DEX, Cardano Decentralized Exchange

. Financial derivatives have everything in the name, they derive all the properties from the underlying asset. When you consider functional programming composability, verbose type systems, and being built upon category theory, you see the natural beauty of deriving the financial system as you'd be computing a derivative of an equation. It works for everything from formulas, through contracts, to generating new ideas.

Why anonymous?

Before getting into the details, we want to answer one question upfront. We submit the project anonymously and plan to continue development as such. However, there's a very good reason behind our choice, and you'd hear it and put it in the perspective of other projects.

Cryptocurrency is strongly under regulated and is likely to undergo very rapid regulation over the next few years. Furthermore, the innate decentralized nature of blockchains and no governing entity (other than Decentralized Autonomous Organization - DAO) makes it extremely even ambiguous as to what regulations to follow (some lawmakers base regulations on where the users are and some where the platform is). Last but not least, any development team having access to smart contracts is prone to the oldest computer exploit in the world - the so-called wrench attack (or rubber-hose cryptanalysis) [SEC.0]. As such each project going fully public with their whole team either accepts the associated attack risks which very likely will severely limit their ability to innovate to the regulated areas or are simply unaware and ignoring the very real risks to both the projects they are working on and themselves.

We'd be happy to confirm our identities and credentials via a secure escrow service. … and we're well experienced in the area having build and lead front-office teams in #1 market making and financial institutions in the world, plus having formal education in informatics and quantitative finance.

Our goal is to follow regulations whenever possible and regulate as soon as the guidance is available. … and there's nothing better than going out publicly and taking credit for your work. However, we believe that it's a much better choice for the project to be developed in this manner.

Finally, we believe that any financial system and institution shouldn't derive its trust from its brand, but rather from the public code, audit, and build track of performance, transparency, and guiding principles.

Proposition

Develop all-in-one market making platform composed of

Decentralized exchange (DEX);
Liquidity providing (LP) and farming solution with innovative curve solutions;
Bridges to all crypto assets, providing one place for trading assets native not only to Cardano blockchain;
Crypto indexes;
Crypto financial derivatives (covered options, shorts/calls, etc.);
Mirrored (synthetic) instruments allowing trading non-blockchain native assets (e.g. stocks) and providing additional ways of creating inverted instruments and financial derivatives (via collateral);
Develop educational materials and access to data and indicators decreasing information asymmetry and helping people make more informed investment decisions.

Purpose

Provide sound and efficient way of investing;
Increase market efficiency;
Build the foundation for the future of financial markets.

Purpose in detail…

Provide sound and efficient way of investing

Sound in the sense of well developed, with auditable code, information symmetry (indicators provided for the traded instruments and downloadable historical data), education content giving everyone ability to understand not only profits, but also risk exposure. Also sound in the selection of used techniques, e.g. in liquidity providing from tight spread market making, to similar instrument liquidity pools, and more.

Efficient in the sense of high return on liquidity provided via automated market making and liquidity farming from token liquidity pools to synthetic instruments and derivatives. Efficient in the sense of high liquidity meaning low slippage and predictable executions.

Increase market efficiency

Markets that cannot be shorted are inadvertently inefficient [PHIL.0, MM.0, MM.1]. This is a simple consequence of the fact that a person that believes that asset X is undervalued can buy it and hold it until the price discovery catches on, while the person convicted that the asset is overpriced cannot take a separate position (short). The person who believes asset X to be overpriced cannot simply sell it as it only protects them from the downside risk, but doesn't provide a way to capitalize on their knowledge of the asset overvaluation. In the result, there is very little incentive for discovering overpriced assets, but there's one for undervalued ones. If you can only add water to a jug, but never take away, the amount of water will inadvertently only increase. It can be even stipulated that a lot of volatility in the crypto market takes origin in this mechanic, due to lack of sufficient access to short instruments the price tends to go up getting to the point when it suddenly reverts to the mean, like stretched rubber bands to its limits.

Developing a sound system composed of all types of financial instruments, most importantly, negatively correlated ones will lead to the increased market efficiency and drive it closer towards the equilibrium.

Build the foundation for the future of financial markets

Last, but not least, having a trading platform with a wide access to tradeable crypto assets, indexes, derivatives, and mirrored assets, will allow for the development of more specialized financial platforms on top of this infrastructure layer. One example of such a layer would be the creation of the first distributed hedge fund in the world allowing to stake investments in automatic trading strategies and in bots giving exposure to people in the wide to additional source of alpha (additional revenue compared to index without taking additional risk).

You can explore the idea behind the first decentralized hedge fund (and specifically one algo) at our other Catalyst fund application: https://cardano.ideascale.com/a/dtd/Democratised-AlgoTrading-on-Cardano/352830-48088 .

Decentralized Exchange

One stop shop for liquidity providing, yield farming, minting, burning, and trading synthetic assets, option, and option strategies minting and trading, access to educational resources, and source of market data (indicators of all the assets and dump of the trading data).

Liquidity Providing

Liquidity providing, a.k.a. market making, is a process of providing both sides of a trade:

Buy and sell around the spread (spread is usually the mean price and spread is the distance from that mean) for single instruments;
Exchange pair (most common example among DeFi) where the market maker provides two assets X and Y, constituting the trading pair and where the taker has to provide X to receive Y and Y to receive X according to the current price. This solution is popular among DeFi as allows for mathematically sound staking using one of LP formulas such as the famous x * y = k (where the x * y has to always equal to the total value of the liquidity pool); this gave the rise to popular automated market making (AMM) concept in crypto. The main disadvantage of this solution is weak price discovery (often the reason for AMM being called the trader of the last resort) and the pairs often being composed of one very liquid token (e.g. usually BNB for BSC and ETH for Ethereum) and one usually illiquid (or even not-so-sound token). This allows for generating high LP returns, but exposes the market maker (the platform user) in this case to high potential impermanent loss when the general market exits the not-so-sound token.
Complex arrangement such as sharing liquid assets among many other pools or staking into pools of similar asset class, e.g. exchanging one DeFi token for another. We propose to deliver x * y = k AMM with liquidity farming rewards upon the exchange launch on the mainnet and continue development and research in the area of curve models for liquidity providing, better price discovery mechanisms, and other LP providing arrangements from spread based, to how the actual pools are composed (and of how many assets). Liquidity providers will earn the 0.2% out of the total 0.3% transaction fee redistributed directly as increase in the amount of LP tokens held.

