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Executive Summary

• Current perp DEXs fail to properly account for risk, resulting in expensive trading fees, suboptimal returns for LPs, a lack of assets offered, lower capital efficiency, and a higher risk of insolvency

• Vest addresses this issue with two core innovations:

1. Dynamically adjusting trading fees based on the amount of risk a trader creates

2. Creating two separate sources of liquidity to protect LP capital and maximize risk-adjusted returns

• This allows Vest to easily list new assets, safely scale OI past TVL, and eventually serve as core infrastructure for a capital-efficient DeFi ecosystem with powerful cross-margining capabilities.

Background

The Vest Labs research team created Vest Exchange after years of rigorous research and discourse in the decentralized perpetual futures space. The team recognized a need for proper risk management and trade pricing, leading to traders paying too much on a per-trade basis and LPs taking on far too much risk to generate outsized returns while not being fairly compensated for that risk. The result of these efforts is a math-driven approach to mitigating risk within a system, allowing for a low cost of trading and fair returns for LPs. This risk engine, known as zkRisk, will first be applied to create a perpetual futures exchange due to their established product-market-fit on-chain. 

zkRisk

Vest's risk engine defines a monetary risk measure for any given trade to calculate the capital needed to ensure solvency. A premium known as Premia is established using this risk measure by calculating the difference in capital needed before and after that trade to ensure protocol solvency. Vest conducts this computation off-chain and submits a ZK proof to an on-chain verifier, only accepting the associated transaction if the proof is correct. Premia allows Vest to take on higher-risk positions and assets without exposing LPs or the AMM to disproportionate risk. 

Vest uses zkRisk to offer a perpetual futures platform where LPs provide capital that traders use to open positions, paying for the risk they create. Through this, Vest can offer trading for any asset with a price feed, safely scale OI past TVL, and offer outsized risk-adjusted returns for LPs.

Traders

Traders pay two fees to trade on Vest, Premia and a flat execution fee. Early simulations show Vest traders paying orders of magnitude lower fees on average than their counterparts trading on fixed-fee perp dexes. This built-in risk management also allows Vest to list new assets without any drastic changes. Trader/wins and losses, regardless of asset listing, are priced in using zkRisk, preventing LPs from taking on significant losses.  

As OI skew increases in any one direction for a given market, funding rate and Premia ensure that traders who exacerbate that skew compensate LPs adequately. The same risk measure used to calculate Premia is used to calculate funding rate. The same value is also split across each market via Euler Allocation to define an overall funding rate per asset. This funding rate is then split across all traders with an open position against that asset, ensuring that any change in risk is accounted for.

Liquidity Providers

Vest compensates passive LPs properly for the capital they provide via the fees traders pay and funding rate to compensate for change in risk. Premia is paid to the Vest AMM and LPs, while the flat execution fee is paid to LPs and the Vest team. Vest's AMM serves as a buffer between traders and LPs by first taking on trader profits and losses. The AMM allows LPs to generate consistent yield from both fees without having their gains wiped out by a profitable trading environment. The principal provided by LPs is intended to be fully protected and have none of its gains subsidized by trader losses. The execution fees create a predictable yield for LPs, while Premia allows them to accrue more or less yield when traders create a particularly skewed or balanced environment.

Many LP-based dexes face issues of LP profitability, generating strong and marketable yield over months only to have it wiped out and more by a single day of profitable trading. Vest's AMM buffer and risk-indifferent approach prevent these days from adversely affecting LPs while maintaining consistent yield generation.

Possibilities

Vest's on-chain perpetual futures exchange aims to be one of the most flexible and liquid on the market. In the long run, Vest will apply the zkRisk to monitor risk for an entire DeFi ecosystem, offering advanced capital-efficient DeFi Products. This ecosystem will have cross margin available across different products, allowing for fun possibilities like loans collateralized by perp positions, perp/options collateral being lent out to borrowers to generate yield, active limit orders being composable across other products, and more.

Vest's perpetual future exchange is the first and paramount step in that process. With the first product going live in the next few weeks, traders, LPs, and DeFi enthusiasts will be able to see just how impactful proper risk pricing can be for any DeFi product. Until then, any and all things related to Vest are open for academic discussion with other like-minded users on our research forum. Any updates, news, and additional info on Vest can be found first on our X and Discord, with a special opportunity to get involved today available on Discord.

