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Overview

In the world of leveraged trading, perpetual swaps stand out as a cornerstone for traders seeking to amplify their market positions. Amid this landscape, Levana Perps introduces a novel protocol aimed squarely at redefining risk management and efficiency within the sector. At its core, Levana is engineered to offer a safer platform for both traders and liquidity providers via its "well-funded" strategy. This unique approach ensures that every trade on the platform is backed by sufficient funding, effectively setting a cap on the maximum profit for stablecoin-denominated trades. This preemptive measure not only aims to eradicate the specter of bad debt and the risk of insolvency but also sets Levana apart in a crowded market. Beyond its safety-first innovations, Levana also pushes the boundaries of the crypto perps market by offering 30+ markets across three different blockchains (Osmosis, Injective, and Sei), while also being the only platform to offer support for liquid staked assets such as stOSMO, stATOM, milkTIA, and others.

The genesis of Levana Perps was driven by a clear recognition of the challenges plaguing traditional perpetual swap platforms, most notably, the hazard of liquidity shortages. In conventional settings, the trading game often devolves into a zero-sum battle, with long traders and short traders vying for supremacy as market prices sway. The linchpin for a fair and operational trading environment lies in maintaining a delicate balance between long and short positions, ensuring both sides have access to the liquidity needed to realize their gains.

Yet, the crypto markets are no strangers to turbulence, and during periods of extreme volatility, the assumed equilibrium between long and short positions can quickly unravel. Historical trends have laid bare the vulnerabilities inherent in these platforms, particularly during market downturns, when a pronounced skew towards short positions can precipitate liquidity crises. Levana Perps emerges as a response to these challenges, offering a blueprint for stability and fairness in the high-stakes arena of leveraged trading.

Crypto Perps

Perpetual swaps, or "perps," are sophisticated financial instruments within the cryptocurrency market. They provide a seamless blend of futures trading benefits without the limitations of an expiry date. These derivatives allow institutional participants to speculate on the price movements of digital assets, leveraging their positions while mitigating the operational and security challenges associated with direct cryptocurrency ownership. The settlement of these trades is conducted in cash, enhancing the liquidity and accessibility of digital asset markets.

Perpetual swaps are akin to traditional futures in offering leverage; however, they distinguish themselves by lacking a predefined expiration date. This characteristic allows for an indefinite extension of the contract, facilitated by a funding rate mechanism. This funding rate—a periodic payment exchanged between long and short positions—ensures the perpetual swap's price remains anchored to the underlying asset's market price, providing a dynamic balance to the contract's valuation.

Advantages of Perpetual Swaps

• Leverage: Perps enable traders to manage positions substantially larger than their initial capital outlay. This feature not only amplifies potential returns but also introduces heightened risk, making risk management a crucial aspect of trading these instruments.
• Hedging: Perps allow traders to safeguard their portfolios against adverse price fluctuations by hedging. By taking positions opposite to their holdings in the spot market, traders can insulate themselves from potential losses, highlighting the versatility of perps in risk management strategies.
• Liquidity: The perpetual swap market is renowned for its high liquidity, ensuring the efficient execution of large orders without significant price impact. This liquidity is anticipated to grow as institutional adoption of digital assets continues, promising even smoother transaction experiences and deeper market depth.

Funding Rate

The funding rate is a pivotal component of the perpetual swap ecosystem, adjusting the cost of holding positions to ensure the perpetual price mirrors the spot market closely. This mechanism encourages market participation to prevent significant price disparities between the perpetual contracts and the underlying assets, although deviations can still occur, reflecting the inherent volatility of the cryptocurrency market.

Institutional participants prefer trading venues where the funding rate closely approximates actual borrowing costs, seeking stability and predictability in their trading activities. An ideal funding rate calculation might incorporate elements from traditional finance, such as Treasury Bills, and align with the borrowing rates for digital assets, providing a fair representation of market conditions.

The Importance of Liquidations in DeFi

To sustain leverage trading within the DeFi ecosystem, the integration of a robust and efficient liquidation mechanism is paramount. This mechanism ensures market integrity and protects the protocol from excessive losses. The liquidation process in DeFi, however, faces unique challenges that differ significantly from those in traditional financial systems, primarily due to the decentralized and on-chain nature of operations. Here, we delve into two principal challenges: identifying the liquidation threshold and orchestrating the liquidation process.

