Introduction
Avalanche closed out 2023 with new all-time highs for both monthly active users and the number of validators on the network. Subnets were a meaningful driver of the broader network's growth in 2023, with ~35 subnets live with validator sets, total subnet validators approaching at 1,700+, and hundreds of thousands of AVAX staked.
Subnets are Avalanche’s solution to scaling the Avalanche blockchain, but they also enable developers to create customized blockchains tailored to specific needs. A subnet, by definition, is a dynamic group of validators collaborating to achieve consensus on their respective blockchain. This framework ensures that while a single subnet is dedicated to validating one blockchain, it possesses the capacity to manage multiple blockchains. This optionality enhances the network's overall efficiency while also offering developers a level of control unprecedented in the blockchain space.
One of the biggest subnet launches in 2023 was Hubblenet, home to the Hubble Exchange, a DEX and perpetuals platform. Hubblenet, as it is called, introduces a fully decentralized matching and liquidation engine, blending the user experience (UX) of traditional centralized exchanges with the composability and transparency inherent in decentralized platforms. Beyond simply deviating from the traditional Automated Market Maker (AMM) model, the exchange introduces a number of other significant boundary-pushing features, like private orders, utilizing USDC as the gas token, and even totally gasless transactions.
Futures and “Perps”
At its core, Hubble Exchange is designed as a multi-collateral perpetual futures protocol. This design allows traders to maintain exposure to a diverse array of assets while using these assets to collateralize their margin accounts.
Futures trading, prevalent in traditional markets, has found significant application in the volatile world of digital currencies. It serves not only as a diversification tactic but also as a tool for hedging against market uncertainties.
Central to futures trading is the concept of a futures contract. This agreement binds two parties to buy or sell a specific cryptocurrency at a predetermined price on a future date. The essence of these contracts, which are traditionally traded on exchanges like the CME, lies in their derivative nature. They derive their value from the underlying digital asset, such as Bitcoin, akin to how futures work for commodities or stocks in traditional finance.
The contract structure involves a buyer, who commits to receiving the asset, and a seller, who agrees to deliver it at the agreed-upon price and date. This framework facilitates a regulated and structured approach to cryptocurrency trading, extending beyond the immediate buying and selling of the digital assets themselves.
When dealing with futures (and options), sellers at the time of settlement have the choice to either proceed with a physical settlement, involving the actual delivery of the underlying asset, or opt for a cash settlement, where the difference in value is exchanged in cash instead. For futures contracts, settlement can occur via either method. Physical delivery entails the contract holder either receiving or supplying the specified commodity through the exchange, while cash settlement bypasses the exchange of physical goods, settling differences in value in cash at the contract's conclusion.
A notable innovation in the cryptocurrency futures market is the perpetual contract. Unlike traditional futures, these contracts lack an expiration date and settlement point, allowing them to remain open indefinitely. This perpetual nature is sustained through a funding rate mechanism, where long and short positions periodically exchange payments based on the price movements of the underlying asset, such as Bitcoin. This ensures that the contract's price remains aligned with the spot price of the asset.
Perpetual contracts have gained popularity on major cryptocurrency exchanges, including Binance, BitMEX, and Bybit. They provide traders with a flexible, ongoing tool for market exposure. The advent of platforms like Hubblenet further democratizes access to these instruments, offering on-chain perpetual contract trading experiences.
Cryptocurrency futures serve multiple strategic functions. Primarily, they act as a risk mitigation tool. For instance, Bitcoin miners might use futures contracts to secure a stable price for their future sales, insulating their operations from market volatility. By locking in prices through these contracts, miners can plan and execute their mining activities with greater financial predictiveness.
Furthermore, futures contracts offer a hedge against potential losses for digital asset holders. Savvy traders or institutional investors can "short" these contracts, betting against the asset's future price. If their predictions hold, they stand to profit from market downturns, turning what would be a loss in a spot market transaction into a gain. This aspect of futures trading underscores its utility in enabling traders to capitalize on their market insights.
The multi-collateral capability of Hubble Exchange, coupled with the composability afforded by the Ethereum Virtual Machine (EVM), unlocks the potential for a variety of innovative products to be built atop the Hubble platform. These potential products include leveraged tokens, cross-margin trading, and on-chain delta-neutral liquid staking strategies.
Hubble Exchange
Hubble Exchange represents the inaugural product on Hubblenet, a new Layer 1 (L1) Subnet developed within the Avalanche ecosystem. The utilization of an Avalanche Subnet endows Hubble Exchange with the flexibility to customize its features highly, tailoring the platform to the specific needs and preferences of its user base. At its inception, the exchange offers trading in AVAX, ETH, and SOL, with plans to expand its pair offerings in the future.
