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Perpetual contracts play a pivotal role in the cryptocurrency ecosystem for various reasons. They facilitate real-time price discovery, reflecting the collective sentiment and expectations of market participants. Additionally, perp markets contribute to market efficiency by providing both long and short positions, reducing price manipulation, and offering advanced risk management capabilities. Traders use perps not only for speculation but also for hedging against price fluctuations, providing stability in a highly volatile market.

A perpetual contract, or perp for short, is a derivative financial instrument that allows traders to speculate on the future price movements of cryptocurrencies without actually owning the underlying asset. Unlike traditional futures contracts, perps have no fixed expiration date. Instead, they are designed to mimic the behavior of spot markets while enabling traders to use leverage to amplify their trading positions.

After the Terra crash in May 2022, many perp exchanges suffered significant challenges both technically and economically. While the market activities performed on derivatives exchanges are vital for DeFi, perp swaps have endured a difficult road towards adoption, with issues arising from contagion risks, capital inefficiencies, centralized chokepoints, and high/inflexible fees. 

With these in mind, Levana launched v2 of its perpetual swap system in July 2023, a holistic upgrade on the exchange launched on Terra’s testnet in February 2022. Levana Perps v2 utilizes the Levana Well-Funded Perps Model, specifically designed to address the major problems highlighted above. 

Background 

Founded in 2021, Levana is a mnemonic device short for “Leverage Any Asset.” Levana Finance was originally developed on the Terra blockchain, but in the following months post-crash, Levana continued development of the platform. In early July, Levana successfully launched its mainnet beta on the Cosmos chain, Osmosis. Following this, the protocol expanded its deployment to include both the Sei and Injective networks. Accordingly, Levana seeks to become the premier perp exchange inside of the Cosmos ecosystem. This should not come as a surprise, as the project itself was initially bootstrapped by Delphi Labs, which has brought projects such as Mars and Astroport to launch on Cosmos. 

Key Features Overview

Levana Well-funded Perps is a protocol designed for perpetual swaps, a form of leveraged trading contracts, with the primary objective of mitigating risk while delivering advantages to both traders and liquidity providers. For traders, Levana's approach – and key differentiating factor – involves ensuring that all positions are "well-funded," guaranteeing that the maximum profit for each position is predetermined (this is only for stablecoin-denominated trades, which we will highlight below). This strategic measure is employed in the aim of eliminating the potential for bad debt and insolvency.

Solving Perp Exchanges’ Biggest Challenge: Illiquidity Risk

Levana Perps was conceived to address a pervasive challenge seen in other perpetual swap platforms: the risk of liquidity shortage. Conventional perpetual swap platforms often pit long traders against short traders, where profits for one party come at the expense of the other as prices fluctuate. The crucial factor ensuring a fair and functioning system is the maintenance of a balance between long and short positions within the platform. This equilibrium guarantees that each side possesses adequate liquidity to secure their profits.

However, historical evidence has shown that this presumption of market balance does not always hold true. This discrepancy becomes particularly evident during extreme market conditions, such as market meltdowns, where an imbalance can emerge, featuring a notably higher number of short positions compared to long positions. Under such circumstances, the protocol may struggle to fulfill profit obligations for those positions due to a scarcity of liquidity resources. Levana looks to solve this problem 2 ways: 

Locked Liquidity

Levana Perps utilizes the services of liquidity providers (LPs). LPs offer assets that traders can use as collateral. On stablecoin-denominated trades, this collateral represents the maximum profit a trader can make on a position, thus rendering the liquidity “locked.” On non-stablecoin, crypto-denominated trades, there are no limits on potential gains for long positions. 

Being an LP can be an attractive, low-risk method for gaining passive income, opening up Levana to a whole new type of market participant. LPs are essentially betting on the overall stability of the market, as their chief risk arises when markets experience extreme price movements or large liquidation events. But, by providing liquidity to both sides of a market, LPs are, in fact, contributing to market stability. We will talk more about LPs and liquidity pools in a separate section below, titled Liquidity Pools. 