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As we gear up for Vest’s mainnet launch, we present Vest’s performance compared to other exchanges in past market conditions. By analyzing historical market data, we gain insights into how Vest will redefine trading and liquidity provision for perpetual futures. This analysis offers traders a deeper look into the expected costs and benefits of trading on Vest, providing concrete projections to guide their decisions. Simultaneously, liquidity providers (LPs) can explore the prospects of Vest’s LP offerings and understand the kinds of returns that can be generated by using Vest. Pre-launch analysis allows the protocol to stay on track with its vision to ensure completely fair and optimal pricing for both LPs and traders in ways that DeFi has failed to thus far.

TL;DR

• Vest traders pay, on average, less than a third of what traders on traditional DEXs pay

• Vest LPs consistently outperform traditional DEX LPs due to preservation of capital and risk pricing

• Traders perform better on Vest than other DEXs due to lower fees on less risky trades and vice versa

Methodology

Our simulation model looked at price data from October 13, 2023, until November 13, 2023, for thirteen of the most commonly listed assets, including ETH, BTC, BNB, SOL, and more. The model made the following assumptions:

• 400 agents (traders) exhibiting random activity and 100 momentum traders who went long/short on a moving average crossover

• Randomized trades were skewed to be slightly skewed long (51% chance of long), with a frequency of about one trade per hour.

• Premium tolerance of 100bps, meaning agents would not accept that trade any time the premium of a given trade measured over 100bps due to market skew

• Each agent was seeded with $10,000 

• Trade size was drawn randomly from 0-10% of their remaining capital

• Total of $1m in starting capital for LPs.

All of the relevant assumptions from above were also applied to DEX β’s simulation. This was created to provide a baseline using a standard AMM fixed-fee DEX model with LP counterparties commonly seen today (GMX, Kwenta, Gains, MUX, etc.). On DEX β:

• LPs uniformly earn fees paid by traders

• Traders are charged 10bps on trade execution.

With these assumptions, we could simulate critical data points for trading fees, trader performance, and LP performance.

Trading fees

By simulating data across the two models above, we estimated trading fees for each of our given assets. Below is a histogram of trading fees on BTC/USDT for the month.

It’s clear that Vest has lower fees on average than DEX β, but the distribution shows just how high/low fees can get for Vest. Traders typically paid only 3bps in most cases on Vest, while DEX β traders paid well over three times that in their fixed fee format. Fee data for other markets shows lower fees across the board for a majority of trades:

Traders consistently enjoy lower fees on Vest as compared to not only DEX β but also as compared to most other DEX models. A trader only needs to pay fees in proportion to the risk they add to the system. There are some scenarios where traders will pay more fees, but they are few and far between, only occurring when contributing to an already significant skew. Most trades (75%) for higher liquidity markets still incurred under 5.5bps per trade, while more volatile markets (PEPE/USDT) saw an earlier spike to compensate the AMM and LPs for taking on additional risk. However, if traders pay less to trade, then LPs should also be earning less - how much would LPs be making in this scenario?

LP Performance

Most assume that if traders are paying less fees, LPs are also earning less. However, the opposite is shown to be the case in our simulations. This is due to AMM capital serving as a protective intermediary for LPs and traders directly paying for the risk they contribute. Via our simulation, we were able to visualize LP returns for the month:

Traders benefited from lower fees on Vest, while LPs experienced increased returns. Traditional DEX models might suggest that traders incurred significant losses using Vest. Yet, our simulations revealed the opposite. Due to the AMM buffer, less LP capital is needed to support trader activity. LPs still receive portions of additional Premia from riskier traders and flat execution fees. This setup makes LPs less vulnerable to profitable trading activity while ensuring they continue earning fees. As a result, they achieve more consistent returns and maintain capital, even during a substantial market upturn.

DEX β, on the other hand, had LPs suffer as a direct result of traders winning. Without a buffer and proper risk adjustment for LPs, trader PnL becomes directly subsidized by passive LP capital. This data suggests that traders may have lost more on Vest - due to the large discrepancy in LP capital. However, the opposite proved to be true instead.