Liquidity Mining

Liquidity mining a.k.a. yield farming is additional reward to the liquidity providers in the form of a platform native tokens often also providing governance functionality in the platform. We plan on stable policy the exchange platform governance tokens minting and distribution to liquidity providers as a form of additional reward. Further, we pledge to use a large portion of the platform income to repurchase tokens out of the market and burn them to maintain upward price pressure. This is exactly the same mechanics as implemented by PancakeSwap.

Tokens are usually allocated based on the total pools volume and multipliers. A platform might use multipliers to reward liquidity providers in illiquid pairs to further incentivize them for taking the extra risk (and hence also indirectly increase the liquidity for exchange pairs on the platform).

Blockchain Bridges

Platform bridges to other blockchains and interaction with other blockchain smart contracts has two main objectives:

Increase the market efficiency by bridging different ecosystems and allowing for simple arbitrage on any assets (regardless of blockchain); Increase the availability of coins and tokens on Daemon Exchange, becoming all in one exchange for all crypto assets, and allowing for construction of more sound financial derivatives (primarily when concerned with crypto indexes and synthetic instruments). Ability to integrate with other blockchain smart contracts as already in scope EVM via Cardano's KEVM project will allow for direct (Plutus / KVM) smart contract to (Solidity / EVM) smart contract integration.

Crypto Indexes

An index is a financial instrument representing a basket of instruments allowing to track the performance of a group of assets in a standardized way [LP.3]. As such it allows you to invest into the entire market, market sector, or a group of similar assets.

The main advantage of holding index as compared to single crypto assets is that they often guarantee much more stable returns, at the efficient market rate, without too much risk exposure. Take for instance smart contract blockchain, one instead of placing all bets on one horse or spreading bets according to their own metric might buy shares of smart contract top 20 index giving exposure to the entire smart contract market with allocation to specific assets correlated to market capitalization. As such investors are betting on smart contracts being successful overall rather than any specific project.

Good example of a similar project from Ethereum blockchain is TokenSet which provide indexes for a range of Ethereum blockchain tokens, e.g. DeFi pulse index: https://www.tokensets.com/portfolio/dpi. In this case, trader buys a stake of the index that represents the market composition by the capitalization for the specific group of assets (e.g. top 100 cryptocurrencies, top 25 DeFis, top 10 smart chain cryptos, etc.); the index is rebalanced at a constant interval (typically 3rd week of every month) and maintains specific index properties (e.g. in the case of TokenSet they limit max position to 25%).

Asset prices and market capitalizations at the time of rebalancing would be ingested from https://coinmarketcap.com/, https://www.coingecko.com/en (similar to TokenSet that takes those 2 as their source of information).

The index rebalancing can be achieved with one of many existing centralized price Oracles and the typical index rebalancing of every 3rd week of the month.

Further, CoinGecko tracks many different asset classes which is a great inspiration for potential index creation. As such, we propose development of the below crypto indexes:

Top 50 crypto;
Top 25 DeFi;
Top 20 smart contract blockchains;
Top 25 oracles, etc.;
Top 25 specialized application blockchains (storage chains such as FileCoin or ARWeave or coverage networks such as HNT), etc.

An example of TokenSet DeFi index on the screenshot below alongside with the composition on 2021/04/27. The URL to the site: https://www.tokensets.com/portfolio/dpi.

Mirrored (Synthetic) Instruments

Mirrored (a.k.a. synthetic) assets are financial instruments deriving their value from the underlying [SYN.2]. The underlying can be anything from real objects such as land, art, or gold ownership to abstract such as commodities, indexes, stocks, equities, and any existing financial instrument.

The name of this asset class is derived from their functionality, i.e. mirrored implies that the asset mirrors the price behavior of its underlying asset which can be simple 1-1, but also can represent inverted (short) where the price is followed in inverse (e.g. lose of $10k in the underlying value is gain of $10k in the inverted synthetic token). Synthetic on the other hand refers to a specific way of issuance of the mirrored tokens, namely by not backing it with the actual underlying assets, but rather providing collateral acting as insurance providing the guarantee of the price. That collateral can be auctioned at a discount to acquire back synthetic tokens and balance the value at risk requirement or liquidated at the margin being returned as collateral to the token owners.

We propose implementation of synthetic (i.e. backed by collateral) protocol allowing for

Minting synthetic tokens by providing the required collateral (in the range of 150-750% of the underlying value) [SYN.2, SYN.4];
Earning liquidity providing fees (proportionally rewarding volatile and illiquid synthetics);
Burning synthetic tokens in order to restore the collateral, acting both as arbitrage (price discovery mechanism) and a convenient way to exit synthetic position;
Trading synthetic instruments as first-class exchange citizens.