While having locked liquidity for stablecoin-denominated trades caps the upside for traders, fully-backed positions have positive externalities for the platform. Most importantly, the locked liquidity mechanism ensures that all positions are fully collateralized and eliminates the need for off-chain liquidation systems, which some other exchanges rely on. Levana Perps conducts liquidations directly on the blockchain, reducing its reliance on external services.

How Locked Collateral Works

In this system, when a trader opens a position, they specify a take profit price. The system internally converts this into a "max gains" value, representing the maximum profit achievable from the position. This conversion involves borrowing liquidity from the pool and locking it against the position. For instance, in a scenario where a trader has a $1,500 position at a current price of $10 and sets a take profit price of $12 (a 20% price increase), the max gains become $300. The protocol then borrows and locks $300 from the liquidity pool as collateral for the position.

Conversely, if the trader adjusts the take profit price to $11, requiring a 10% price increase, the protocol only locks $150 in collateral. Despite the position size remaining constant, the locked collateral differs significantly.

This mechanism illustrates that the closer the take profit price is to the entry price, the smaller the required locked collateral. It serves both as a risk management tool and a means to reduce trading and borrowing fees. Levana sees the consideration of take profit prices as not only a risk mitigation strategy but also a cost-saving measure.

LPs and Locked Collateral

If we continue with the example above, a trader has a $1500 position with locked collateral at $300. The entry price is $10, and the take profit price is at $12. If the price moves up to $11, the trader has experienced a 10% increase, and in this trade, the liquidity pool loses $150 to the trader. When a trader goes long on a perp future on Levana, the LP essentially takes the short position, experiencing a % increase if price moves below the entry. 

The immediate concern that arises is that if a liquidity pool is imbalanced towards one side of the trade, the LP is rendered to playing house with losing odds. If the liquidity pool is heavily imbalanced towards longs, LPs will lose money due to impairment if the asset increases in value. Thus, Levana works to create a balanced market where LPs losses are protected by equivalent gains on a corresponding trade. In simpler terms, for every loss an LP experiences on a long position, Levana LPs should see an equivalent gain on a short position, and vice versa. Levana’s goal to keep longs and shorts balanced is also known as maintaining 0 net notional, or being delta neutral. One of the ways Levana does this is by implementing a funding rate payment system that is tied to the divergence of long and shorts within a liquidity pool. We will discuss this system further in the following section. 

The second – and more innovative – way Levana attempts to maintain a balanced pool is through the delta neutrality fund. When the protocol moves away from being balanced, opening a trade that would worsen the imbalance requires a fee paid into the fund, while actions that restore balance receive a payment from the fund. In extreme cases, if the protocol strays too far from balance, it may limit the ability to open new positions or make changes to existing ones. However, closing positions is always allowed, even if it pushes the protocol further from its balance limits. This mechanism helps maintain stability in the system.

In summary, Liquidity providers face the inherent risk of unbalanced price exposure, which the protocol aims to minimize but cannot eliminate entirely. Extreme market conditions pose particularly high risk, with the potential for impairment or even a complete loss of funds for liquidity providers.

To address this risk, liquidity providers have the option to choose their preferred level of risk and receive corresponding rewards. There are two mechanisms for providing liquidity: LP tokens with no lock-up period and xLP tokens with a 45-day lock-up period. LP tokens can be withdrawn immediately if there's sufficient liquidity, while xLP holders assume higher risk but receive greater rewards, including a larger share of trade and borrow fees.

