Nowadays most of the trades are conducted through centralised exchanges. These are relatively efficient as they require traders to deposit the assets first in order to proceed with the trade. Dishonest or unprofessional exchange operators may confiscate or lose the assets given into custody. Moreover, centralised exchanges are susceptible to be attacked and therefore are exposed to malicious third parties. On the other hand, decentralised exchange protocols mitigate these issues by removing the trust requirement. Users do not need to deposit their assets as these remain in their control until the trade is executed. Smart contracts represent the linking bridge between traders. Both sides of the trade are performed in one indivisible transaction, mitigating the counter party credit risk. The contracts can assume the roles of custodians, escrow agents and central counter party clearing houses. For more information about the Decentralised Finance (i.e. DeFi) world and the overall risks to which traders are exposed to, visit the following link:
Asset holders are equipped by the Mettalex system with risk management tools without charging high spreads. Users are not exposed to counter party risk as all transactions and trades happen through the Mettalex smart contract. This decentralisation can additionally be guaranteed through Position tokens which are backed by a fully collateralised collateral so removing the need for margin requirements and settlement. That is, no further funding is needed. Mettalex users have the opportunity to generate their own liquidity by creating more position tokens by locking-up new collateral. These new minted token pairs can be used to mitigate exposure to risks or create an exposure to certain commodity assets thanks to leveraging opportunities. The autonomous market maker uses a liquidity sensitive algorithm with bounded loss to manage market risk.
Demand and liquidity in the Mettalex decoupled liquidity pool play an essential role in the automated market making process as the AMM adjusts the price of each token according to liquidity demand and the reference index fed from outside oracles. Trades take place inside a band of price values (Δ). In fact:
if traders open a long position and then the spot price goes up then they will experience an increase in the value of the L token and a decrease in the value of the S one. As demand arises, the price of L tokens will go up until it reaches the cap. At this point the value of L tokens would be equal to the value of the backing collateral and S tokens would be worthless;
if the spot price falls and reaches the floor of the reference band, the price of S tokens would be equal to the price of the backed collateral whereas L tokens price would be equal to zero. In this case, traders who had opened a short position would have gained a profit.
This means traders are exposed to volatility risk. On the other hand, liquidity providers expose themselves to timing risk when providing liquidity to the AMM. Liquidity providers will see substantial returns on their investments due to trading fees that will increase their governance influence. Thus, it is possible to collect enough liquidity to provide to the AMM if needed to guarantee the execution of transactions. The Governance Layer rewards LPs with MTLX tokens. These governance tokens will increase LPs governance influence and can gain additional yield via yield farming strategies. Furthermore, LPs can trade using their position tokens on the market by opening long or short positions according to their strategies and risk propensity as the trader will have to face volatility risk connected to the underlying assets prices. However, each LP is allowed to exit a position at any point. An additional way Mettalex DEX reduces risk is through the properties of position tokens. With no expiry date or delivery associated with the tokens, the need for market participants to engage in complex rolling of positions or carry trades is eliminated. Mettalex’s cap and floor trading band gives confidence to traders as any potential losses will be limited to the initial acquisition cost of the tokens. Mettalex DEX offers the potential for scalable liquidity to be brought to sectors of the commodities market that have either been poorly traded or inaccessible to the vast majority of traders so providing a decentralised model that also helps to keep transaction fees to a minimum.
In Mettalex DEX, liquidity is provided in a single token and not as a ratio of multiple tokens. Also, the liquidity is provided using stable coins (e.g. USDT) which reduces the volatility risk. The stablecoin used as a collateral to issue position tokens has a combined value which is always equal to the collateral value. When supplying liquidity to pools, traders expose themselves to risk of potential losses. In Mettalex DEX, this risk is lower for LPs due to lower volatility of the underlying assets and provision of liquidity in stablecoin. This combination guarantees a very low risk of impermanent losses. However, in regular circumstances, LPs who provided liquidity to the system have the opportunity to exit the system in times of high demand. This provides them with an opportunity to recoup capital before re-engaging with the system. By the way, in periods in which the Mettalex smart contract need for liquidity is high, LPs may be required to wait a short period in order to guarantee a baseline level of liquidity to be reached. This is not only to make sure the system remains afloat, but also to protect the investment they made into the exchange.