It's important to note few distinguishing characteristics of synthetic instruments that (often) make them more desirable to trade that the actual underlying instruments:

Fractional ownership: minted synthetic tokens can be fractionally traded giving access to them to low net worth individuals. Let's just as an example give a stock of Berkshire Hathaway worth at the 2021/04/27 market close $411,400.00. We strongly believe that creating frictionless market access gives much more fair access for financial betterment to everyone regardless of their total net worth.
Derivative financial instruments: synthetic tokens can use any formula to derive the price from the underlying asset, from a simple reversed token, where for the case of example, $10k loss in BTC price represents $10k gain in the reversed synthetic BTC token. This effectively provides an easy mechanism to trade short (capitalize on the knowledge of the asset being overpriced) and leads to creation of much more efficient markets. Further, derived instruments don't stop with reversed, but can be as well indexes, future contracts, options (deriving price from the Black-Scholes formula), and much more. Covered calls and puts are the easiest to implement using collateral.
Liquidity: some assets pose a challenge to trade, e.g. physical assets or illiquid ones; synthetic token issuance as it only reflects the price of physical commodities makes them easy to trade and in the case of illiquid assets injects additional liquidity to the system via the market making incentives proportional to the risk derived from the exoticity of the underlying asset.
No geographical boundaries: not everyone has equal access to financial markets from the brokerage requirements to some assets not being available to citizens of specific countries from restricted trading lists to actual market frictions. A permissionless blockchain provides a platform for deployment of assets available to everyone in the world and in combination with synthetic instruments it gives access to trading them to a much wider audience which in turn creates a more even field for all traders and injects additional liquidity into the market.
Low transaction costs: majority of financial instruments are available to low net worth individuals only via brokerage often charging significant fees for order execution and in the case of exchanges or market makers providing options to trade in fractional shares it always comes at a premium. The blockchain implementation both provides transparency of what liquidity fees are, creates peer to peer transaction network removing the intermediary and hence the cost, and provides much quicker settlement mechanics.

Synthetic token interface:

Mint: provide collateral and the price oracle minting synthetic tokens.
Burn: return synthetic tokens, burn them, and receive the stake of collateral represented by them.
Trade: trade as any token on the blockchain.

The critical functionality of synthetic tokens is ingestion of asset price and evaluation if the provided collateral is sufficient. If it's not then either the synthetic tokens need to be repurchased at a premium using the collateral (which is similar to Maker's Collateralized Debt Position - CDP) or the contract must be liquidated [SYN.0, SYN.1, SYN.2, SYN.3, SYN.4]. It's worth to note that the risk can be shared among a pool of similar or even all synthetic instruments. The settlements would still reflect the price movements, but the risk can be collateralized for the system together, similar in the below example from Synthetix [SYN.4].

Platform Governance Process and Tokens

We plan on release of the platform native tokens that will fulfill 2 roles:

Rewards in the LP token staking farms (similar to PancakeSwap);
Governance token used to vote on the development proposals for the platform (same as on UniSwap and PancakeSwap).

The implemented burn mechanics (from LP platform take off fees) and lottery on top of the token native functionality (governance) will provide a price foundation for the token (similar to PancakeSwap). The circulation control and a stable and consistent burn mechanics is paramount, where the platform portion of revenues is used to buy tokens and burn them maintaining the stable price point, or in the case of high burn pressure and platform popularity, might even drive it up. Interestingly, UniSwap token that only provides governance functionality has market capitalization of $21B and Cake token that is PancakeSwap native reward and governance token has a total market cap of $0.658B.

We'll aim to airdrop tokens to the early platform adopters and from then on provide it in the form of liquidity provider and educational content creators rewards.

Crypto Derivatives

In this section we focus primarily on crypto options. However, we plan on adding descriptions of other derivatives that could be minted in similar fashion.

Options

Options contract is the right, but not the obligation, to buy (or sell) the underlying asset at a specific price at a specific time. Options are great instruments to increase the money making potential (as it allows the trader to take a larger exposure to the price movements in the market), allow for risk control by providing inversely correlated instruments (calls/puts), allow for structuring trades to bet on specific outcomes (e.g. take limited exposure to price increase via bull spread), and provide efficiency to the market.

Options are priced using Black-Scholes formula. Options derive their price from the assumption that market dynamics follow Generalized Brownian Motion and the underlying asset volatility, free interest rate, and the option parameters itself (type - call or put, strike price, the expiration date). Call option price C is defined as

C=S_t * N(d1) - K * e^{-r * (T-t)} * N(d2)

where

C- call option price;
N- CFD of the normal distribution;
S_t- current underlying price;
K - strike price;
r - risk-free interest rate (in the case of Cardano, this should be equal to the staking reward);
T - expiration date, where T-t is the time to expiry;
σ - volatility of the underlying asset;
d_1 = { ln(S_t/K) + (r + 0.5 * σ_v^2) * (T-t) } / { σ * sqrt(T-t) }
d_2 = d_1 - σ_s * sqrt(T-t)

Put option price P is defined as

P = K * e^{-r * (T-t)} * N(-d2) - S_t * N(-d1)

where all symbols including d1and d2 are the same.

We propose two implementations of option contracts

Covered options where the option writer owns an equivalent amount of the underlying security. This means that the underlying is locked into the contract when the covered call option is minted. This provides the guarantee that the option can be exercised as per specification (according to the option type - European, American, Bermuda and the price oracle). For covered option creators it generates income in the form of options premium.
Collateralized option (synthetic instrument approach) where collateral is provided to hedge the underlying volatility to around 200% underlying value and be subject to collateral rebalancing.

Advantages of option trading on the blockchain

Usually options are written by big institutions (e.g. banks or large market makers) and sold in bulks of option for 100 underlying shares each. This not only limits the liquidity and who issues the option contracts on the market, but also access to buying option contracts (as they need to be bought in bulk of 100s and they carry the corresponding risk with them). Not to mention, the cryptocurrency market is much more volatile than the stock market, and taking the same exposure doesn't make sense for a lot of crypto assets.