Hubble Exchange introduced a perpetuals platform marked by a fully decentralized matching and liquidation engine built on its subnet in Q4 2023. This innovative approach melds the user experience of traditional centralized exchanges with the composability and transparency inherent in decentralized platforms. The platform's hallmark feature is its utilization of USDC as a gas token, streamlining transactions and enhancing user experience by negating the need to hold multiple coin types for transaction fees. As of Q1 2024, Hubble supports trading pairs, including AVAX, ETH, and SOL, with a roadmap for expanding its offerings.
Decentralized exchanges (DEXs) have emerged as a transformative force within the cryptocurrency landscape, redefining how individuals trade digital assets. Unlike traditional centralized exchanges (CEXs), DEXs operate on the principles of decentralization, utilizing smart contracts on blockchain networks to facilitate peer-to-peer transactions. In this article, we delve into the intricacies of decentralized exchanges, explore the key distinctions between CEXs and DEXs, and provide a framework for evaluating and comparing different DEXs.
DEX vs CEX
Despite their efficiencies, centralized exchanges (CEX) come with notable drawbacks (see FTX or any number of examples over the last decade). Beyond fraud and implosion risk, they rely heavily on intermediaries for order book management and trade execution. This centralized control introduces various security risks, such as the potential mishandling of private keys. Additionally, these platforms can incur higher costs compared to decentralized exchanges (DEXs), mainly due to the intermediary's role in transactions and the frictions associated with fiat and regulatory compliance.
At its core, a DEX is a platform that enables direct, trustless, and transparent trading of cryptocurrencies and other digital assets. This groundbreaking concept hinges on the utilization of smart contracts, which execute trades automatically without the need for an intermediary. These smart contracts ensure that transactions are governed by code rather than centralized authorities.
Decentralized exchanges play several critical roles within the cryptocurrency market, contributing to its vibrancy and resilience:
- Price Discovery: DEXs facilitate price discovery by determining asset prices based on supply and demand dynamics within their platforms. This process is a cornerstone of efficient markets, aiding traders in making informed decisions.
- Arbitrage Opportunities: Traders can capitalize on price discrepancies across different exchanges, engaging in arbitrage to profit from market inefficiencies. DEXs often play a central role in identifying and correcting these disparities.
- Liquidity Provision: Users can contribute their assets to DEX liquidity pools, earning rewards in return. This incentivizes the maintenance of liquidity, ensuring that traders can execute orders promptly and with minimal slippage.
As the crypto economy grows with every cycle, DEXs are becoming critical infrastructure, with their growth mirroring their importance. Nearly $1 trillion was traded on DEXes in 2023 (first image below), which equates to ~15% of what CEXes traded in the same year. DEX volume compared to CEX volume has increased from 0% pre-2020 to ~15% in 2024 (second image below).
Issues with DEXs
However, despite the consistent growth experienced by DEXes over the last several years, they remain a work in progress. Despite increased order volumes, the presence of professional market makers, and a wider range of quoted assets, Automated Market Makers (AMMs), which currently dominate the DEX landscape, are not without their flaws.
LVR and Toxic Flow
One of the major issues with AMMs stems from a phenomenon known as loss-versus-rebalancing (LVR). Uniswap LPs, for instance, have often been found to be quite unprofitable due to LVR resulting from toxic flow. This is because AMMs, being passive entities, cannot independently adjust their prices to match real-time price movements on more active exchanges, like Binance. Toxic flow emerges when the future's marked price deteriorates compared to the execution price, even after factoring in fees and price fluctuations. In simpler terms, when informed traders possess superior knowledge about a cryptocurrency's price compared to AMMs, the Liquidity Providers (LPs) often find themselves on the less favorable side of trades, engaging at outdated, less favorable prices.
This mismatch creates opportunities for arbitrageurs, leading to losses for LPs. Unlike active market makers on limit order books who strive to adjust their quotes instantaneously as prices change, LPs on AMMs often end up selling at non-optimal prices to arbitrageurs, hence suffering losses versus the potential profits from rebalancing their assets at the current market price.
Liquidity Fragmentation
Fragmentation of liquidity also poses a challenge for AMMs. The same tokens are often paired with different tokens across multiple pools, leading to a diffusion of liquidity, resulting in reduced fees for LPs, and lower depth and sub-optimal prices for traders. Centralized exchanges, by comparison, generally use a single quote asset, enabling market makers to concentrate most liquidity around the current market price.
High Gas Fees
One of the major drawbacks of AMMs is high gas fees. Trading on-chain remains expensive. Though AMM pool fees are comparable to centralized exchange (CEX) spreads, gas fees can substantially inflate the cost of small trades (under $1000), even on L2s. Additionally, prices on AMMs can often become stale, given that they only move through trades. This necessitates reliance on arbitrage traders to ensure AMM prices align with current market prices, yet these arbitrage traders face their own constraints such as pool fees, gas costs, and the inherent risk of holding volatile assets.
