Economic model behind Mettalex DEX
Mettalex DEX overall structure is composed of four different layers:
- Tokenisation Layer
- Exchange Layer
- Liquidity Provision Layer
- Governance Layer
Inside the Mettalex platform an important role is played by Position tokens. These tokens are minted in pairs by the Mettalex smart contract by locking up collateral into it (i.e. stablecoins such as USDT, BUSD or USDO). This process takes place on the Tokenisation Layer. In the latter, the Mettalex Vault is fundamental as it contains the collateral that backs the pairs of Long and Short Position tokens. The Mettalex Exchange Layer provides a reference price feed from an index or data-feed provider. The fairness of the information is guaranteed by the multiple sources providing different data (e.g. QUANDL, Chainlink, REFINITIV, Davis) and more data feeds will be added in the near future (e.g. Platts and Fetch.ai agents) thus providing a wide variety of possible oracles from which gather data. These multiple sources allow the communication between Mettalex and the real world. The price data gathered is processed by the Mettalex CloudSQL component in order to allow the implementation of new markets, the recovery of price feeds and to ensure the continuous updating of prices displayed to on-chain and off-chain components. Traders are presented with reliable indices providing valuation for the commodities listed. On this layer, Position tokens track the change in the price of an underlying asset and users are free to open positions on the market with them. As mentioned, Position tokens can be divided into Long tokens (i.e. L tokens) and Short tokens (i.e. S tokens). These respectively track the positive and negative change in a given price of an underlying asset. Traders can buy or sell using stable coin (e.g. USDT, BUSD) collateral by trading with other participants or the Mettalex AMM. In this case, the latter refers to the AMM pool (i.e. a different Balancer-based pool) which contains a mix of stable coin, L and S tokens that can be swapped among traders, while it adjusts the price of the tokens depending on liquidity demand and data from outside oracles. Position tokens are a disruptive technology equipped with various properties, such as:
- No need for further funding as these are always fully collateralised (i.e. there are not any margin requirements);
- These are ERC-20 tokens, so it is easy to store them in wallets (e.g. MetaMask);
- No fixed expiry date so holders do not need to rollover their positions as token expiry reaches;
- These allow holders to open a leveraged position (i.e. in this case, the ratio between the price of L tokens and S tokens will differ from the spot price available on the market).
These tokens do not require the entire value of the collateral to be locked up in a smart contract: it means that contracts of much larger sizes can be traded with fewer collateral requirements on Mettalex. Let’s consider the following example:
E.g.: A trader wants to open a position on the market via buying an asset like Bitcoin (i.e. BTC). If the BTC price on the market is BTCUSD = $10’000.00, with Cap = $11’000.00 and Floor = $9’000.00 the collateral required on Mettalex DEX to mint a pair of L/S tokens would be equal to $2’000.00 rather than the market spot price equal to $10’000.00.
As outlined in the example above, distinctly from conventional market, Mettalex leverage requirements refer to price movements: the trade happens in a range of price (Δ), until this one hits a pre-set price band of reference (i.e. floor or cap). The value of a L/S pair of tokens is equal to the Δ, so the pair can be minted just by depositing a collateral as worth as Δ. The underlying spot price moves inside this range of values and as it trades away from the centre price (i.e. the central value of the band), it will be cheaper to buy tokens representing the trend opposite to the price movements. If the spot price breaches the band, the L/S pair will be settled automatically and all of the backed collateral will be distributed back to the token holders. The new spot price will initialise the smart contract around the new price value with the same Δ. At this point new position tokens will be minted and trading starts again. The following example helps to visualise the idea:
E.g.: Table 1 depicts the historical price graph for the London Metal Exchange (i.e. LME) Steel Scrap: For commodity Position tokens we expect the spot price to usually trade inside Δ. If we consider the steel scrap this might range from $225.00 to $375.00 per tonne (i.e. a delta of $150.00 centred around $300.00). We can use this trading range to set the floor and cap prices for the token pair. The value of a long and short pair of tokens is equal to the delta, here $150.00, with floor set at $225.00 and cap at $375.00. That is, depositing a collateral worth $150,00 will allow the trader to mint a L/S pair. Assuming the spot price when the tokens are minted is $300, each token will have a value of $75.00, representing a leverage of $300.00/$75.00 = 4x.
