity profiles.
Funding rate velocity
This is mathematically a minor adjustment to the current model but with significant implications to the mechanism. Put simply, instead of
r = c * skew, instead we have
dr/dt = c * skew. In practice the effect of this change is that funding rates will continuously drift higher/lower in the presence of long/short skew, creating a natural price discovery mechanism for funding rates. Another notable change is that with this mechanism, the debt pool would no longer exclusively earn funding (e.g. short skew + positive funding). However, it can be mathematically shown that expected net funding earned for the debt pool over time is zero (debt pool earns funding when
dr/dt > 0 ; pays equal and opposite funding when
dr/dt < 0 (see plots below for illustration).
Hybrid oracle approach
This approach creates multiple execution tiers: (1) traditional execution through purely on-chain oracle, either atomic or asynchronous; or (2) execution using data from an off-chain oracle network whose validity is verified on-chain. Tier (1) is superior in composability, while tier (2) is superior in performance and execution efficiency. With signed price updates made available off-chain, on-chain costs are only incurred when an exchange is made thus improving cost sustainability while also improving liveliness.
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