No Mark Price

Many of Levana’s competitors utilize a virtual automated market-maker (vAMM) to match buyers and sellers based on predefined rules. While vAMM’s have their strengths, there are a few key drawbacks, most notably with setting and maintaining mark prices. For those new to derivatives markets, the mark price serves as a reference price in cryptocurrency derivative markets, including perpetual contracts. It helps determine traders' profit and loss, margin requirements, and liquidation triggers by hopefully providing a fair and accurate valuation of the underlying asset. A trader will compare the mark price on a derivatives exchange with the going rate on a spot exchange, assessing potential arbitrage opportunities, position adjustments, and risk assessment. With that in mind, a couple key problems that arise with mark prices in vAMMS include: 

1. Initial Mark Price Selection: In vAMMs, setting the initial mark price can be a challenge. As stated, the mark price is crucial for determining traders' profit and loss, as well as for managing liquidations. Deciding on an accurate initial mark price can be challenging, especially when the asset's market is highly volatile or illiquid. An inaccurate starting point can lead to discrepancies in traders' positions and potential liquidations based on inaccurate price references.

2. Drifting from the Mark Price: One of the significant drawbacks of vAMMs is their susceptibility to drifting away from the true market price over time. Since vAMMs rely on automated algorithms and liquidity pools, they may not adjust rapidly enough to match sudden and significant market price movements. This can result in a gap between the vAMM's estimated mark price and the actual market price, leading to potential profit or loss disparities for traders.

3. Market Manipulation: The automated nature of vAMMs can make them vulnerable to manipulation. Traders with large amounts of capital can potentially exploit vAMMs' pricing mechanisms by engaging in strategies that trigger price deviations, exploiting arbitrage opportunities, and affecting the mark price, which can negatively impact other market participants.

With these issues in mind, Levana decided to remove mark prices from their platform altogether, instead opting to use the current spot price as the entry point and calculation of PnL within the system. This allows the protocol to remain stable even with little internal volume and avoid the challenges highlighted above. 

While without mark prices, Levana still incorporates funding payments to encourage cash–and-carry arbitrage. An exchange that has a high amount of cash-and-carry arbitrage trades generally exhibits a more balanced market of shorts and longs, a key goal of Levana’s touched on above. 

Funding payments in cryptocurrency derivatives refer to periodic payments made between long and short traders to maintain the perpetual contract's price (the mark price) close to the underlying asset's market price. In cash and carry arbitrage, traders exploit differences between the funding rate (the rate at which these payments occur) and the cost of funding the position to profit. Normally, funding rates are based on a mark/spot price divergence. Without mark prices, Levana’s funding payments are now based on the net notional or total difference in long vs short position sizes. 

This difference in determining fund payments is a key differentiator for Levana, as it pushes the protocol towards a delta-neutral stance. If there are more long positions than shorts, a funding rate from longs to shorts (and vice versa) is implemented. This opens up various strategies, such as the cash and carry or purely LP positions, allowing users to earn fees without being exposed to the price of a crypto asset. 

For instance, imagine a trader is bullish on an asset and they have some of that asset staked, earning an attractive APR. If a trader wants to secure some profit on their staked assets but cannot exit immediately due to an un-bonding period and the attractive risk-free rate from validators, Levana perps can come to their aid. In this case, the funding rate is going to be paying to anybody taking the short side, presumably because the market is bullish. This means the trader can earn additional income by owning a crypto asset, depositing it to a validator (staking the asset), and simultaneously taking a short position on Levana, effectively making the staked asset market neutral. This example is just one way that Levana’s funding payment mechanism can create attractive investment options for even the more risk-averse. 

Crypto-Denominated Pairs

Levana Perps addresses two additional challenges in the cryptocurrency space:

1. Supporting Chains without Stablecoins: Some blockchain networks lack easy access to stablecoins like the US dollar. This makes trading pairs like ATOM/USD difficult for users on these chains. Levana Perps wants to make trading accessible on such chains.

2. Capped Gains with Stablecoins: As stated earlier, stablecoin-denominated pairs on Levana have maximum gains, which might not suit traders looking for unlimited profit potential. 

