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Building Binance On-Chain | Cindy Leow & Chris Heaney, Drift Protocol

By Unlayered

Published on 2024-03-22

Discover how Drift Protocol is building the future of decentralized perpetual futures trading on Solana, aiming to rival centralized exchanges like Binance.

The notes below are AI generated and may not be 100% accurate. Watch the video to be sure!

The Origins of Drift Protocol

Drift Protocol, co-founded by Cindy Leow and Chris Heaney, emerged in the summer of 2021 as a response to the lack of perpetual decentralized exchanges (DEXs) on Solana. The founders recognized Solana's potential as the ideal blockchain for hosting a fast and performant on-chain DEX due to its impressive speed and efficiency. Interestingly, the co-founders met on Twitter, highlighting the power of social media in bringing together innovative minds in the crypto space.

Chris Heaney, coming from a background as a software engineer at Amazon, became fascinated with crypto during the COVID-19 pandemic. He fell in love with Solana's technology and community in 2021, which led him to dive deep into the ecosystem. Cindy Leow, on the other hand, brought valuable experience from her trading background in crypto.

The team launched their first product in November 2021, which was a pure virtual AMM (Automated Market Maker). Building on the ideas and lessons learned from their initial version, they developed and launched Drift V2 in November 2022. This latest iteration has propelled Drift to become the largest perpetual DEX on Solana, boasting impressive statistics:

  • Over 100,000 users
  • $250 million in Total Value Locked (TVL)
  • Daily trading volume between $100 million to $200 million

Understanding Perpetual Futures

Perpetual futures, often referred to as "perps," are a crypto-native financial invention that has gained significant popularity in the digital asset space. Unlike traditional futures contracts that have expiration dates, perpetual futures don't expire. They are designed to track the price of an underlying asset through a mechanism called the funding rate.

The funding rate is a periodic payment between long and short traders that keeps the perpetual future price aligned with the spot price of the underlying asset. For example, if the price of Solana perpetual futures is higher than the spot price, long position holders will pay short position holders, and vice versa. This mechanism ensures that the perp price stays close to the spot price over time.

Cindy Leow explains the recent market dynamics: "In the past couple of months, the price of Solana perps has been elevated compared to the price of the underlying. It's a lot of demand to buy the underlying and leverage up on the futures contract as well. So yeah, premium on perps have been anywhere between 100 to 200% annualized, million centreds. Yeah, that shows heavy to mine for the underlying."

The Advantages of Perpetual Futures in Crypto

Perpetual futures have become incredibly popular in the crypto space for several reasons. Chris Heaney highlights one of the key advantages: "Part of the reason why perps have gotten really popular in crypto is we see all these crypto assets like scattered across a bunch of blockchains, a bunch of L2s, et cetera. And bridging between all these blockchains is pretty painful. So the nice thing about perps being synthetic is it means that you can trade all these different assets in one place, which reduces a lot of friction for users."

This means that Drift users aren't limited to trading just Solana-related assets. They can potentially trade any asset, including those from other blockchains like Ethereum or Bitcoin. This synthetic nature of perpetual futures opens up a wide range of trading possibilities without the need for complex cross-chain interactions.

Another significant benefit of perpetual futures is their use in hedging strategies. Heaney explains: "Someone might believe, like someone might wanna hold their Solana because they're earning staking, but they're worried about the price of it going down. They can open up a short perp to hedge their exposure in USD."

Why Perpetual Futures Dominate in Crypto Over Options

While options trading is hugely popular in traditional finance, perpetual futures have taken center stage in the crypto world. Cindy Leow offers insights into why this is the case:

  1. Simplicity: Perps are much simpler to understand and trade compared to options. With options, traders need to consider various factors like strike prices, expiration dates, and implied volatility. Perps, on the other hand, are simply a bet on whether the price will go up or down.

  2. Volatility: Crypto assets already have significant volatility. Options, which are essentially leveraged bets on volatility, can be too complex and risky for many traders in such a volatile market.