The concept of a liquidation point is foundational in determining when a leveraged position becomes unsustainable and thus subject to liquidation. This threshold is typically reached when the value of the trader's margin plus unrealized profit and loss (PnL) dips below the required maintenance margin. Yet, the task of pinpointing this liquidation moment within a blockchain environment introduces complexities largely attributed to the high volatility of crypto assets and the limited performance capabilities of some blockchain networks. 

To address these challenges, some platforms have moved off of Ethereum’s mainnet and embraced Ethereum's Layer 2 solutions and alternative chains. The primary reasons for leaving Ethereum are to reduce costs, enhance scalability, maintain more sovereignty/customization, and/or reduce latency in liquidation execution. Furthermore, DeFi protocols have developed varied strategies for calculating and executing liquidations, ranging from selling the entire collateral to only a portion sufficient to meet the maintenance margin.

The execution of liquidations in a decentralized environment lacks a centralized authority to continuously monitor and enforce liquidations, making the selection of an executing entity a critical challenge. The high operational costs and the technical impracticality of constant on-chain monitoring necessitate incentivizing external participants to undertake liquidation tasks. DeFi protocols, therefore, often rely on Backstop Liquidity Providers (BLPs) or similar mechanisms, offering them a portion of the liquidation proceeds as an incentive to identify and execute liquidations efficiently.

Inadequacies in the liquidation framework can expose protocols to bad debt-related attacks, where the rapid depreciation of collateralized assets leads to irrecoverable losses. Protocols with exposure to highly volatile assets are particularly susceptible to such scenarios, underscoring the need for preventive measures.

General Risks

Global Liquidity Pools

A central feature of many Perp DEXs is the adoption of a "global liquidity pool," a model that draws inspiration from prominent DeFi lending platforms such as AAVE and Compound. This approach offers several advantages, including the integration of borrow/lend functionalities, thereby enhancing the utility and flexibility of the platform for its users.

The global liquidity pool model provides a unified source of funds from which all trades are executed, offering several benefits:

• Efficiency: By pooling resources, Perp DEXs can optimize capital utilization, allowing for better liquidity management and order execution.
• Innovation: This model facilitates the introduction of additional financial instruments and services, such as lending and borrowing, expanding the platform's offerings.
• Simplicity: For users, interacting with a single, comprehensive pool can simplify the trading process, making it more accessible to a broader audience.

Despite its numerous advantages, the architecture of the global liquidity pool is fraught with risks, encompassing both financial vulnerabilities and the potential for smart contract breaches. One of the main security concerns stems from the centralized nature of the liquidity pool, which makes it an attractive target for malicious actors. Should these actors successfully attack or exploit the pool, the repercussions could be dire, leading to substantial losses or even the complete forfeiture of user deposits. Furthermore, the liquidity pool's design might harbor financial vulnerabilities that sophisticated attackers could uncover and exploit, potentially resulting in significant financial damage or the complete depletion of the pool's resources. Another critical aspect lies in the design and implementation of liquidation mechanisms. These algorithms play a pivotal role in preserving the platform's solvency; however, if they are not executed effectively, it could result in inadequate or biased liquidations. Such shortcomings not only affect the platform's financial stability but also negatively impact the financial well-being of its users.

Liquidity Risks

The intricate balance maintained on a perps platform is susceptible to disruptions from market manipulation, particularly in virtual Automated Market Makers (vAMMs). vAMMs, a cornerstone of DeFi, rely on algorithms to provide liquidity and set prices. However, they can suffer in low liquidity environments as slippage becomes not only a burden to a potential user but an attack vector for a malicious actor. Slippage can potentially lead to significant price shifts from relatively modest trades, especially when leverage is used, like in the case of perps. 

A scenario illustrating the potential for manipulation involves leveraging a substantial amount of USDC to influence the market dramatically. By employing a strategy that exploits low liquidity, a trader can manipulate prices to trigger forced liquidations, subsequently profiting from the resultant price movements. This not only undermines fair trading conditions but also threatens the financial stability of the exchange.