To tackle these issues, Levana Perps introduces the concept of "crypto-denominated pairs." Instead of the traditional "collateral-is-quote" market where the base asset is priced in terms of a stablecoin (e.g., ATOM/USDC, a popular pair on Levana), they propose a "collateral-is-base" market. This means users deposit the base asset (e.g., ATOM) to trade, even though they still refer to it as ATOM/USD.

This approach allows Levana Perps to support trading pairs on chains that might not have access to stablecoins, addressing the first challenge. Additionally, it gives traders the potential for unlimited gains, addressing the second challenge.

Understanding how “collateral-is-base” trades offer unlimited profit potential requires some explaining, which Levana does a great job of on their public-facing docs. Here is a reworking of their example, highlighting both a collateral-is-quote and a collateral-is-base trade: 

Option 1: Stablecoin-Based Market, “Collateral-is-Quote”:

1. In this scenario, you're trading ATOM (a cryptocurrency) using a stablecoin called USDC (which is like a digital version of the US dollar).
2. You decide to buy ATOM at a specific price, say $10 per ATOM.
3. To secure your trade, you deposit $200 worth of USDC as collateral (equivalent to 20 ATOM).
4. The trading platform sets a limit on how much profit you can make by locking in counter collateral from the liquidity pool, let's say $400. This sets up the max gain at $600. So, if the price of ATOM rises, you can't make more than $400 in profit.

Option 2: ATOM Collateral Market, “Collateral-is-Base”:

1. In this scenario, you're still trading ATOM, but instead of using USDC, you deposit ATOM as collateral.
2. You also lock some ATOM from the liquidity pool to secure your position. If we are making the same trade from above, you deposit 20 ATOM (equal to $200), and the platform locks up 40 ATOM ($400) from the liquidity pool.
3. In this set-up, the maximum amount you can walk away with is 60 ATOM (20 from you, 40 from the counter collateral). This appears to be the same as before, but …
4. Here's the key difference: In this trade, your profit and loss is calculated in a different way. Instead of measuring your gains in ATOM, they're denoted in US dollars. This means that as long as the price of ATOM keeps rising, the value of the collateral continues to rise, meaning your profit potential in terms of US dollars is essentially infinite.

This setup, known as "infinite max gains," allows traders to chase unlimited profits when they're using the cryptocurrency itself as collateral. When a trader goes long on a crypto-denominated pair’s base asset (ATOM), they are essentially shorting the quote asset (USD). But remember, this only works for long positions and when the base asset (ATOM) is used as collateral. In other scenarios, like using a stablecoin as collateral or going short (betting the price will fall), infinite gains aren't possible.

Recent Changes to Levana 

Levana recently implemented a huge change to its contracts in response to an exploit targeting its protocol. The exploit involved manipulating price points for opening and closing positions, leading to significant profits. To counter this, Levana introduced deferred execution, a mechanism where user actions are scheduled to occur at the next price update.

As mentioned previously, Levana used a system where user actions were regulated by an oracle, with most recent oracles deciding where a user exits or opens a position. Various mechanisms employed by attackers led to stale prices being used for protocol actions, with the ability to grab these stale prices for a trade and close for profit a few seconds later, performing a moderate oracle exploit while remaining somewhat undetectable. 

In order to prevent this, Levana has introduced new rules for opening a position: when a user performs the action of opening a standard position, this is scheduled to open at the next price update. The attackers have no means of grabbing old prices from the oracle for new positions, preventing them from gaming the protocol and botting this. The process works on the closing side as well, making users take the closing price given to them without the ability to control or “choose” this upon exit. 

This is referred to as “Deferred Execution Queue” by the Levana team, as users must place a position and wait until the oracle updates to the next price, with bots handling the order queue. Users are able to manually “crank” this queue in a first-in-first-out manner (FIFO) if their orders have not been placed. However, the adjustments to Levana are fairly minor and provide little difference to the user experience of trading on their platform. 