Trader Performance

Trader performance on Vest is subsidized by AMM capital first and LP capital second. This allows the system to safely restabilize when traders are profitable without putting LPs at risk. Trader fees are paid in a risk-adjusted proportion to LPs and the AMM capital to support this process. These two design principles allow traders to profit more in similar market conditions, as seen below.

In a period where BTC/USD moved up nearly 30%, DEX β traders finished just under breakeven on average, while Vest traders finished up close to 50%. Part of this can be attributed to the random nature of the simulation. Still, when taken within the context of LP performance and fees paid, it’s clear how Vest improves returns and experience for all participants. By adjusting the cost of trading based on risk and providing LPs with a buffer to preserve initial capital, all participants can win using Vest.

Considerations 

These simulations show that properly adjusting for risk with a math-first approach creates a more profitable trading environment and higher LP returns than traditional fixed fee models on LP-based DEXs. However, it’s important to remember that these models don’t represent exactly what will happen in reality, and it’s up to the end user to practice proper risk management regardless. The first projections are very promising and pose that Vest will be one of the top trading venues at launch - but the only way to know for sure is to take these exact measurements post-launch.

We’d encourage all users/researchers to dig into our findings more to understand Vest better leading up to launch. These projections/ideas and more are open for discussion with other like-minded users on our research forum. Any updates, news, and additional info on Vest can be found first on our X and Discord.

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Only Possible on Vest

Vest Exchange’s design allows for the creation of liquid and secure perpetual futures markets for traders and sustainable and compelling returns for liquidity providers. In addition to this, Vest also creates the possibility for additional software to be built on top of the infrastructure to offer additional products that haven’t been appropriately executed elsewhere. 

With Vest’s zkRisk engine, offerings like structured products, new markets, and more can all be easily provided. Vest’s superior LP experience and returns can be used to create custom-built strategies backed by one of the most sustainable yield sources in DeFi.

Due to Vest’s composability-first software approach, all of this can be feasibly built by any individual or team with an idea. Building on top of Vest will be entirely permissionless and open. Teams interested in trying something new or even adding more robust infrastructure to an existing product will be able to leverage Vest as they please.

New Markets

Protecting LP capital and the overall system from insolvency in all market conditions without capital limitations has the benefit of quickly listing any asset with a price feed on Vest. This means that a new class of assets can easily offer perpetual futures on Vest. Vest can be a hub for perp trading against tail assets, NFTs, real estate, bonds, forex, commodities, and other real-world assets (RWAs) on zkSync. 

Vest can offer these assets because the risk engine does not need direct asset backing for every trade. This can have the unintended consequence of putting too much risk on LPs and the AMM due to the volatility of illiquid assets. Still, Vest mitigates that risk by charging traders for executing trades that increase risk and compensating LPs with those additional fees, or Premia. In addition, the AMM buffer between LPs and traders creates a cushion that lets LPs gradually generate fees proportional to any risk they take without compromising their initial capital deposit.

Most NFTs, tail-end digital assets, and RWAs don’t have any derivatives markets to trade - on-chain or elsewhere. The few existing markets are limited in many ways and/or have backfired on users and LPs in the past. With Vest, traders will be able to access these markets and more with fewer limitations and more liquidity than previously was possible.

Structured Products

Early simulations of Vest’s LP offering predict a potential return well into the triple-digit APYs. Unlike most LP opportunities backed by perp DEXs, this figure is largely agnostic towards trader PnL, making it one of the market’s most delta-neutral high-yield LP opportunities. Given such a high baseline, creating strategies backed by Vest LP positions opens up a world of possibilities. Long/short delta strategies that carry a directional bias can be developed, allowing users to earn high yields while also getting exposure to the price of certain assets.

Combining a Vest LP position with a long/short bias to anything from specific assets to volatility to create more sophisticated structured products for users. Starting with a position that yields three-digit APY while keeping most of the capital risk-off, strategies built with a Vest LP as one leg of the equation start with a higher baseline than any others. Strategies like this will also serve as a net positive for the Vest ecosystem, deepening liquidity for traders and allowing the platform to scale with greater demand and assets. 