Trading options on the blockchain provides 2 category of benefits - to the market by increasing its efficiency and the number of instruments that can be traded, structuring risk, and hedging, and to investors as doing so on the blockchain has a series of benefits:

No middle man - options are minted by people on the blockchain and available to everyone else on the blockchain, hence the execution fees are low, and the premium is only paid for the service provided by the writer and the risk that they take;
Fractional shares - options can be traded in much smaller units and even in fractions;
Cheaper settlement - settlement is automatic via smart contracts;
Full transparency as all the information is publicly available on the blockchain.

Option trading strategies

We further propose composite smart contracts allowing purchase of option trading strategies. A user would select the risk and profit profile, input strategy parameters, and smart contract would automatically structure using the required composites for the strategy.

This adds a new innovative way of trading and makes option trading (usually very risky to novice) available in a risk controlled manner (outlying the risk at value, the best/worst potential outcomes, and for savvy trades just allows for easy locking option strategy).

We outline below a dozen of option trading strategies that we'd expect to introduce as a follow up to ability to trade options. This list should evolve in the future and additionally welcome new strategy propositions from the community as long as they're sound and the risk is easy to understand and display.

Bull Call Spread

Structure:

Buy N calls, at strike price K1 with the expiration date T;
Sell N(the same number) calls, at strike price K2 where K2> K1, with expiration date T (the same expiration date).

This type of vertical spread is used when the investor is moderately bullish on the underlying asset and protects from the maximal potential loss, but also kaps the total profit if expired above the strike price K2.

Bear Put Spread

Structure:

Buy N puts, at strike price K1 with the expiration date T;
Sell N(the same number) puts, at strike price K2 where K1> K2, with expiration date T (the same expiration date).

Similar to bull call spread, bear put spread is a tool for moderately bearish investors, who wants to protect against the upside risk, and accepts the potential limitation of the income if puts expires deeper into the money.

Long Straddle

Structure:

Buy N calls, at strike price K with the expiration date T;
Buy N puts, at strike price K with the expiration date T.

Long straddle doesn't provide risk protection, however allows to bet on volatility, i.e. that the underlying will move significantly off the strike price K, but without knowing which direction.

Long Strangle

Structure:

Buy N out-of-the-money calls, at strike price K with the expiration date T;
Buy N out-of-the-money puts, at strike price K with the expiration date T.

Long straddle doesn't provide risk protection, however allows to bet on volatility, i.e. that the underlying will move significantly off the strike price K, but without knowing which direction, and is efficient for betting on large price movements. This allows for betting on calendar events, e.g. the SEC lawsuit against XRP for the day on which the verdict is announced.

Other Option Strategies

There are many other option trading strategies that can be structured from a simple call and put options, once those are available on the platform. We will provide the description on the below strategies and more in the short future (wrapping up here because of the Catalyst application timeline).

To mention a few other option strategies:

Short Straddle
Long Call Butterfly Spread
Barrier options
Long term option
Calendar (Time) Spread
Collars
Iron Condor
Iron Butterfly
Fig Leaf
Long Call spread
Long Put Spread
Short Call Spread
Short Put Spread
Double Diagonal .. and much more.

Foundations for the Future of Distributed Financial Ecosystem

For first proper decentralized hedge funds which trading strategies could be staked like liquidity provider pairs, for first proper decentralized algorithmic trading that can provide a revenue fee to the author and the rest profits to the stakers, for complex trading strategies with well understood risk available to low net worth investors, we must build financial infrastructure first. Daemon Exchange's goal is to provide exactly this infrastructure and to allow for development of the next generation of investment vehicles known from the financial world on the blockchain accessible to people in the wide. Further we believe that the way blockchain operates and the new idea it sparks will lead to financial revolution not only in the terms of democratization, but also in the ways we think about investing, and invest.

Timeline

Launchpad

Daemon Exchange launch plan will follow closely the planned timeline of IOG to rollout Alonzo smart contracts onto testnet (late April / early May) and mainnet (July): Daemon Exchange will be rolled out in 3 main phases:

(early summer) Paper trading system on testnet;
(closely following smart contracts mainnet launch in July) Daemon Exchange providing swap and liquidity mining at launch on mainnet;
(steady pace continued development on the features listed in this document) Rolling out all other functionalities described in this document such as crypto indexes, futures, derivatives, synthetic (mirrored) instruments, and more.

We plan to launch paper trading [TR.0] on testnet in the early summer. The scope of paper trading will cover ADA faucet to seed each paper trading account with the initial ADA balance, and allow trading of testnet ADA for synthetic instruments following the price oracle. Synthetics will include inverse (short) tokens (e.g. iBTC price increases proportionally to the BTC price decrease and "i" stands for inverse BTC). We plan to provide synthetic tokens following the price of real assets for top 20-30 cryptos.

As all money on testnet isn't assigned real-world value, we can enforce synthetic price at the swap level, and use external oracle sources such as https://coingecko.com.

Paper trading would give users access to

Faucet to seed the trading account with initial ADA amount (same for everyone);
Allow to swap any crypto currency for any other available on testnet via synthetics and their inverse;
Track the paper trading performance against other traders via wallet leaderboard. Daemon Exchange paper trading testnet has 2 main goals to fulfill:
Engage the community to explore the platform and have a safe paper trading environment for crypto, which is a great - educational resource, and will remain active, even after Daemon Exchange launching on the mainnet.
Test the platform in the real world scenario. There will be some significant differences between mainnet and testnet (paper trading) implementations and one has to take into the consideration, that testnet doesn't have incentives to exploit bad code (as cryptos on testnet don't represent real value), but still it will provide a test bed for many of the platform future functionalities.

As any financial system goes, testnet doesn't provide the ability to test all platform functionalities and potential vulnerabilities as the lack of financial incentives (testnet cryptos don't hold real value, hence don't provide incentives for arbitrage, gaming the system, finding exploits, or platform traffic that mainnet would have), hence there will be transition phase to mainnet once it gets smart contracts Alonzo update.