Levana’s deferred price update system for perps is a step up from the previous one, as they were able to effectively eliminate these corner cases that resulted in the exploit, though a few additional corner cases are possible despite the system upgrade. The Levana team has been building for quite some time now, and their platform has undergone a few significant periods of revision dependent on broader risk appetite and systemic risks across the crypto ecosystem. Let’s examine a few of their previous designs and changes to get a feel for where they are now, along with an examination of how much the design of Levana’s contracts and pricing systems have improved since launch. 

With all of these adjustments, it’s worth noting that the process of liquidity provision on Levana has remained unchanged, with standard deposits occurring immediately without the inclusion of the deferred execution pool. However, the team has stated their intent to move liquidity providing into this pool at a later date, for the sake of standardizing all protocol actions and providing the best possible pricing for users without the ability for exploitation.

Levana v1 and v2

After the collapse of Terra in May 2022, the Levana team re-evaluated their approach to well-fundedness significantly to address some of the issues revealed in the collapse. Price oracles were used to grab most recent on-chain prices at the change of each block, though this had led to issues for both crank and epoch mechanisms.

Opening, updating and closing position tasks were all delegated to the crank mechanism, and the epoch mechanism faced issues around excess work around frequent price changes with the oracle. This led to a lack of standardization around trigger of limit order prices, stop losses and user profit taking, resulting in a somewhat messy system that wasn’t consistent for users and their expectations. 

Levana v2.1

This version of Levana enabled the immediate opening of a position, removing the epoch mechanism entirely to address the significant pain points from original v1 and v2 of Levana. As we highlighted earlier, while this was a step improvement, corner cases were introduced and led to oracle issues for users and the eventual botting exploit. 

Levana began utilizing more data structures to try and isolate protocol behaviors and better compartmentalize actions, in an attempt to reduce the workload on any singular mechanism. One of the more integral aspects of Levana v2.1 was its use of fee collecting, referred to the team as “Liquifunding” which was responsible for 

More on Levana v2.2

With all of the changes and Levana’s history covered, we can take another look at these protocol revisions given that context.

All user actions rely on a future price, as the prior use of past prices was the issue that caused Levana to revamp the protocol entirely. Many of the data structures utilized within Levana v2.1 are still included within the protocol, with the only major downside in all of this being the user experience in not knowing entry price until after the trade has been executed. 

Standard process for opening a trade in Levana is as follows: 

• User pays a crank fee, designed to improve decentralization and dis-incentivize attackers due to fee presence 
• New deferred execution ID is issued to user
• A new task item is added to protocol’s mapping, keyed by user ID upon opening a position; includes block time when task was entered
• When oracle updates prices, Levana searches through ID issuance times and find position entrances to open a user’s position with most accurate pricing

With all of this in mind, the downside in using future price points isn’t as significant to user experience as it would seem, given execution occurs in roughly 10-30 seconds on average compared to previous range of 5-15 seconds in past versions of Levana. Altogether, the upgrade and new architecture of Levana’s data structures present a stronger protocol and make the user experience better through the mitigation of bots and exploiters.  

Token

Levana has its own native LVN Governance Token which recently launched in December. LVN helps the Levana Foundation transition into the Levana DAO. Holders of LVN are able to help decide on community proposals, ecosystem developments, strategic partnerships, and potentially gain access to not-yet-released premium features on the platform (fee discounts, priority access, exclusive airdrops, etc.)

Levana intends on introducing a staking model for LVN holders, intended to incentivize long-term holding and active participation on the platform. Stakers will earn a to-be-determined portion of the fees collected on the exchange. 

Let’s dive into the token distribution: 

In total, the LVN token was launched with a supply of 1 billion tokens, which are distributed among various categories. These categories include the Community pool, Foundation, Advisors, Team, and Investors.

The Community pool consists of 30% of the total token supply, with an initial allocation of 5% unlocked at launch.