Cross-Product Margin

Vest’s zkRisk engine is great for creating a risk-adjusted environment for perp trading, but it doesn’t stop there. The framework monitors the risk of the entire exchange, meaning any number of products can tap into it. This means that anyone can permissionlessly create a myriad of new products, such as options trading, money markets, and spot trading,  while tapping into Vest’s risk framework and deep liquidity. This has the key benefit of composable liquidity for any products in the Vest ecosystem, allowing for a myriad of new usecases.

Positions on Vest perps could be used as collateral for a loan. LP positions could be used as collateral to open positions for options. Active limit orders can rest in Vest’s money market, earning yield while the user waits to be filled. The end vision for Vestis to create a fully composable and cross-margined DeFi ecosystem - where every product is risk-indifferent for LPs and infrastructure, liquidity is composable across said products, and users can make use of them with little to no restrictions.

Sky is the Limit

The above solutions presented only scratch the surface - the possibilities the broader Vest ecosystem will provide are endless. Stablecoins could be built and backed by Vest LPs so that they are naturally yield-bearing. Different perp-based stablecoin models could be built with Vest perps as a backing as opposed to LPs due to the higher liquidity and security available. Composable Vest LP positions could be used as collateral in money markets, freeing up liquidity within the ecosystem. 

The possibilities are limited by user demand and builder imagination. Offering an innovative space for users to trade a wide variety of assets and for LPs to earn yield like never before also opens up the possibility for brand-new ideas that have never been seen before. If you’ve got such an idea, discuss it with other like-minded users on our research forum. Any updates, news, and additional info on Vest can be found first on our X and Discord.

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On-chain perpetual futures markets represent a revolutionary advancement in technology for global finance. Since Bitmex first announced XBTUSD perpetual futures in 2016, crypto traders and developers have contributed to ongoing innovation and technical advancements in trading perps.

Perpetual futures decentralized exchanges (perp DEXs) now exist across various blockchain networks, each with a distinct set of modifications and tradeoffs. However, these DEXs face significant shortcomings as they are forced to trade between speed, decentralization, liquidity, and safety. 

The Vest exchange is the culmination of the team’s efforts in addressing these core challenges. Vest redefines the paradigm, not by offering incremental improvements but by implementing capital-efficient pricing for traders and LPs, introducing a novel funding rate mechanism, and eliminating open interest (OI) caps.

The resulting platform represents a convergence of safety and efficiency, providing traders with fewer limitations and a broader range of options, all within a secure and reliable ecosystem where solvency is guaranteed by mathematical principles.

Vest champions a security-first strategy, ensuring traders benefit from robust protection without compromising capital efficiency.

Where We Are

The perpetual futures space looks vastly different from what it did a year ago. Modern DEXs employ broadly similar approaches but on various chains or with slightly different design principles. To better illustrate how Vest will revolutionize the currently available trading options, let's look at two types of DEXs common in today’s landscape. 

DEX A: Uses a multi-asset pool backing, where the amount and type of each asset available dictates OI caps and assets available for trading.

DEX B: Uses single-asset backing that serves as a debt pool for minting synthetic assets, where governance dictates OI caps per market. 

DEX A can offer liquid trading against any assets supported in its liquidity pool. These are usually limited to a handful of popular assets - each can only provide as much OI as TVL in the liquidity pool. This limits capital efficiency but protects the protocol from most insolvency risk. DEX B can more easily add new assets so long as a proper risk analysis is conducted and agreed upon via governance. However, this also limits the capital efficiency of the more popular assets, as there is no risk segmentation between higher-risk and lower-risk assets - all are backed by a debt pool consisting of a single asset (usually a stablecoin). In addition, this creates contagion risk for the protocol - as all assets are backed by a single pool. OI caps help mitigate this, but truly scaling to meet demand (in pure volume and asset variety) is near impossible. 

Funding rate calculations can also be a point of friction for traders on both DEXs and a point of risk to the overall system. Common funding rate mechanisms fail to adequately distribute risk throughout the system, incurring price risk for the assets being held by LPs. In addition, funding rate can quickly flip in volatile markets, hurting funding rate farmers and longer time frame traders. These mechanisms generally work by applying a coefficient of imbalance to a given market's long/short ratio and then charging an equal funding rate to all traders that gradually increases as long as OI remains skewed in one direction.