We plan the Daemon Exchange platform launch to follow as closely smart contract mainnet launch as possible, but if necessary, we want to be upfront about 2-4 weeks of required time after mainnet smart contract launch for testing and migration.

Daemon Exchange mainnet launch will include at minimum the below functionalities:

Swapping ADA and Cardano blockchain tokens;
x * y = k liquidity pools;
Liquidity farming.

Followed by Daemon Exchange launch on the mainnet we'll follow with development and deployment of the rest of functionalities:

Bridges to other blockchains and wrapped tokens;
Crypto indexes;
Crypto synthetic and mirrored assets (starting with inverted tokens for the major liquidity pairs);
Crypto futures and derivatives.

Depending on the platform and team growth we'd expect different timeline for the development timeline following the Daemon Exchange launch on the mainnet, but it's safe to assume that each item on the above list would take anywhere in the range of 3 months to launch and additional 3 more to fine tune.

Definition of Success

After 3 months:

Daemon Exchange paper trading launch on testnet providing the below functionalities:

Seeding trading wallet with initial supply of ADA from a faucet;
Synthetic tokens following top 20-30 cryptos via price oracle and their shorts/inverted synthetic tokens;
Paper traders leaderboard (by wallet address).

After 6 months:

Daemon Exchange launch on mainnet with the below functionalities:
ADA and Cardano token swaps;
x * y = k liquidity pools;
Liquidity mining (a.k.a. yield farming).

After 12 months:

After the Daemon Exchange launch on the mainnet we'll continue with the development of the features from the below list:
Bridges to other blockchains and wrapped tokens;
Crypto indexes;
Synthetic and mirrored crypto assets;
Crypto futures and derivatives.

Each of the above is a very complex development effort in its own right, but we expect to be able to launch at least 2 of the above in the 6 months following the mainnet launch (we assume each of the above will require about 3 months of development at least before launch).

Impact on the challenge metrics

Source: https://cardano.ideascale.com/a/campaign-home/25941

DeFi (liquidity providing and farming) applications attract enormous amounts of users and monetary value: https://dappradar.com/defi.

PancakeSwap which launched just on September 20, 2020 already amassed (source: https://dappradar.com/binance-smart-chain/defi/pancakeswap):

579.23k monthly active users;
2.93M monthly transactions;
$30.64B in traded volume; and
$4.08B in total value locked.

We believe that PancakeSwap's success can be replicated on Cardano blockchain due to similar advantages that Binance Smart Chain (BSC) poses compared to Ethereum, namely low transaction fees. As DeFi users often engage in approving new liquidity pools, swap pairs, and staking, and collecting rewards, we believe that a good underlying transaction cost structure is paramount to attracting large volumes of users and efficient and liquid swap platforms.

As such similar DeFi solution allowing for token swaps and liquidity providing via automated market maker (AMM) mechanism and LP token farming will be paramount to Cardano wide adoption, as similar to Binance Smart Chain it seen parabolic growth (https://dappradar.com/blog/binance-smart-chain-2021-overview) due to wildfire adoption of DeFi applications, many simply cloning PancakeSwap.

Specifically addressing the challenge metrics, we believe that

Number/growth of application output: The application will attract new users onto Cardano blockchain, primarily interested in investing into DeFi, and in the future using verbose trading platform, and ability to buy crypto indexes, and other instruments; if we assume the best case scenario growth, this might be even in hundreds of thousands year on year growth as in the case of PancakeSwap, or in the more moderate case in 4-5 digit range.
Number/growth of application transactions: As the platform is trading focused it'll translate significantly to the amount of transactions performed on Cardano blockchain. A typical PancakeSwap user stakes 5-10 contracts and either uses an auto compounding platform or compounds manually from daily to weekly. This gives an estimate of 5 (LP contracts) * 8 (actions per week) = 50 transactions per user per week = 5 transactions per day (rounding down and assuming conservative metrics). This combined with expected year on year (YoY) growth of 10-100k users translates to about 50-500k daily transactions.
Total volume of Ada involved in application transactions: As exchanges and DeFi apps attract everyone from a typical small volume user to whales, we expect typical distribution known to the other platforms - high volume from small groups of people and small volume from large numbers of people (fat tail distribution).

Last, but not least, DeFi and financial applications are the top DApps developed on any other existing blockchain as of today. UniSwap, SushiSwap, 1inch, and many others in the case of Ethereum, and PancakeSwap and many clones in the case of BSC. We believe the similar state for Cardano blockchain once smart contracts Alonzo update is rolled out and DApps establish on the blockchain.

Community engagement

Paper trading platform on Cardano testnet via mirrored assets and ADA from the faucet. Leaderboard of paper traders.
Educational articles, code, videos, and "idea dinners" via Twitter Spaces for everyone wanting to trade on the exchange.
IFO (Initial Farm Offerings) of Cardano community tokens.
Trade for a good cause - LP fees will be contributed to a charity of choice elected by the community (votes via LP tokens).

KPI

User retention - users who are still active after 6 months; can be projected using power series (e.g. approx 6 month retention from 1 month, take 1 month retention to 6th power). Calculated based on the connected wallet address.
User growth - year on year user growth (can be projected via regression or taking into the account marketing campaigns).
Monthly Active Users (MAU) and average attention span.
Average trade volume, average slippage, divergence from centralized exchange and price oracles.
Number of assets traded, total trade volume.