To mitigate such risks, some perps protocols have adopted measures like the implementation of a Time-Weighted Average Price (TWAP) and a rule that limits the impact of large trades if the mark price deviates significantly from the spot price (discussed more below). By employing a 10% threshold for divergence, these protocols aim to deter manipulation by making it less profitable and more challenging to execute. Although these measures can reduce the likelihood of market manipulation, they also introduce new complexities, such as the potential for liquidations based on temporary market conditions rather than underlying asset values. Levana, in combination with several new enhancements, has implemented a new strategy altogether to combat this issue, plus many more.

Levana’s Solvency Solutions

Despite the popularity of crypto perps, the current platforms frequently grapple with a critical vulnerability: liquidity risk. This risk is particularly acute during market extremes when the balance between long and short positions tilts dramatically, potentially compromising the platform's ability to honor profit payouts. Levana Perpetual Swaps (Levana Perps) emerged with a clear mission: to tackle the endemic issue of liquidity risk that plagues the perpetual swap market. The cornerstone of this issue is the adversarial dynamic between long and short traders within traditional platforms. In such environments, a zero-sum game ensues where the gain of one party directly results from the loss of another, contingent on price movements. 

The protocol seeks to mitigate the risk of market manipulation — a prevalent concern where low-volume or small-cap coins are involved. Traditional vAMM/mark price platforms, which determine position entry and exit prices based on a protocol-defined mark price, are especially vulnerable in low-volume scenarios, enabling traders to manipulate prices to force liquidations unfairly.

Levana Perps differentiates itself through the following pivotal strategies:

Locked Liquidity:

On Levana, LPs supply assets that can be locked as collateral, setting a cap on the maximum gains a trader can secure from a position. This mechanism applies to both stablecoin and crypto-denominated pairs, albeit with a unique approach to each. In stablecoin-denominated pairs, gains are capped to ensure positions are fully collateralized at all times, a safeguard that, while limiting potential upside, ensures market stability and solvency.

Upon initiating a position, a trader specifies a take-profit price, prompting the system to secure an equivalent amount of liquidity as locked collateral. This amount reflects the maximum profit achievable from the position, thereby guaranteeing that trades are fully funded without necessitating external liquidation mechanisms. Additionally, position size within Levana Perps is defined by the extent of a trader's exposure to market movements, calculated as the product of deposited collateral and applied leverage. For instance, a $1,00 deposit employing 5x leverage equates to a $5,00 exposure, mimicking a direct purchase of the asset on the spot market. The platform delineates open interest into long and short categories, summing individual position sizes to calculate total and net open interests, which serve as indicators of market position and sentiment.

This framework not only opens avenues for passive income with relatively low risk but also negates the need for off-chain liquidation mechanisms. By facilitating on-chain liquidations, Levana Perps enhances its autonomy and reduces reliance on external services. 

No Mark Price:

In a departure from conventional practices, Levana Perps eliminates the internal concept of mark price, opting to use the spot market price to determine entry prices and calculate profits and losses. A "mark" price, is a calculated average that serves as a proxy for the asset's value on the exchange. This price is crucial for ensuring the perpetual contract's price aligns with the underlying asset's spot market price.

This decision stems from the recognition of inherent issues associated with virtual automated market-makers (vAMMs), such as the challenge of setting an accurate initial mark price, the potential drift from true market prices, and susceptibility to market manipulation. Levana opts for a direct utilization of the current spot price for entry points and profit and loss calculations, thereby sidestepping these challenges and fostering a more stable trading environment. By basing funding payments on the net notional difference between long and short positions, Levana encourages strategies that align with a delta-neutral market, offering attractive investment options even to risk-averse traders. This approach, exemplified through scenarios where traders can hedge their staked assets while earning additional income, underscores Levana's innovative edge in addressing the liquidity risk inherent in perpetual swap platforms.

Funding Payments and Delta Neutrality Fund:

LPs play a crucial role in maintaining market equilibrium. By providing liquidity on both sides of the trade, they inherently assume a position opposite to the trader, thereby aligning their risks with market movements. When a trader opens a position, the corresponding locked collateral signifies an opposite position taken by the LPs, effectively exposing them to counter-side leverage. This relationship underscores the necessity for the platform to maintain balanced long and short positions, ensuring that LPs are not disproportionately exposed to market volatility.

Net open interest is pivotal for assessing the cumulative market risk borne by liquidity providers. A disparity between long and short positions could subject LPs to undue financial risk, especially in fluctuating markets. Levana Perps employs funding rate payments and delta neutrality fees as mechanisms to incentivize market equilibrium, striving for a delta-neutral position that minimizes LP risk.

