Product Deep-dive #2: Market Making through ZLP
Sages,
It’s good to see you all here again. If you haven’t got a chance to check out our previously released article on Product Deep-dive #1, we’d highly encourage you to do so. You can check out the article here.
As for today, we will be covering our Market Making feature through the ZLP Vault. Specifically, we’ll delve into what ZLP is, its technical architecture, benefits for the depositors, and our 7 unique LP-protection mechanisms to minimize potential risks to the LPs.
Without further ado, let’s get right into it!
🏦 What is ZLP?
ZLP Vault provides liquidity for leveraged traders and spot traders on Zeno. In another word, it functions as the counter party to the traders on Zeno. Consequently, the profits and losses from counter trading on the platform also accrue to liquidity providers.
The value of the ZLP Vault is calculated using the following formula:
ZLP Value =Σ(AssetsinZLP∗AssetMarketPrice)+PnL
PnL = Net profit/loss of all the current open positions, where profits to traders are registered as losses to ZLP and losses to traders are registered as profits to the fund.
💻 ZLP Mechanics & Technical Architecture:
The ZLP vault operates as follows:
- ZLP depositors earn trading fees, borrowing fees, and swap fees from traders.
- Liquidity in the ZLP is reserved to pay out profits to traders.
- In the event of traders incurring losses, their collateral is seized and added to the ZLP as profit derived from counter trading.
- Net long/short exposure of ZLP is maintained close to zero to minimize impact from individual trades and directional market exposures. This is achieved through various protection mechanics (explained below.)
The process flow diagram for ZLP is shared below:
- User deposits assets into Zeno’s ZLP & receive ZLP tokens
- User stakes ZLP tokens to earn yields & incentives
- The liquidity in the ZLP vault is used to market make for traders at Zeno, and consequently accrues profits/losses from counter trading & fees in the form of m.USDC
- Collected fees from traders are redistributes back to the ZLP depositors along with esZENO emission rewards
🪙 ZLP Assets & Target Weight
The ZLP fund will consist of the bluechip assets, starting off with WETH, m.USDC & m.USDT. As ZLP fund acts as liquidity for traders, it is highly important to ensure that there’s sufficient liquidity for each type of asset for leveraged trading and swapping. Zeno has assigned a target weight to each of the asset in the ZLP fund to achieve an optimal allocation of the fund. Target weight could be adjusted in the future to suit the market and trading conditions. For the most updated data, please visit our docs.
0% Price Impact Swap: In addition to the assets in ZLP being used as market making liquidity, users can also swap accepted assets through ZLP with 0% price impact.
💸 Benefits for Liquidity Providers
By depositing assets in the ZLP vault, you will earn the following benefits:
- 50% of Zeno’s protocol revenue, paid in m.USDC
- Profits (or losses) from counter trading on Zeno
- esZENO rewards based on the size of your ZLP deposits & emission rates
🛡️ Protection for ZLP Depositors
Zeno puts in multiple measures to minimize the risk of LPs such as taking on too much one-sided exposure. The goal is to let our LPs earn passive yield with a high Sharpe ratio — i.e., continually earn on protocol generated fees without impact from an individual trade.
1. Max Utilization limit: Zeno reserves the liquidity in ZLP to be paid as profits to traders. There is a max utilization for ZLP, beyond which new positions are not allowed to be opened (traders are still allowed to reduce their OIs). This parameter is in place to ensure some liquidity is always available for LPs to withdraw.
2.Auto Deleverage (ADL): Each individual trading position will have an in-profit price target where a position will be automatically closed for users. This guardrail is put in place to limit the downside to the LPs. The ADL price is market-specific and is a function of initial margin requirement. It is set at level that balances between the risk for LPs vs. the attractiveness for traders.
3. Profit Reserve Buffer: Zeno keeps track of the net global PnL of all traders against the ZLP pool. Once the net global PnL hits a percentage threshold relative to the ZLP’s TVL, the protocol will start auto deleveraging open positions, starting from the most in-profit positions, to de-risk the overall platforms and LPs.
4. Open Interest Limit: Each market will have its own open interest limit, which can be set separately for the short side and the long side. The Open Interest Limit defines the maximum ongoing open interest that each asset can have on each side, beyond which new open interest are not allowed.
5. Velocity-based Funding Rate: The Funding Rate is charged on the traders’ position, similar to the borrowing rate. The Funding Rate helps bring a balance between long and short OI on Zeno, thus ensuring our LPs are not too exposed to one side of the market. Zeno utilizes a velocity-based funding rate model. Instead of the typical model where the long-short skew determines the funding rate, our model have the skew determine the velocity of the funding rate.
This slight adjustment in the formula has a large implication. With the traditional model, there is no incentive to completely eliminate the skew as funding would immediately go to zero, and some arbitrage strategies -e.g., carry trade, would no longer be viable.
For more information on the funding rate emulator, please click here.
6. Adaptive Pricing Mechanism: Zeno employs a mechanism called “Adaptive Pricing” as another way to incentivize / penalize traders to help bring balance between the long and short open interest of each trading asset. When a user opens or closes a trading position, the Adaptive Pricing mechanism applies a premium or a discount on top of the oracle price based on the resulting skew after the transaction is executed between the long and short open interest of the asset.
If the long open interest is larger than the short open interest, a premium will be applied to the price of the asset. On the other hand, if the short open interest is larger than the long open interest, a discount will be applied to the oracle asset price. The premium/discount from the Adaptive Pricing mechanism will encourage or discourage traders to open long or short positions on the asset accordingly.
For more information, please check out the Adaptive Pricing calculator here.
What’s Next? 🤔
Our next article will focus on the tokenomcics of ZENO, our governance token, as well as its utilities and special mechanics. If you haven’t already, please don’t forget to follow us on Twitter to stay up to date with our latest developments.
Til next time, Sages! 👋