  3. Infrastructure Challenges: The nature of blockchain technology makes it difficult to support the complex liquidity requirements of options markets. Leow explains, "But imagine having to have market makers for every single strike for an option on chain and forcing them to liquidate users on chain. So I think that the nature of blockchain make it quite difficult for it to support the complex nature of options."

  4. User Preferences: The fast-paced, high-dopamine nature of crypto trading aligns well with the straightforward long/short positions offered by perpetual futures.

Leverage and Risk Management on Drift

Drift offers users the ability to trade with leverage, in some cases up to 20x on certain markets. However, managing leverage and associated risks is a complex task that requires sophisticated systems and strategies.

Chris Heaney explains that leverage is not fungible across time and varies based on several factors:

  1. User Size: "For example, the bigger a user, the less leverage you wanna extend them because if they're very big, it's actually, it's harder to liquidate them because their size will move the price."

  2. Global Leverage Caps: "So Drift is cross collateral, which means you can borrow against different spot positions, which poses a lot of different risk. So we have the concept of like basically max borrowing power for a given asset."

  3. Dynamic Adjustments: "So if you're always offering 20x leverage, regardless of like the global leverage in the system or how big users are, you can get into trouble."

These risk management practices help ensure the stability and sustainability of the platform, protecting both users and the protocol itself.

The Insurance Fund and P&L Settlement

To manage risks associated with leveraged trading, Drift implements several mechanisms, including an insurance fund and a settled P&L pool. Cindy Leow explains the importance of having sufficient P&L in the system:

"So you need to make sure that there's actual P&L or losses in the system given to the protocol in order to realize someone else's profits. So in the past, if you remember the famous BCH having incident on Okeyats back in I think 2019, they had an issue where there wasn't enough P&L in the system in order to settle huge profits made by people who longed the BCH breakout."

To prevent such issues, Drift has a settled P&L pool per market. Users with significant profits need to settle against this pool, ensuring that there are always sufficient funds to pay out winnings.

The insurance fund serves as an additional layer of protection. Chris Heaney elaborates: "Each perp market, if there is not enough P&L for the user to withdraw, either if it's, and this is like configurable perp perp market, but either the money is pulled from the insurance fund."

For smaller, riskier markets, losses may be socialized across users. This approach allows Drift to list a wider range of markets without putting excessive risk on the insurance fund.

Drift's Product Ecosystem

Drift offers a diverse range of products beyond just perpetual futures trading. These include borrow-lend markets, insurance funds, delta-neutral vaults, and counterparty trading. This variety stems from Drift's unique cross-collateral functionality.

Cindy Leow explains: "So you can deposit sole spot, you can deposit BDC, wrapped ETH, even assets like Jupiter or Geto on the platform. And how we've enabled this is that we've built a backend bar-lend market that supports the cross collateral, the long-planned liquidation system, which enables assets to be liquidated if they can't support the open positions that you have."

This cross-collateral system has become a key differentiator for Drift, attracting traders who want to maintain exposure to various assets while trading. It has also led to the development of additional products, such as delta-neutral vaults that allow users to earn yield without taking on market risk.

Sourcing Liquidity in a Bull Market

One of the challenges for any trading platform is ensuring sufficient liquidity, especially during volatile market conditions. Drift employs a multi-pronged approach to sourcing liquidity:

  1. Virtual AMM: This serves as a backstop liquidity provider, collateralized by the protocol's fees and revenue, as well as users who want to provide liquidity.

  2. Active Market Makers: These entities can place resting limit orders or provide just-in-time liquidity by filling user orders atomically.

  3. Funding Arbitrageurs: These traders help balance the market by taking advantage of funding rate discrepancies.

Chris Heaney emphasizes the importance of active market makers: "A big thing we realized is you need active market makers taking on positions because they're good at managing risk. So the virtual AMM tends to have about one to two percent of the OI at any time."

The protocol has performed well in the current bull market, with open interest reaching $140 million and the insurance fund showing net positive growth. Heaney notes, "There's probably-there's been less than 50k in bankruptcies and I think millions of dollars of revenue to that insurance fund."