No Order Book
AMMs and liquidity pools function on a principle that facilitates asset swaps at prevailing market prices. Users engaging with this model face a binary choice: execute trades at current rates or wait until the asset reaches a desired price point. This mechanism, while efficient for immediate transactions, lacks the sophistication to accommodate limit orders, a key feature in traditional trading systems.
Traditional financial markets (TradFi) predominantly operate using a Central Limit Order Book (CLOB) design and limit orders. Limit orders represent a specific type of trade instruction where an investor specifies the price at which they wish to buy or sell an asset. For example, if AVAX is trading at $40, an investor might place a limit order to buy it if the price drops to $30. This contrasts sharply with market orders, which execute trades immediately at the best available current price.
One of the key differences in these models is that depositing tokens into an AMM does not represent a specific viewpoint on the asset's intrinsic value. Instead, it facilitates liquidity provision through a predefined algorithm, without the need for active management or strategic order placement. This fundamental difference underscores the distinct nature of liquidity provision and market operations between traditional and decentralized financial markets.
Centralized Limit Order Book (CLOB)
The Central Limit Order Book (CLOB) is a cornerstone in the trading of various assets, encompassing securities, commodities, and cryptocurrencies. This system, integral to the functioning of exchanges, offers a detailed and dynamic view of market activity, distinguishing itself from the liquidity pool-based approach commonly seen in decentralized exchanges (DEXes).
At its core, the CLOB is a comprehensive aggregation of buy orders (bids) and sell orders (asks), each marked with a specific price and quantity as determined by traders. This mechanism efficiently bridges the gap between buyers and sellers, providing a structured platform for market interactions.
In a CLOB system, market makers are integral to the market's functionality. They actively submit bids (buy orders) and offers (sell orders) to provide liquidity at specific price points. This targeted approach to liquidity provision is strategic and reflects the market makers' perception of an asset's intrinsic value. A bid typically indicates a belief that the asset's true worth is higher than the current bid price, whereas an offer suggests it is lower.
The role of a market maker in a CLOB environment is dynamic and demands agility. Market makers must continuously adjust their orders in response to real-time market movements. This process involves frequent additions and cancellations of orders, with professional electronic market makers often executing millions of such transactions daily. Their goal is to narrow the bid-ask spread — the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept — thereby enhancing market efficiency.
The utility of an order book lies in its ability to offer traders a real-time snapshot of the market's state. This includes an understanding of the buying and selling pressures on an asset. Key features like the 'top of the book', which displays the lowest sell orders and highest buy orders, are where most immediate transactions occur. The 'spread', or the difference between these orders, alongside 'slippage'—the difference between expected and actual transaction prices due to varying trading volumes—offers essential insights into the market's behavior and liquidity.
Advantages of CLOBs
- Control Over Trades: Traders in a CLOB have the ability to place limit orders at specific prices, offering more control over trade execution.
- Market Transparency: CLOBs provide visibility into the order book and market depth, aiding traders in making informed decisions.
Disadvantages of CLOBs
- Implementation Costs: The high volume of on-chain transactions in a CLOB can be prohibitively expensive on blockchains, such as Ethereum, with high gas fees. Successful implementation is currently feasible on more cost-effective chains or Layer 2 solutions.
- Vulnerability to Market Manipulation: Traders with significant capital can potentially influence market prices in their favor in a CLOB system.
- Liquidity Challenges: Certain assets in CLOBs may suffer from low liquidity, leading to price slippage and difficulties in executing trades at desired prices.
On-chain Order Books
On-chain order books represent an advancement in the evolution of DeFi. These systems, colloquially known as 'settlement engines' or 'matching engines', represent a fusion of traditional exchange mechanics with the decentralized, trustless ethos of blockchain technology. This integration not only enhances the transparency and efficiency of trading processes but also aligns with the core principles of decentralized exchanges (DEXes).
The primary advantage of on-chain order books is their ability to operate free from centralized control and interference. In traditional centralized exchanges, risks such as backdoors, emergency controls, and biased customer treatment often undermine the integrity of trading operations. By leveraging the cryptographic security inherent to blockchains, on-chain order books mitigate these risks, fostering a more equitable trading environment.
To effectively integrate a CLOB on-chain, a blockchain must possess certain characteristics. High throughput is essential, as orders need to be matched and updated in real-time. A blockchain lacking in speed could lead to significant issues like front-running orders. Additionally, low transaction fees are crucial since each on-chain matching incurs gas fees. Therefore, blockchains like Aptos or Solana or scaling solutions like Avalanche subnets, known for their speed and cost-effectiveness, are more suited for this purpose compared to slower and more expensive chains like Ethereum.
