A Complete Guide to Market Making on Perpetual Protocol V2.

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December 2, 2021

In conclusion

Hello again! So after releasing A Complete Guide and A Complete Tutorial, covering Perpetual Protocol V2, I did say I would cover standalone articles for market makers and market takers, so here we go with the former.

The reason for doing this, as discussed in the first article is that Perp V2 has come up with an extremely innovative way of allowing on-chain leverage trading by building on top of Uniswap v3 pools utilising concentrated liquidity.

On top of that, there is a very very lucrative opportunity for market makers with an extremely interesting strategy with USDC only…

So with that being said, let’s have a quick recap of how market making works on Perpetual Protocol V2…

First of all, Perp V2 has now deployed on Optimism, so you will need to bridge USDC and ETH over to layer 2 to get started. You can head to the optimism bridge HERE to get started.

Please verify this link before using the bridge, there are some shady characters out there.

<img src="https://blocmates.com/wp-content/uploads/2022/01/unnamed.png" alt="">

Also, this is another feature I love. You can bridge USDC from multiple chains of choice. Simply connect your wallet and head to the bridge.

Metamask Configuration for Optimism -

Network Name: Optimistic Ethereum

New RPC URL: https://mainnet.optimism.io

Chain ID: 10

Currency Symbol: ETH

Block Explorer URL: https://optimistic.etherscan.io

Again, please verify this info before inputting this into your Metamask.

<img src="https://blocmates.com/wp-content/uploads/2022/01/Screenshot2021-12-01at16.00.15.png" alt="">

Or to save you a job just go directly to https://app.perp.com/ and head to their new V2 app, this should prompt you to configure your Metamask directly to Optimism.

From here you can deposit your assets from Ethereum mainnet to Optimism.

I’m pretty happy about the UI for bridging to Optimism…

I’d recommend sending ETH over and trading to USDC while you are on Optimism with cheap fees and speedy transactions.

Right, so now you have your funds onto Optimism, you are good to go.

Scenario - You want to become a market maker for the ETH-USDC training pair on the new Perp V2.

As you can see from the infographic, you come to Perp V2 and deposit USDC into the Clearing House directly from your Metamask.

From here, you request how many virtualUSDC (vUSDC) tokens they wish to mint. The real beauty here is that you can actually mint up to 10x more USDC than your initial deposit into the Clearing House, giving you a much bigger LP position further downstream.

This, in turn, increases your notional position size and hence you have a larger share of the ETH-USDC pool and generate a larger amount of trading fees. Cool, huh?

So, how do you get your vUSDC that has been minted from the Clearing House into the Perp v2 pools to start earning those trading fees?

As the protocol utilises a virtual AMM, it requires an isolated Uniswap v3 pool to facilitate trades. For example, vETH can be traded against vUSDC and vUSDC can be traded against vETH, you will need to take your vUSDC and select the asset you trading pair you wish to provide liquidity to.

I’ll take some snapshots from the Perpetual Protocol V2 testnet, although at the time of writing the mainnet product is live HERE.

<img src="https://blocmates.com/wp-content/uploads/2022/01/Screenshot2021-11-16at12.06.15.png" alt="">

So once you have deposited your USDC into the Clearing House, you head to the market you wish to become an LP for.

Simply head to the left-hand side and select “Maker”.

From here, you will want to use the dropdown box to select ETH.

Input the amount denominated in ETH or USDC that you wish to provide as liquidity.

This is where things get really cool.

<img src="https://blocmates.com/wp-content/uploads/2022/01/Screenshot2021-11-16at12.12.07.png" alt="">

As mentioned above, one of the most innovative features of Perp V2 is that it utilises Uniswap V3 pools which allow its makers to deposit their assets in a specified price range.

So why is this important? Well, with Uni V2 pools LPs provide their assets across the full range of the price curve. This is all well and good but it doesn’t create the most optimal capital efficiency for both the LP and the trader.

<img src="https://blocmates.com/wp-content/uploads/2022/01/0_YoEt0CUnPnPdC8YH.png" alt="">Image from Uniswap Docs

As this brilliant infographic above shows, with concentrated liquidity, if an asset is trading within your specified range (which you can change by removing and re-adding liquidity) then you effectively utilise your full LP position each time that a trade is made and as a consequence, you generate greater APR from trading fees.

So just to recap, you can leverage your LP position to generate more fees and also utilise the Uniswap V3 pools to further concentrate that leveraged position. It is a good time to become a market maker with Perp V2, that is for sure.

Once you have selected your price range, then you can go ahead and click add liquidity.

<img src="https://blocmates.com/wp-content/uploads/2022/01/Screenshot2021-11-16at12.22.39.png" alt="">

This will then be confirmed in your Metamask.

From here you can then scroll down to the position overview where you can see and even add or remove liquidity.

