October 31th, 2023
Surf Protocol, with ABCDE as the lead investor, is a permissionless AMM derivative trading protocol that supports the creation and trading of the broadest range of crypto assets. To put it in a familiar model, Surf can be considered the contract-based version of Uniswap, with a key innovation: it allows anyone to provide perpetual contracts for any on-chain token without requiring permission.
Compared to platforms like GMX and dYdX, which offer only 9 and 37 assets, respectively, Surf’s advantage lies in its permissionless nature, enabling the one-click provision of perpetual contracts for any token. In the future, Surf is expected to host perpetual contract trading pairs for thousands of long-tail assets.
I. Trader Extractable Value (TEV)
To understand Surf’s key innovation, it’s essential to comprehend the role of Trader Extractable Value (TEV) in the AMM derivative space.
When discussing Miner Extractable Value (MEV), the blockchain is often likened to a dark forest, with various bots, scientists, and actors searching for potential profit opportunities in the unconfirmed transaction pool (Mempool) through multiple means. MEV primarily pertains to arbitrage opportunities in the broader blockchain ecosystem, such as spot DEXs and liquidations in lending platforms. In some niches, there are more refined concepts, such as the Loss Value Ratio (LVR) for DEX liquidity providers, which A16Z has elaborated in a separate article.
Another example is the arbitrage opportunities arising from price differences between spot and derivative markets, which we refer to as Trader Extractable Value (TEV).
In essence, GMX’s manipulation of Ava’s price on Avalanche last year is a typical example of TEV. When the cost of manipulating the spot price is lower than the friction cost on the futures side, there’s an opportunity for profit.
You might question whether this is only feasible for assets like Avax due to their liquidity and specific characteristics, while assets like BTC and ETH cannot be manipulated in the same way.
The answer is both yes and no.
Yes, because BTC and ETH’s depth and consensus make it significantly harder to control spot prices. That’s why GMX V1 only had two trading pairs for BTC and ETH on ARB.
No, because if GLP’s TVL were in the tens of billions and traders could profit at the expense of LPs, there would be prominent players willing to manipulate BTC and ETH prices, similar to what happened with the AVAX trading pair. As long as GLP’s depth is sufficient, GMX’s fixed trading friction cost will lead to spot price manipulation cost being lower than futures friction cost. As GLP TVL grows, the possibilities and success rates of TEV increase, explaining why GLP’s TVL is capped at around 350 million USD.
II. A Protocol for Anyone to Establish a DEX — Surf’s Solution and Innovation
How can we incentivize greater TVL in derivatives and create an innovative trading protocol? Surf’s solution is straightforward. To maximize LP incentives, Surf introduces a unique mechanism in its LP structure, creating a B2B2C trading protocol.
Typically, LPs earn 70–80% of trading fees, with the remaining 20–30% going to the protocol. Surf, however, innovates by allocating 80% of trading fees to LPs, 10% to the protocol, 5% to the creator of each pool, and 5% to the contributor with the highest TVL in each pool.
Under this incentive system, LPs are more motivated to create trading pairs for non-blue-chip long-tail assets. Furthermore, because the entity with the highest TVL in a pool receives 5% of the trading fees, there is an additional layer of real competition in terms of TVL, encouraging large and loyal TVL providers to continue offering LP, resulting in a better trading experience and deeper liquidity for traders.
Moreover, how can we address the friction cost in futures? It can be done by transforming the friction cost on the futures side into a dynamic cost by introducing pools with different fee rates, similar to Uniswap V3’s homogeneous trading pairs.
In Surf Protocol, each trade automatically creates five different pools, each with a unique fee structure, forming various liquidity pool structures across different assets. In this envisioning, highly liquid assets like BTC are expected to have a significant share of liquidity in low-fee pools, while less popular assets like PEPE may have more liquidity in high-fee pools.
For traders, these pools are transparent, and when placing an order, they are automatically matched with the pool with the lowest fee. For LPs, choosing different pools is also a market game, allowing them to earn higher fees and dynamically select pools before traders close.
For the overall system, more stable periods may lead to significantly reduced fees (as more LPs choose low-fee pools), potentially reaching theoretically feasible minimum levels. During periods of extreme market activity, costs may increase to prevent scenarios like GMX’s AVAX trading pair price manipulation that continuously depletes GLP.
III. Permissionless — The True Essence of Cryptocurrency
Those familiar with the early history of cryptocurrencies know that Bitcoin’s main selling point in its early days was “Permissionless,” not “Decentralization.” Satoshi Nakamoto used the term “Permissionless” in the whitepaper and forum discussions rather than “Decentralization.”
Decentralization is essentially a form resulting from the core concept of Permissionless.
Uniswap succeeded in the spot DEX market by focusing on the permissionless listing of tokens and LP incentives.
In the derivative space, GMX V1 benefited from GLP’s innovative invention but was limited by its mechanisms in creating permissionless trading pairs. Most of the primary derivative trading for both blue-chip and long-tail assets still occurs on centralized exchanges. This is why we recently introduced GMX V2.
We need a more open and robust on-chain derivative financial mechanism, a fairer trading market, and an era where we transition gradually from centralized contract markets to decentralized markets.
The battle for Permissionless derivative trading has only just begun.
We have reason to believe that, by introducing game-like “homogeneous but different-priced” trading pools, along with permissionless and innovative LP reward mechanisms, Surf has the potential to elevate TVL in AMM derivative products to new heights. The mechanism not only provides traders with a better trading experience but also safeguards the interests of LPs, achieving a “win-win” situation.
About ABCDE
ABCDE is a VC focused on leading investment in top Crypto Builders. It was co-founded by Huobi Cofounder Du Jun and former Internet and Crypto entrepreneur BMAN, who both have been in the Crypto industry for more than 10 years. The co-founders of ABCDE have built multi-billion dollar companies in the Crypto industry from the ground up, including listed companies(1611.HK), exchanges(Huobi), SAAS companies(ChainUP.com), media(CoinTime.com), and developers platforms(BeWater.xyz). If you are a Builder with the dream of changing the world, join us to build the next-generation encrypted network.
Twitter：https://twitter.com/ABCDELabs
Website：www.ABCDE.com
