As we aim to enable anyone who wants to take a directional view on any asset to be able to easily open leveraged long or short positions against AlphaX smart contract, one of the functionalities that we simplify is baking in the concept of funding rate payments into the mark price. As a result, there will be no explicit funding rate payments between long and short traders.
Mark price, for simplicity, represents the price that traders open and close their positions at.
Combining this feature of no explicit funding rate payments and the feature of tokenizing the leveraged positions, traders and DeFi users in general will be able to simply hold the tokens to be exposed to this leveraged position or even to hedge out their existing positions!
What is funding rate payment and why do perpetual swap markets have it?
Since in a perpetual swap market, traders don’t need to have the asset they are trading, are in fact not trading the actual asset, and are trading on the asset price movement, there needs to be a mechanism that enables the price in the perpetual swap market that traders are trading at, which is called mark price, to track the actual price on external exchanges, or the index price. The concept of funding rate payments was then introduced for this purpose.
Typically, funding rate payment happens at every fixed time interval, e.g. 8 hours. If the mark price is below the index price at the time of funding rate payment, the short traders would pay the long traders. This effect would incentivize long traders to open their positions or short traders to close existing positions, knowing they would gain/lose from funding rate. Thus, this effect pushes the mark price up to be closer to the index price. On the other hand, if the mark price is above the index price, then the long traders would pay the short traders.
We believe that a seamless trading experience is when traders don’t need to worry about the funding rate payments and just need to know what price they enter and exit at, much like a regular spot market.
Therefore, we have come up with a model to bake in this concept of funding rate payment into the mark price on AlphaX.
How do we bake in the concept of funding rate?
For AlphaX, long and short traders are still paying each other but not explicitly, as the mark price is automatically adjusted to take into account the funding rate payments.
Specifically, the mark price will readjust when it deviates from the index price by more than a certain threshold. When this happens, the price adjustment will be updated to converge to the index price.
For instance, if the mark price is below the index price (typically short would pay long traders), then the mark price on AlphaX would be adjusted higher. If the long traders on AlphaX were to close a position, they would be able to close at a slightly higher price than if they were to close before the mark price adjustment. Thus, the long traders’ gains will be higher than before.
On the other hand, if the short traders were to close a position, they would close at a higher price than if they were to close before the mark price adjustment. Thus, the short traders’ net gain will be lower than before.
So, with this novel baked-in funding rate concept, a trader’s net gain is only affected by the entry and exit prices without the need to worry about intermediate payments required by the conventional funding rate.
How does AlphaX handle extreme imbalance of long and short positions?
In case of extreme imbalance of long and short positions, the mark price may temporarily deviate from the index price. In this case, the protocol automatically readjusts the mark price, incentivizing it to track the index price.
This automatic readjustment also creates a huge arbitrage opportunity for any arbitrageurs to rebalance such price deviation by opening long or short positions at a much better price. When the spot price is corrected, arbitrageurs can gain more profit.
This is the first time that a perpetual swap protocol is baking in the concept of funding rate payments into the mark price. Therefore, please feel free to reach out to us on Discord and ask more questions if you have any!
Going forward, Alpha team will continue to share more details and explain the underlying mechanics that power the other unique functionalities of AlphaX!
→ Tokenized leveraged long/short positions
→ Lower slippage through dynamic K
→ Bot-less on-chain liquidation mechanism
About Alpha Finance Lab
Alpha Finance Lab is an ecosystem of cross-chain DeFi products that will interoperate to maximize returns while minimizing downside exposure to users. Alpha products focus on capturing unaddressed demand in DeFi in an innovative and user friendly way.
We are also recruiting for developers and looking for passionate community members who are looking to contribute to the Alpha ecosystem. If you are interested, please feel free to reach out to @tascha_panpan on Twitter.