Roadmap

Implement React.js, TypeScript, yarn compilation stack UI learning from the familiar layout and UI ideas from PancakeSwap and UniSwap.
Setup cardano-graphql [CODE.0] node for querying Cardano blockchain for on-chain data, integrate with the portal via GraphQL API [CODE.1, CODE.2] calls.
Implement x * y = k AMM (Automate Market Maker) model to start with using Plutus [LP.0].
Implement yield token farming mechanism and mint token.
Publish open beta on testnet for paper trading (trading with worthless assets). Testnet will provide ADA via faucet and we can implement mirrored (synthetic) tokens for popular crypto using token emissions policies (it's testnet, so technically everything is "worthless" when it comes to real money value). Testnet exchange will serve as a great code testing battleground and feedback gathering vehicle. However, it's important to note it won't test the platform in the real market conditions (e.g. arbitrage trading).
Research path independent AMM models. The most known models are x * y = k (UniSwap and PancakeSwap), similar asset pools (Curve), and dynamic liquidity pools of up to 8 assets (Balaner) [LP.0]. However, we believe there's a lot of value in fundamental study of market mechanics behind each AMM model and that there's a lot of potential for innovation, from different value on the LHS of x * y = k giving different balancing mechanisms, through sharing very liquid assets (such as BTC, ETH, BNB, ADA, etc.) among different pools, etc. This would be a research study with tested implementations and either learning that specific model is subpar or superior and then added to the exchange. The most fundamental questions to answer are what are the risks to reward models and if each AMM mechanism is sound and safe [LP.1, LP.2].
Implement crypto indexes [LP.3]. A good example of a similar idea already implemented is TokenSet: https://www.tokensets.com/portfolio/dpi (DeFI pulse link). Trader buys a stake of the index that represents the market composition by the capitalization for the specific group of assets (e.g. top 100 cryptocurrencies, top 25 DeFis, top 10 smart chain cryptos, etc.); the index is rebalanced at a constant interval (typically 3rd week of every month) and maintains specific index properties (e.g. in the case of TokenSet they limit max position to 25%). Prices and market capitalizations would be ingested from https://coinmarketcap.com/, https://www.coingecko.com/en, and other exchanges.
Integrate coins and tokens from other blockchains. Unique approach of Cardano cross-blockchain interoperability creates the first of a kind opportunity to create a decentralized exchange that operates similarly to a centralized one, in the sense it gives access to assets from across all the chains, with the additional benefits that it doesn't auto censor specific crypto assets out, and it has no central authority governing it (hence, for instance no KYC - Know Your Customer).
Implement cryptocurrency derivatives - futures and option contracts, provided via collateral and automatic liquidation, allow takers to specify the liquidation threshold via provided collateral.
Implement mirrored (synthetic) instruments via tokens and collateral mechanism (this is not that different in technical and quantitative sense as the derivatives trading, it just gives the impression of holding an underlying asset). Mirrored assets allow for listing instruments such as stocks (e.g. Tesla - mTSLA [LP.9], Apple - mAAPL [LP.10], etc.). The price is guaranteed via provided collateral and price is tracked via oracle. Some of the most known examples of such protocols are Mirror [LP.5, LP.6] and Syntetix.
Interesting observation is that there is not much difference in providing an opposite instrument to the mirrored one (i.e. the one of which the price rises equal to the price decline of the underlying and vice versa). Synthetix implements that and assets instead of "s" in front of the ticker, e.g. sTLSA, have "i" (standing for inverse) such as iTSLA. However, in practice collateral mechanism opens doors for any financial instrument representation, even volatility index, of which a good example from the classical finance world would be VIX [LP.11, LP.12].
Develop educational resources with Jupyter Notebook and a series of articles providing information how liquidity provides work, what are the risks, what are the rewards, and what market mechanisms are involved. Jupyter Notebooks will further give examples, with which the user can play, showing what really impermanent loss (IL) is and how it's affected by different LP models, and market mechanisms. Develop resources for all provided financial instruments via the exchange.
Create an incentivization model for traders to write articles and share their knowledge. The idea is to use a small portion LP reward token (1-5%) minted to distribute to educational content providers on the platform (from the community) with each LP reward token emittance, hence promoting education on par with investing.
Build API and column-oriented data store (ClickHouse) with read-only mode providing all exchange market data for consumption by users to allow to build complex models. Due to the size of some of this data, small requests will be free, but bulk ones will be likely charged in accordance to the throughput price of the cloud provider from where the data would be streamed.
Build API for strategy integration allowing to write custom code that takes pricing data from the exchange, potentially historical as well for backtesting and strategy development, and perform algo trading. We might consider the ability to host strategies on the exchange and charge % fee for the usage of it (e.g. strategy earns X in profits, 5% is paid to strategy developers and 95% to the user).
Develop fluentd, prometheus, and Grafana platform monitoring, and make some of the metrics available to the website users.
Add NFTs similar to PancakeSwap to allow people to customize their exchange accounts and to be able in the future to create trading competitions.
Implement a lottery system for burning LP reward tokens.

References

Fundamentals

[FUN.0] Composing Contracts: An Adventure in Financial Engineering. Simon Peyton Jones et al. URL: https://www.cs.tufts.edu/~nr/cs257/archive/simon-peyton-jones/contracts.pdf. Accessed on 2021/04/26.

Security

[SEC.0] Rubber-hose cryptanalysis. Wikipedia article. URL: https://en.wikipedia.org/wiki/Rubber-hose_cryptanalysis. Accessed on 2021/04/26.