Vest

Vest's zkRisk engine ensures that traders can trade any assets with higher capital efficiency (no OI caps), low risk of insolvency, and more dynamic funding rate calculations to protect traders and the protocol. The protocol can be undercollateralized with minimal risk to LPs and full profit realization for traders. This is done by mathematically calculating risk for any given trade and using those calculations to increase/decrease the cost of trading for a given asset. This maintains risk indifference across any number of markets to keep inventory risk to a minimum without limiting traders. The increase in the cost of trading is known as Premia.

Most dexes today require user fees to be wholly arbitrary, not properly compensating LPs for the risk they take on and thus preventing the system from scaling due to improper risk adjustment. Vest’s zkRisk engine optimally aligns interaction between traders, LPs, and the exchange such that each one is able to act in their best interests without harm to any other. This also makes it easy to list new assets. Since risk is mitigated on a per-asset basis depending on the market skew, the system (as well as LPs) are properly compensated for the inventory risk they take on for holding certain assets. 

Vest’s zkRisk engine also calculates funding rate in a way that’s safer for the protocol and more friendly for traders. The same risk measure (EVaR, Entropic Value at Risk) used to calculate Premia, is also used to calculate risk for funding at any given time. Given that funding is charged with respect to time rather than on open/close, this risk measure is continuously calculated every second. This measure, calculated for the entire exchange, is split across markets via Euler Allocation and then across traders based on how much OI they own within that market. 

This creates a system where the amount of funding needed to account for inherent risk is calculated every second and dynamically readjusted. This gives traders a continuous and smooth funding rate and gives the exchange another risk mitigation mechanism.

Vest provides a security-first approach to traders that doesn’t require tradeoffs in capital efficiency. Via the zkRisk engine, traders can enjoy leveraged trading with peace of mind that their PnL, Vest, and LPs will all remain secure and solvent. More information on Vest and how users can get involved in creative ways is yet to come - We encourage anyone looking for further information to check out and participate in our research forum. Any updates, news, and product features can be first found on X and in our Discord.

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Core Challenges for Liquidity Providers

Liquidity providers (LPs) must deal with a minefield of risks when evaluating opportunities. The main inefficiencies LPs deal with within the perpetual futures space include:

1. LPs being unwilling and unprotected counterparties to smart traders

2. LPs not being compensated properly for taking on that risk

3. Protocol/AMM insolvency.

Problem #I: Settling Trader PnL

AMM-based dexes require LPs to put up idle capital in order to facilitate trading. LPs receive trader losses and fees for doing so but are also required to fulfill trader profits. A profitable trading environment can result in negative returns for LPs, wiping out gains from steady double-digit positive returns from months prior. A lack of proper risk management has long been inherent to passive LP strategies.

Problem #2: Lack of Proper Compensation

In most models, LPs are compensated for taking on the above risk with fees. These are often a few basis points per trade that allow these pools to offer what often looks like low double-digit yield. In a neutral/risk-off market environment, these returns can often remain steady and sustainable. But in a volatile/risk-on market environment, returns can be wiped out in a single day. Even in calmer market conditions, an intelligent trader(s) can drain LP funds with a profitable trade or strategy - a risk rarely reflected in the 15% APY users see on the frontend.

Problem #3: Insolvency

An issue specific to undercollateralized systems, insolvency can occur when an AMM takes on more liabilities than assets without a proper hedge. Should a dex become insolvent, LPs may be unable to withdraw their initial capital while traders may not be able to close active positions. A number of virtual AMMs and other protocols have seen their downfall as an unintended outcome of trying to create a more capital-efficient system.

Risk-Indifferent LPing with Vest Exchange

Vest is an AMM-based perpetual futures dex, built on zkSync. The above problems are addressed on Vest by:

1. Creating a barrier between traders and LPs via AMM capital

2. Paying risk-adjusted compensation to LPs

3. Dynamically adjusting the cost to trade based on its effect on insolvency risk.

Vest is an AMM-based dex with a proprietary risk management system known as zkRisk, designed to protect LP capital while safely increasing capital efficiency for traders. The AMM is the first point of contact for traders, providing liquidity for trades and taking on all trader PnL until it no longer has any available liquidity. At this point, LP capital is used to fill trades. Regardless of the counterparty, a portion of the fees from a trade always go to LPs in order to maintain a stable balance. These fees consist of flat execution fees and premia.