Table 1: LME Steel Scrap historical price graph.
By choosing the floor and the cap basing on historical delta we can create a non-expiring perpetual token that can be held indefinitely as long as the spot remains within the historical range of reference. Therefore, as the spot trades away from the centre price it becomes cheaper to buy exposure for the position opposite the movement.
Following the example above, if spot increases to $350.00 the value of a long token becomes $125.00 (i.e. leverage of $350.00/$125.00 = 2.8x) while the short token is now worth $25.00 (i.e. leverage of $350.00/$25.00 = 14x). This is an incentive for market participants to provide liquidity for the short position at low.
Mettalex DEX offers to Liquidity Providers (i.e. LPs) the chance to supply liquidity directly to Mettalex system through the Liquidity Provision Layer. The liquidity collected throughout this layer is stored into decoupled liquidity pools. The AMM uses the Mettalex smart contract to convert the supplied collateral into position tokens for market making operations. In exchange for locking up their collateral, LPs are rewarded with a further aggregated yield on the capital invested via transaction fees and trading spreads between prices, according to the amount and duration of liquidity supplied into the system. Compared with other liquidity pools, like Uniswap or Balancer, Mettalex DEX allows LPs to deposit just a token in order to provide liquidity, as only one asset (i.e. USDT) is contained in the Liquidity Providers pool (i.e. the LPs pool). Other liquidity pools' liquidity providers would need to supply a pair of tokens (e.g. ETH/USDT) in order to provide liquidity into them. The Mettalex LPs pool works as a decoupled liquidity pool whose role is to guarantee the provisioning of liquidity to the AMM so minimising the timing risk of any impermanent losses the AMM is exposed to. This liquidity will be then converted internally by the AMM pool into a mix of stablecoin, Long and Short tokens which will be supplied to the Exchange layer in order to be traded among traders on the market. This is, the AMM pool contains a mix of tokens whereas LPs pool contains just stable coin collateral. The mechanism is based on the fact that LPs take on the timing risk in exchange for a return from the AMM. The contract is very simple as it focuses on only one variable: total liquidity provided (i.e. deposits). The objective is having always enough liquidity in the pool. So, the liquidity provision layer represents the component that funds autonomous market making processes. Because of this, the Governance Layer rewards LPs with governance tokens (i.e. MTLX Tokens) via a liquidity mining process that rewards in proportion to the amount and duration of supplied liquidity in the system. These tokens were initially distributed among Fetch.ai stakeholders (i.e. FET token holders) in accordance with the quantity of FET owned. This layer enables decentralised governance of the platform itself: MTLX tokens enable stakeholders to take part in the decision making processes regarding the platform. These allow them to govern on the policies and fees applied inside the platform itself, including:
- System parameters (e.g. the choice of the AMM to back with liquidity from the liquidity pool);
- Creation of new markets;
- Usage of the collected exchange fees;
- Percentage of spread going into the liquidity pool;
- The buy-back and borrowing rates from the liquidity pool.
The following table offers an overview of the Mettalex Decentralised Exchange overall structure (Table 2):
Table 2: MTLX system diagram. Source: Mettalex Litepaper, September, 2020.
As an additional part of the mechanism, Mettalex DEX uses a fraction of the exchange fees earned on the platform to algorithmically buy MTLX tokens back from the market. Governance tokens are minted at a linear rate to incentivise early liquidity providers in the system. However as the total liquidity in the pool increases, liquidity mining will become more difficult.
In conclusion, as we can see in Table 2, Mettalex DEX comprehends three different pools of liquidity. Even if all these liquidity pools are connected one to each other at the same time these work separately and each one of them accumulate a different type of collateral tokens. We can distinguish the following pools of tokens:
- Mettalex vault: contains the liquidity coming from the collateral used to back a pair of L and S Position tokens (i.e. Tokenisation Layer);
- LPs pool: LP supplies coin to earn a return return from trading fees (i.e. Liquidity Provision Layer);
- AMM pool: AMM that contains a mix of stable coin in addition to L and S tokens. The liquidity contained in the AMM pool is for traders to swap between each other (i.e. Exchange Layer).