Market Making & Efficient Market Hypothesis (EMH)

[MM.0] Risk, Uncertainty, and Divergence of Opinion. Edward M. Miller. URL: https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.667.5934&rep=rep1&type=pdf. Accessed on 2021/04/23. [MM.1] Token sales and shorting. Vitalik Buterin. URL: https://ethresear.ch/t/token-sales-and-shorting/376. Accessed on 2021/04/23. [MM.2] Covered Call. Akhilesh Ganti. URL: https://www.investopedia.com/terms/c/coveredcall.asp. Accessed on 2021/04/23. [MM.3] LEAP Options (A Simple ExplanationGuide). ID Analysts. https://www.investingdaily.com/44771/leap-options-explained/#:~:text=LEAP%20options%20(or%20LEAPs)%20are,offered%20at%20option%20contract%20prices. Accessed on 2021/04/23. [MM.4] Long-Term Equity Anticipation Securities (LEAPS). James Chen. URL: https://www.investopedia.com/terms/l/leaps.asp. Accessed on 2021/04/23. [MM.5] Rolling LEAP Options. Tristan Yates. URL: https://www.investopedia.com/articles/optioninvestor/07/rolling_leaps.asp. Accessed on 2021/04/23. [MM.6] The Shorting Premium and Asset Pricing Anomalies. Itamar Drechsler. Qingyi (Freda) Song Drechlser. URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2387099. [LP.0] What Are Automated Market Makers? Cryptopedia Staff. URL: https://www.gemini.com/cryptopedia/amm-what-are-automated-market-makers. Accessed on 2021/04/22. [LP.1] On Path Independence. Vitalik Buterin. URL: https://vitalik.ca/general/2017/06/22/marketmakers.html. Accessed on 2021/04/22. (Path safe automated market making). [LP.2] Bancor Is Flawed. Emin Gün Sirer and Phil Daian. URL: https://hackingdistributed.com/2017/06/19/bancor-is-flawed/. Accessed on 2021/04/22. (On gaming LP by miners and the cost of price discovery) [LP.3] What is an Index? James Chen. URL: https://www.investopedia.com/terms/i/index.asp. Accessed on 2021/04/22. [LP.4] Pulse Main Page (check section at the bottom explaining how indexes are built and maintained, screenshot of the section below for your convenience). URL: https://www.pulse.inc/. Accessed on 2021/04/22. [LP.5] Mirror: assets reflected on the blockchain main page. URL: https://mirror.finance/. Accessed on 2021/04/22. [LP.6] Mirror Protocol: A trading and liquidity protocol whitepaper. URL: https://mirror.one/Mirror_Protocol_Whitepaper.pdf. Accessed on 2021/04/22. [LP.7] Synthetix - the derivatives liquidity protocol main page. URL: https://synthetix.io/. Accessed on 2021/04/22. [LP.8] Synthetix Litepaper. URL: https://docs.synthetix.io/litepaper. Accessed on 2021/04/22. [LP.9] Mirrored Tesla (mTSLA) on CoinGecko. URL: https://www.coingecko.com/en/coins/mirrored-tesla. Accessed on 2021/04/22. [LP.10] Mirrored Apple (mAPPL) on CoinGecko. URL: https://www.coingecko.com/en/coins/mirrored-apple. Accessed on 2021/04/22. [LP.11] Cboe Volatility Index (VIX). Justin Kuepper. URL: https://www.investopedia.com/terms/v/vix.asp. Accessed on 2021/04/22. [LP.12] Cboe VIX Index: Turn Volatility to Your Advantage. URL: https://www.cboe.com/tradable_products/vix/. Accessed on 2021/04/22.

Synthetics

[SYN.0] The Dai Stablecoin System. The Maker Team. December 2017. URL: https://makerdao.com/whitepaper/DaiDec17WP.pdf. Accessed on 2021/04/27. [SYN.1] The Maker Protocol: MakerDAO's Multi-Collateral Dai (MCD) System. URL: https://makerdao.com/en/whitepaper/. Accessed on 2021/04/27. [SYN.2] Mirror: Reflecting Asset Value On-Chain. URL: https://docsend.com/view/kcsm42mqiyu5t6ej. Accessed on 2021/04/27. [SYN.3] Synthetix White Paper. A decentralized payment network and stable coin v0.8. Samuel Brooks, Anton Jurisevic, Michael Spain, Kain Warwick. URL: https://www.synthetix.io/uploads/synthetix_whitepaper.pdf. Accessed on 2021/04/27. [SYN.4] Synthetix Litepaper. Version: 1.4 (March 2020). URL: https://docs.synthetix.io/litepaper. Accessed on 2021/04/27.

Trading

[TR.0] Paper Trade. Christina Majaski. Investopedia Article. URL: https://www.investopedia.com/terms/p/papertrade.asp. Accessed on 2021/04/27.

Financial Philosophy

[PHIL.0] Inadequate Equilibria - Where and How Civilizations are Stuck? Eliezer Yudkowsky. URL: https://equilibriabook.com.

Platform Development

[CODE.0] Cross-platform, typed, and queryable API for Cardano. URL: https://github.com/input-output-hk/cardano-graphql. Accessed on 2021/04/22. [CODE.1] GraphQL Official Website. URL: https://graphql.org/. Accessed on 2021/04/22. [CODE.2] GraphQL explained in 100 seconds by Fireship. URL: https://youtu.be/eIQh02xuVw4. Accessed on 2021/04/22.

Additional References

References used in the preparation of the white paper, but not referenced in it directly. They pose as an additional source of information and will be linked in the future.