Premia

Traders will have to pay an additional premium when executing specific trades. The Vest AMM assigns a monetary risk measure, Entropic Value at Risk (EVaR), to any given trade. This value measures the capital needed to minimize the probability of a position (in this case, the AMM) going underwater. EVaR is applied to the difference between liabilities (trader profits) and assets (current liquidity + collected premiums) to determine a risk value at any time. Premia is calculated by taking the difference between the risk after accepting the trade and the risk before accepting the trade. If the trade increases risk, the trader is charged a premium proportional to the additional risk it introduces. 

Premia is distributed to the AMM and LPs, along with execution fees going directly to the LPs. The fee distribution is roughly detailed as follows:

• Premia: paid to both AMM and LPs

• Execution fees: paid to LPs and the Vest team.

Trader PnL is settled by AMM capital, while fees are split between the two sources. Premia is used to maintain a healthy risk level for LPs and the AMM. Execution fees are used solely to ensure positive PnL for LPs. Premia is split between the two sources for two different purposes - AMM capital receives premia in order to maintain solvency while LPs receive premia in order to maintain risk-indifference. The EV of LP gains is intended to be 0 in any market conditions - LPs keep what they initially deposited, while execution fees are routed directly to them in order to generate steady yield based on demand rather than the profitability of traders.

While Premia is used to mitigate inventory risk for Vest, funding rates are used to mitigate price risk; the risk associated with the changes of price in the held assets. Vest distributes funding rates via Euler Allocation, a traditional risk distribution method that evenly distributes funding across markets. Euler Allocation determines a risk measure for each asset, which is then multiplied by the percentage of open interest owned by a trader in that market to calculate the funding paid. This allows funding to be evenly distributed throughout the system, correcting long/short imbalances while protecting the system from price risk.

Capital Efficiency Without Insolvency

Most AMM-based perpetual futures dexes must either set an open interest (OI) cap or risk an insolvency scenario. This prevents these dexes from meeting trader demand and reduces capital efficiency, as the system can usually only take on (at most) as much OI as there is TVL. Vest uses a risk engine to dynamically affect the cost of trading based on the quantifiable risk metrics, removing the need for OI caps. This allows the exchange to safely move past traditional OI caps and even scale OI past TVL without being at risk of insolvency. Doing so also allows LPs and the AMM to earn more, since Vest can handle greater OI it will be able to generate more fees.

Many perp dexes fall victim to the chicken-and-egg liquidity problem, where low liquidity results in a less ideal trading environment, which leads to lower fees for LPs, exacerbating the low liquidity issue that started the cycle. By prioritizing safety while increasing capital efficiency, Vest can become one of the most liquid on-chain perp trading venues. This will prevent the liquidity death cycle from taking place, maintain and steadily grow LP capital, and offer dynamic pricing and deep liquidity for traders.

Providing Liquidity to Vest

The process of LPing on Vest will be familiar to most LPs. Users can deposit any amount of USDC and immediately begin earning fees on their deposit. The initial USDC deposit is intended to remain stable while earning interest primarily via fees rather than trader PnL. Once an active LP chooses to withdraw, they must first signal the intention to do so, triggering a 24-hour waiting period. After this, the LP can withdraw with no issue. Should they choose to withdraw immediately, Vest charges an additional withdrawal fee - this fee is calculated similarly to trader premia in that it’s used to balance LP risk. This is to maintain Vest’s approach to data-driven security; 24 hours gives the system enough time to price the loss of capital and adjust all parameters accordingly. 

More Information Coming Soon

Vest Exchange is being built with a math-centric approach to bring numerous innovations to the on-chain perpetual futures space. Providing a risk-indifferent approach to LPing is just one way Vest aims to offer one of the strongest on-chain trading venues in DeFi. Over the coming weeks, you can expect to see more info on Vest’s key features for all kinds of users. In the meantime, we’d encourage anyone looking for further information to read and participate in the ongoing discussion on our research forum. To keep up with all current news and information, follow us on X and join our Discord.