Levana strives to maintain a balanced liquidity pool, ensuring that gains in opposite positions counterbalance LPs' losses. This equilibrium is further supported by a funding rate payment system and a delta neutrality fund, which incentivizes trades that contribute to maintaining market balance.

While funding payments remain a tool to encourage cash-and-carry arbitrage and maintain market equilibrium, Levana Perps recalibrates the basis for these payments to the net notional difference between long and short positions. Additionally, the introduction of a delta neutrality fund further incentivizes a balanced market, penalizing actions that exacerbate imbalance while rewarding those that contribute to neutrality.

Levana Security and December 2023 Exploit

In mid-December 2023, several accounts, presumably interconnected, engaged in trading activities on Levana that coincided with a notable uptick in the broader market prices. These transactions were initially deemed innocuous. However, the situation took a critical turn on December 26, when an exploit led to a substantial loss of liquidity for Levana. The series of attacks, beginning 12 days earlier and culminating on the 26th, resulted in an approximate 9% depletion of Levana's liquidity pools, with an estimated $1.15 million siphoned off. This represented ~10% of the total funds within Levana's liquidity pools over the period of the attacks. The impact appeared to be isolated to the Osmosis network.

The core of the exploit was a price delta attack, leveraging the lag in price updates to the Pyth oracle—a system designed to provide real-time price feeds for assets. Levana's protocol allowed for a grace period in price updates, assuming no significant deviation occurred from the previous price. However, this window created an opportunity for exploitation. In volatile market conditions, especially with the use of high leverage, attackers could execute trades based on the discrepancy between the current price and a price from approximately 80 seconds prior. By identifying a sufficient price delta, such as 0.05%, and exploiting the latency in price updates, the attackers could ensure profitable trades by opening positions at an "attack entry price" and closing them at an "attack exit price," all while potentially hindering other users' ability to trade or interact with the platform.

In response to the incident, Levana has taken steps to refine its protocol to safeguard against similar attacks. The platform has revised its approach to the timing and execution of market orders. Previously, Levana had avoided decoupling the placement and execution of market orders due to concerns over complicating user interaction and increasing gas costs. However, recognizing the necessity for enhanced security, Levana now implements a queue system for new positions or position update requests. This system ensures actions are executed only upon receiving a new price update from the Pyth oracle or after a set timeout period, aiming to mitigate the risk of exploitation through oracle manipulation.

Tokenomics

Levana has its own token, the LVN token, which plays a critical role in trading and governance on the platform. Token holders have several options within the system, including:

• Direct Distribution: Monthly distribution of a diverse asset basket to LVN stakers, including cryptocurrencies like BTC, OSMO, ATOM, and others, directly to their wallets.
• Swap Distribution: Conversion of collected fees into LVN tokens, which are then distributed to stakers.
• Protocol Improvement: Utilizing fees to fund developer efforts to enhance the Levana platform.
• Marketing Initiatives: Allocating fees for promotional activities to increase protocol awareness.
• Strategic Partnerships and Operations: Investing in essential but gradual processes for development and partnerships.
• Analytical Expertise: Funding for experts to ensure system integrity and prevent failures.
• Insurance Fund: Creating a financial safety net to address and rectify potential system failures.

Fees and Governance

On Levana, traders incur fees when they initiate or adjust leverage positions. These fees are then allocated to counterparties, liquidity providers, and a designated protocol fee collection mechanism. Levana Perps presents liquidity providers with options regarding their risk tolerance and potential rewards. The platform offers both LP tokens, which can be liquidated without a lock-up period, and xLP tokens, subject to a 45-day lock-up, each offering varying degrees of risk and reward. 

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To date, over $2 million has been distributed to users of the Levana platform. The governance structure of the Levana Decentralized Autonomous Organization (DAO) is responsible for determining the allocation of protocol fees. Initially, these fees are managed by the founding entity to support market liquidity and operational expenses related to protocol development. Eventually, fee governance will transition to a DAO treasury, overseen by token holders, to decide on their allocation.

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Token Distribution

The LVN token has a total supply of 1 billion tokens, with only ~50.5 million currently circulating. The initial token allocations can be seen in the chart below. 