Fundamentals

[] Options Volatility & Pricing. Advanced Trading Strategies and Techniques. Sheldon Natenberg. 2nd edition. [] Active Portfolio Management. A Quantitative Approach for Producing Superior Returns and Controlling Risk. Richard C. Grinold, Ronald N. Khan. 2nd edition. [] Derivatives - Models on Models. Espen Gaarder Haug. [] Systematic Trading. Robert Carver. [] Modern Portfolio Theory and Investment Analysis. Edwin J. Elton et al. 9th edition. [] The xVA Challenge. Jon Gregory. 3rd edition. [] Econometrics. Fumio Hayashi. [] Principles of Professional Speculation. Victor Sperandeo. [] Futures Markets. Robert W. Kolb. 3rd edition. [] Analysis of FInancial Time Series. Ruey S. Tsay. 3rd edition. [] Asset Price Dynamics, Volatility, and Prediction. Stephen J. Taylor. [] Paul Wilmott on Quantitative Finance. Paul Willmot. 2nd edition. [] The Alchemy of FInance. George Soros. [] Money Changes Everything. William N. Goetzmann. [] Trading Volatility, Correlation, Term Structure, and Skew. Colin Bennet. [] Options, Futures, and Other Derivatives. John C. Hull. 8th edition. [] Nonlinear Option Pricing. Julien Guyon, Pierre Henry-Labordere. [] Modern Investment Management. An Equilibrium Approach. BOb Litterman and the Quantitative Research Group, Goldman Sachs Asset Management. [] Continuous-Time Finance. Robert C. Merton. Revised edition. [] Pricing and Trading Interest Rate Derivatives. A Practical Guide to Swaps. J. H. M. Darbyshire. Revised edition. [] Derivatives demystified. A Step-by-Step Guide to Forwards, Futures, Swaps and Options. Andrew M. Chisholm. 2nd edition. [] The Volatility Surface. A Practitioner's Guide. Jim Gatheral. [] The Man Who Solved The Market. How Jim Simons Launched The Quant Revolution. Gregory Zuckerman. [] The Complete Guide to Option Pricing Formulas. Espen Gaarder Haug. 2nd edition. [] Asset Pricing. John H. Cochrane. Revised edition. [] Modeling Derivatives in C++. Justin London [] Basic Stochastic Processes. Zdzisław Brzeźniak, Tomasz Zastawniak. [] Stochastic Differential Equations. Bernt Oksendal. [] Advances in Financial Machine Learning. Marcos Lopez de Prado. [] Investment Science. David G. Luenberger. [] Fractals and Scaling in Finance. Discontinuity, Concentration, Risk. Benoit B. Mandelbrot. [] Finding Alphas. A Quantitative Approach to Building Trading Strategies. Igor Tulchinsky et al. [] Brownian Motion, Martingales, and Stochastic Calculus. Jean-François Le Gall. [] Credit Risk. Darrell Duffiee, Kenneth J. Singleton. [] Stochastic Volatility Modeling. Lorenzo Bergomi. [] Risk and Asset Allocation. Attilio Meucci. [] Dynamic Hedging. Managing Vanilla and Exotic Options. Nassim Taleb. [] Tail Risk Hedging. Creating Robust Portfolios for Volatile Markets. Vinner Bhansali. [] Modelling Extremal Events: for Insurance and Finance. Paul Embrechts et al. [] Statistical Consequences of Fat Tails. Real World Preasymptotics, Epistemology, and Applications. Nassim Nicholas Taleb. [] The Price of Fixed Income Market Volatility. Antonio Mele, Yoshiki Obayashi. [] Options Trading. Pricing and Volatility Strategies and Techniques. Euan Sinclair. [] Chaos. The Amazing Science of the Unpredictable. James Gleick. [] Nonlinear Dynamics and Chaos. With Applications to Physics, Biology, Chemistry, and Engineering. Steven H. Strogatz. 2nd edition.

Market Making & Efficient Market Hypothesis (EMH)

[] "Let's run on-chain decentralized exchanges the way we run prediction markets" Reddit post from 2016/10/03. (The consideration of more traditional buy-side / sell-side order book model and the inception of the famous x * y = k AMM model). Vitalik Buterin. URL: https://www.reddit.com/r/ethereum/comments/55m04x/lets_run_onchain_decentralized_exchanges_the_way/. Accessed on 2021/04/22. [] Euler: The simplest exchange and currency. (Euler: e^n pricing model for providing tokens from LP. Initial price determination via distributed farm offering). Nick Johnson. URL: https://www.reddit.com/r/ethereum/comments/54l32y/euler_the_simplest_exchange_and_currency/. Accessed on 2021/04/22. [] Gemini market making model. (buy/sell order submission in the time-window, matching at the end of the time window, more efficient price discovery via auction system). URL: https://www.gemini.com/fees/marketplace. Accessed on 2021/04/22. [] Revenue equivalence. URL: https://en.wikipedia.org/wiki/Revenue_equivalence. Accessed on 2021/04/21. [] Improving front running resistance of x*y=k market makers. Vitalik Buterin. URL: https://ethresear.ch/t/improving-front-running-resistance-of-x-y-k-market-makers/1281. Accessed on 2021/04/21. [] Decentralized exchanges research. URL: https://ethresear.ch/c/decentralized-exchanges/17. Accessed on 2021/04/21. [] A Practical Liquidity-Sensitive Automated Market Maker. Abraham Othman, et al. URL: https://www.cs.cmu.edu/~sandholm/liquidity-sensitive%20automated%20market%20maker.teac.pdf. Accessed on 2021/04/21.

Financial Philosophy

[] The Black Swan. The Impact of the Highly Improbable. Nassim Nicholas Taleb. [] George Soros. The Alchemy of Finance: The New Paradigm. [] Deep Thinking. Where Artificial Intelligence Ends… And Human Creativity Begins. Garry Kasparov. [] Antifragile. Things that Gain from Disorder. Nassim Nicholas Taleb.

Behavioural Economics

[] Quasi Rational Economics. Richard H. Thaler. [] Behavioral Finance. Understanding the Social, Cognitive, and Economic Debates. Edwin T. Burton, Sunit N. Snah. [] Behavioral Investing. A Practitioner's Guide to Applying Behavioural Finance. James Montier. [] Advances in Behavioral Finance. Richard H. Thaler et al. [] Game Theory. An Introduction. Steven Tadelis. [] Ultra Society. Peter Turchin. [] Predictably Irrational. The Hidden Forces that Shape Our Decisions. Dan Ariely.

Legal

[] SEC Exchange Platform Checklist. URL: https://www.forbes.com/sites/tedknutson/2018/03/08/sec-offers-bakers-dozen-questions-to-sniff-out-in-cryptocurrency-platforms/#7a3057be148c. Accessed on 2021/04/23.

bookmarked!

bookmarked!