Note - This is a BTC position from the previous week…

Simply click on the position and this will then allow you to change your range and also claim any trading fees you have generated. Optimising your range based on price action would be the best strategy to increase your concentrated LP position.

<img src="https://blocmates.com/wp-content/uploads/2022/01/Screenshot2021-11-16at12.27.24.png" alt="">

It is important to note that fees are all paid in USDC as the LP position is technically made up of vTokens.

<img src="https://blocmates.com/wp-content/uploads/2022/01/Screenshot2021-11-16at12.27.32.png" alt="">

So, what is happening under the hood?

Effectively as traders come in and open a long or short position, as you are a market maker your automated position will take the opposite side of that trade (if in range).

For this reason, if you wish to remove your LP position at any time, you may still be providing liquidity for ongoing trades.

If this happens then you will be left with “left-over” trades until the counter-position from the trader closes their position.

Maker Stats -

I covered these stats in the last article but just to reiterate this point I will write them again…

Perpetual Protocol V2 - Test Week Analysis -

  • Based on liquidity and trading fees makers would roughly receive 119% APR!
  • For each dollar, there was roughly $23 in trading volume and effectively $0.023 in transaction fees.
  • 900% less slippage… this is a big one thanks to UniSwap v3 pools.

Source - Recap of The Perpfect Game, Perp v2 Testnet Trading Competition

So, I know what some people are thinking… what are the risks? What about Impermanent Loss (IL)?

Well, it is a little different to the IL we have all come to know…

You are depositing a single asset in USDC. You are then using this to effectively mint virtual tokens which facilitate the leveraged trades. So, in short, the main risk is that the asset in your selected market trades outside of your selected range.

What will happen here, is that if you have selected $4000-$5000 for ETH as your range on the price curve, then if ETH dips below $4000, then you will only be providing liquidity with your vETH portion of the LP.

The same happens if ETH passes $5000, your position will only be collecting fees from the vUSDC side of the LP until you remove liquidity and re-add or wait for the asset to begin to trade within the correct range again.

It is worth noting that to remove liquidity you would need to return the same amount of assets your initial provided liquidity for.

So if your initial maker position was 1ETH:4000 USDC, then you need to return this at a minimum. If the price of ETH moons then it may cost you more than you deposited to remove the LP position. This is one of the risk factors you need to consider here.

In short, if the asset trades outside of your range, the least desired token will effectively be provided as a single-sided liquidity position and hence you earn reduced fees.

For more information on this, you can head to the UniSwap V3 documents HERE.

The following question was asked at a recent AMA which I know was on a lot of peoples mind’s…

Q: Can you explain the risk of liquidation when providing leveraged liquidity and will there be a tool to track collateralization factors?

Yenwen: This is an interesting thing because the Curie update actually brings in the limit order so you can actually control the price of your liquidity. You should not get liquidated if you place the liquidity right. It’s like you have a limit order on a centralized exchange order book. If that’s what you want to do then you should not get liquidated.

So, the first answer is, I think there’s definitely a risk for the maker to get liquidated, but I think you can avoid it wisely. As for the second question, I don’t know if we have a characterization factor?

Nick: I think this is in relation to multi-collateral.

Lee: Well if I’m not mistaken I think it’s related to the cross margin mode so if you have a bunch of positions open, your collateral health factor…

Yenwen: oh okay, so it’s kind of like margin ratio. we definitely will provide a tool for everyone to track collateralization factor because we or our keeper will calculate the margin ratio for liquidations.

Lee: Yeah for sure the UI will have ways of visualizing your collateral health.

I’d expect more of this to be announced and released as the mainnet is rolled out, but I agree on the health factor it would be a very nice addition once implemented.

Fees and Revenue -

Each time an asset within your range is traded then you will receive a proportional split of the 0.1% trading fee which is derived from the notional size of the position.

<img src="https://blocmates.com/wp-content/uploads/2022/01/TradingFees.png" alt="">

This split will be determined once the protocol has gone live on mainnet and put to a governance vote. I can imagine it will lean slightly in favour of makers as deep liquidity is required for a successful protocol and hence generate more revenue for stakers in the long run.

For now, the V2 documents state that 90% of the 0.1% trading fee will be distributed to market makers proportional to their share of that specific trading pool.

If you wish to skip a lot of these steps and have a UniSwap V3 strategy provider such as Popsicle Finance look after your position for you then this will also be possible following the launch.

For more information on that, you can head to A Complete Guide to Popsicle Finance.

Summary -

So, that is about it! I will be releasing the market takers guide for you traders out there too, possibly next week. I’d keep notifications on for Perp on Twitter and Medium as there will be a flurry of updates coming out over the coming weeks.

If you have any questions in the meantime you can jump into the Perp discord or give me a shout on Telegram.

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