The remaining tokens from the Community pool have a linear vesting schedule, with 0.83% of the tokens unlocking monthly over 18 months. This incentivizes community members to hold onto their tokens and participate in the governance of the network over an extended period. Here is a breakdown of the token unlocks for each member of the ecosystem for the first 3 years post-launch: 

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A significant amount of the community tokens will be focused on farming, a popular method for DeFi platforms. Farming enables users to earn tokens by adding liquidity to the platform. Levana currently plans to allow users to deposit ATOM, ETH, and BTC into liquidity pools to begin to earn farming rewards. At launch, ~40 million LVN will be liquid, with roughly 65% of these tokens allocated to farming rewards: 

Traction

In the few months since its mainnet beta launch, Levana has faced challenges in gaining adoption. There are roughly 18,800 Osmosis users trading on Levana. In the same time period Lavana has amassed over $1.8 billion in total trading volume and over $2.1 million in fees collected.

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The third important statistic when looking at any crypto exchanges is total value locked, TVL. Below, provided by DeFiLlama, with USD Inflows over a 10 day period added: 

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When looking at individual liquidity pools on Levana, the ATOM pool has maintained a lionshare of the TVL pie: 

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If we look at each pool’s TVL over time, we do see an uptrend for most pools, providing some optimism on future growth: 

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Competitive Landscape

Let’s look at the TVL for some of the largest decentralized derivatives exchanges in operation today: 

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While each of these employ different order book strategies and offer unique trading pairs/features, GMX and dYdX have cornered a lionshare of the market here. Looking at the entire DeFi ecosystem, GMX and dYdX are the only derivatives exchanges in the top 150 platforms ranked by TVL. This is without including centralized exchanges such as Deribit and Binance, which have TVL’s that outstrip the numbers seen above. 

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Roadmap

Levana recently released a 8 step roadmap on their Twitter profile, some of which have already reached completion: 

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1) Successfully implemented support for LSTs such as Stride Zone’s stATOM markets (complement not compete with staking rewards)

2) Support for Metamask. This has successfully been achieved via an Injective integration and will later have compatibility with other chains.

3) Introduction of synthetic markets based in USDC and USDT, with the ability to cross margin

4) Better PnL planning for traders

5) Successfully integrated the Squid Router which enhances multi-chain functionality, simplifies token swaps and streamlines asset transfers across blockchains. This allows for efficient cross-chain swaps, asset bridging and one-click payments, improving user transaction capabilities on various networks.

6) Targeted onboarding flows from users outside of the ecosystem like OKXWeb3's 200K MAU's

7) Successfully integrated notifications for triggers by NotifiNetwork, better UX for traders within Levana platform

8) Gas fees paid in the market token (not OSMO) so that new users can get started without the need to find gas money, powered by Keplr Wallet

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Closing Thoughts

Levana’s “well-funded” approach to crypto derivatives is a more than respectable response to the issues that arose in the aftermath of the Terra/Luna collapse early last year. By implementing locked liquidity and removing the mark price, Levana has afforded itself an opportunity to distinguish itself from its competitors inside the increasingly-crowded derivatives market. Through such practices Levana has accumulated a trading volume of $1.77 billion in addition to 18,317 unique users.  While the platform has a long way to go in terms of adoption, the release of a governance token should add more fuel to the fire in terms of pulling new users onto the platform. Overall, Levana’s strategy seems well-positioned to capitalize on the growing Cosmos ecosystem and the overall heightened interest in crypto derivatives. 

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Disclaimer: This report was commissioned by Levana. This research report is exactly that — a research report. It is not intended to serve as financial advice, nor should you blindly assume that any of the information is accurate without confirming through your own research. Bitcoin, cryptocurrencies, and other digital assets are incredibly risky and nothing in this report should be considered an endorsement to buy or sell any asset. Never invest more than you are willing to lose and understand the risk that you are taking. Do your own research. All information in this report is for educational purposes only and should not be the basis for any investment decisions that you make.