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With this relatively low floating supply, the protocol will experience meaningful unlocks and token inflation, beginning most aggressively in 2025. However, some of that (~20 million LVN) will be airdropped to the community over the course of 2024.

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The primary aim of distributing community tokens is to ensure widespread ownership among both current and prospective users of the Levana platform. These strategies include rewarding protocol usage through farming incentives, enhancing liquidity on both decentralized exchanges (DEXs) and centralized exchanges (CEXs), rewarding active governance participation, and supporting growth initiatives such as marketing and content creation.

Up to 8.33 million LVN tokens are available each month from the community pool for distribution. However, there is no obligation to distribute these tokens in any given month. Decisions may be made to reserve tokens for future use or to keep them perpetually locked.

Additional strategies for the use of community tokens include potentially burning unused tokens to reduce supply, aligning interests with Osmosis over the long term through strategic initiatives, supporting third-party developers who contribute to the ecosystem by increasing trading volume, improving delta neutrality, integrating with independent front-end interfaces, and pursuing other collaborative projects, and more.

Other Perp Token Designs

In the ever-evolving landscape of blockchain-based perpetual futures (perp) projects, the design and utility of native tokens stand at the forefront of innovation and user engagement. These utility tokens vary significantly in their functionality, economic models, and impact on the ecosystem. From governance and staking to fee discounts and revenue-sharing mechanisms, the utility of these tokens reflects a project's strategic priorities and its approach to attracting and retaining users. As we delve into the specifics of how projects like dYdX, GMX, Synthetix, and Vertex have tailored their tokenomics to foster growth, sustainability, and user participation, it becomes clear that the success and valuation of these tokens hinge on their utility, supply dynamics, and integration within their respective ecosystems.

The DYDX token, the native token of the dYdX platform, has faced market skepticism due to its limited utility beyond governance and staking for fee discounts since its launch in 2021. Despite dYdX commanding a dominant position in the DEX perps market, its valuation has lagged significantly behind its peers, primarily attributed to its low circulating supply and initial lack of direct revenue-sharing mechanisms. The transition to dYdX version 4 (v4) marks a pivotal shift, with plans to decentralize revenue allocation and integrate the DYDX token into the security and economic fabric of the dYdX chain, potentially through fee sharing with validators and stakers. This evolution suggests a promising horizon for DYDX token holders, especially considering the planned adjustments in token supply and the distribution mechanisms post-v4 launch.

GMX, with its tokenomics rooted in escrowed GMX and a conservative emission schedule, presents a case of managed supply growth. The platform's strategy, focused on minimizing dilution while incentivizing participation through staking and rewards, aims for a sustainable expansion of its token circulation. By assuming a moderate increase in circulating supply, GMX endeavors to balance growth with stability, ensuring that token holders are not adversely impacted by excessive inflation.

Synthetix (SNX) exemplifies a proactive approach to inflation management, aligning token emissions with the platform’s staking ratio objectives. The introduction of dynamic inflation adjustments, as governed by SCCP-211, underscores Synthetix’s commitment to actively balancing incentive structures with market health. This methodical reduction in inflation, coupled with vesting periods for rewards, serves to moderate the impact on SNX’s circulating supply, fostering a healthier ecosystem for stakers and investors alike.

VRTX, as the native token of the Vertex protocol, enters the market with clear and user-friendly tokenomics. The design encourages active participation through staking, governance, and the utilization of VRTX for fees, aiming to distribute protocol revenue and emissions equitably among its community. 

Conclusion

Levana Perps has emerged as a transformative project within the volatile world of cryptocurrency perpetual swaps. By introducing innovative risk management and efficiency protocols, Levana looks to set new standards for safety and liquidity provision, distinguishing itself from traditional platforms plagued by liquidity shortages and insolvency risks. Its commitment to ensuring fully collateralized positions, eliminating the reliance on mark prices, and integrating liquid staked assets across multiple blockchains highlights its forward-thinking approach. Moreover, Levana's strategies to mitigate liquidity risks and market manipulation further enhance its appeal to both traders and liquidity providers, fostering a balanced and equitable trading environment. With its novel funding rate mechanism, robust liquidation process, and dynamic governance model, Levana Perps is poised to redefine the landscape of crypto perps, offering a secure, fair, and efficient platform that caters to the evolving needs of its users. 

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Disclaimer: This report was commissioned by Jiritsu. 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.