Hubble Exchange, run on Hubblenet, introduces an on-chain CLOB . This architecture ensures that all computations, including order matching and liquidations, are executed on-chain by Hubblenet's validators. The result is a trading platform that combines the transparency of AMMs with the capital efficiency and pricing accuracy of an order book.
As a decentralized order book, Hubble Exchange offers the full suite of features found in centralized exchanges while achieving a higher degree of decentralization.This model blends the precision of CLOB with the liquidity and user-centric design of AMMs, offering several advantages:
- Enhanced Price Discovery: The CLOB mechanism aggregates buy and sell orders, leading to more accurate market pricing reflective of real-time supply and demand.
- Increased Liquidity: Integration with AMMs ensures continuous liquidity, crucial for less frequently traded assets.
- Reduced Slippage: Combining order books with liquidity pools significantly lowers slippage, particularly beneficial for large order executions.
- Flexibility in Order Types: This model introduces various order types like limit orders, providing traders with greater flexibility, a feature generally absent in standard AMM setups.
- Efficient Trade Execution: Trades are routed through either the CLOB or AMM, depending on which mechanism offers optimized execution.
Hubble-specific Features
USDC as Gas
Hubblenet has introduced an innovative approach to enhancing the user experience by employing stablecoins, specifically USDC, for gas payments as opposed to AVAX. This is intended to simplify transactions for users who no longer need to navigate the complexities of bridging native tokens. The process has been further simplified by the introduction of the Circles Cross-Chain Transfer Protocol (CCTP). This innovative protocol aims to improve the interoperability of USDC, benefiting both developers and users by enabling the seamless transfer of USDC across different blockchain networks. With bridging frictions reduced, specifically for USDC, users and projects like Hubblenet stand to benefit. Moreover, this USDC-for-gas model benefits validators by ensuring they receive payments in USD, adding a layer of financial stability.
EVM Compatibility
Despite shirking the norms with its gas payment design, Hubblenet maintains full compatibility with Ethereum Virtual Machine (EVM). This compatibility is crucial as it allows developers to seamlessly integrate and create products, such as vaults, on the Hubblenet platform. The EVM compatibility ensures that popular tools like Metamask and other standard development utilities remain functional, further easing the transition for developers. It also enables the creation of the multi-collateral/cross-margin perpetual exchange, which acts as a foundational 'money lego' set.
Additionally, Hubble boasts a robust bridging system, powered by LayerZero. This feature allows for seamless asset deposits from a multitude of EVM chains directly onto Hubble Exchange, paving the way for Hubble to become a central trading hub for these networks.
Technical Efficiency -> Better Performance
A key feature of Hubblenet is its use of precompiles. These are specialized code segments that enable the extension of EVM's basic functionality at a predetermined gas cost. This feature is particularly beneficial for keeping certain operations, including order placement and liquidations, both swift and economical. Hubblenet's implementation of precompiles ensures decentralized order-matching, where validators manage liquidations and order matching. This decentralization means that order-matching is as distributed as the chain itself.
A testament to Hubblenet's efficiency and robustness was its performance during a recent market downturn. The platform successfully processed 13,265 liquidations, reaching a peak capability of 42 liquidations per second. This impressive feat underscores Hubblenet's potential in handling high-volume, high-stress financial scenarios within the DeFi landscape.
Others
Hubble’s on-chain order book design enables other novel possibilities like the capacity to support multiple order books. This flexibility permits the integration of additional order book sources, contingent only on the support of at least one validator within the network. An innovative aspect of this system is the shared liquidity across all order books, which opens up several possibilities:
- Private Orders: These allow traders to relay orders privately to participating validators.
- Just-in-Time Orders: These orders are revealed only at the point of matching, enhancing privacy and strategic trading.
- Gasless Orders: Removing the barrier of gas fees for order placement.
- Broadcast Orders on an Agnostic Data Availability Layer: Traders can relay signed orders through an economical data layer, with validators on Hubblenet matching these orders.
Conclusion
The advancements and innovations in Avalanche's ecosystem, particularly the introduction and growth of subnets such as Hubblenet, have marked a significant evolution in the blockchain and DeFi landscapes. Hubblenet's Hubble Exchange, with its pioneering features like a fully decentralized matching and liquidation engine, use of USDC as a gas token, and gasless transactions, represents a major leap forward in blending the efficiency of traditional centralized exchanges with the transparency and flexibility of decentralized platforms. The introduction of perpetual contracts and multi-collateral trading capabilities further democratizes access to complex financial instruments, allowing traders to harness the benefits of blockchain technology while mitigating risks associated with market volatility. As decentralized exchanges continue to grow and evolve, they are likely to play an increasingly vital role in the financial markets, offering users innovative trading solutions and contributing to the overall resilience and efficiency of the cryptocurrency ecosystem.
Disclaimer: This report was commissioned by Ava Labs. 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.