Scaling on Solana: Just-in-Time Liquidity

As Solana's popularity grows and block space becomes more contested, Drift has innovated to ensure efficient use of blockchain resources. Chris Heaney explains their approach:

"So one of our theses was that in the full block regime, Solana would converge towards just in time liquidity because it relies on less transactions actually being needed to fill users' orders. So even though Drift has a ton of volume, it still takes up a relatively small percentage of the block space."

This just-in-time liquidity model has allowed Drift to scale effectively on Solana, using only about 3.5% of the blockchain's block space while processing around $200 million in daily volume.

Attracting Market Makers to Solana

One of the challenges Drift faced, especially during the bear market of 2022-2023, was attracting market makers to the Solana ecosystem. Cindy Leow explains the difficulties:

"I guess the difference between integrating on Drift and integrating month, these are the perp's taxes that have order matching engines that are essentially off-chain, is that you have to really go through the nuts and bolts of integrating on Solana and understand all the technical details of integrating on Solana, which is very different from integrating on the centralized exchange or an off-chain order book."

To overcome these challenges and improve liquidity, Drift implemented a maker rewards program. This program incentivizes market makers by rewarding three key aspects:

  1. Just-in-time liquidity provision
  2. Maker volume
  3. Liquidity provided on the order book

The results have been positive, with both institutional market makers and community-driven market makers now providing liquidity on the platform.

Drift's Global User Base

While Drift is not available in certain jurisdictions due to regulatory constraints, the platform has attracted a diverse global user base. Cindy Leow notes that there isn't a dominant region for their users, but they see significant adoption from Europe and various parts of Asia.

Interestingly, Drift has found success in markets where access to perpetual futures trading is limited on centralized exchanges. Leow explains: "A lot of our users are coming from places where there's little perp coverage, so a little way to trade on centralized exchanges. And where you, for instance, in Hong Kong, you have to be an accredited investor in order to even touch trading perps."

Looking ahead, Drift plans to focus on localization efforts in key markets with strong trading cultures, such as Korea and Japan. The team aims to create more tailored product experiences for these regions, potentially moving beyond the current DeFi-centric interface to something more akin to traditional trading platforms like Robinhood.

The Importance of On-Chain Order Books

Drift's commitment to maintaining fully on-chain order books sets it apart from some competitors and offers several advantages. Chris Heaney emphasizes the importance of this approach:

"I think the main thing about being on chains is it increases censorship resistance. So especially as the protocol gets bigger, it means that the core team doesn't, can't stop it from going down."

This decentralized approach allows community members to run keeper bots and maker bots, ensuring the protocol's continued operation even without direct involvement from the core team. As Drift moves towards further decentralization, this on-chain infrastructure becomes crucial for maintaining a truly permissionless and resilient trading platform.

Simplifying the User Experience

While Drift's current interface caters well to experienced DeFi users and pro traders, the team recognizes the need to simplify the experience for mainstream adoption. Cindy Leow shares their vision:

"In the next couple of weeks we're actually launching a light mode that abstracts a lot of the difficulty of opening up a position and looks like a very simple button just like how much you went along, how much you went a short. This is your market price that you're going to be entering it and that's as simple as it goes."

The team is also exploring innovative ways to integrate trading functionality into popular communication platforms. Leow mentions the possibility of enabling trading through Telegram bots, allowing users to execute trades with simple commands like "slash buy $100,000 worth of sole perk."

Looking further ahead, Drift is considering how to integrate perpetual futures trading directly into wallet interfaces, though this presents regulatory challenges that need to be carefully navigated.

Drift vs. Jupiter Perps: Key Differences

As competition in the Solana DeFi space heats up, it's important to understand the distinctions between different perpetual futures offerings. Chris Heaney explains how Drift differentiates itself from Jupiter's perps:

"I think the main differentiation between something like Drift and Jupiter is the Jupiter, like GMX style perps are basically backed by Spot. It limits what you can actually trade, especially on Selana."

Drift's key advantages include:

  1. Wider Market Selection: Drift offers a broader range of trading pairs, including long-tail assets and even pre-launch markets for tokens that haven't been listed yet.

  2. Cross-Collateral Functionality: Users can leverage various assets as collateral, offering more flexibility in how they manage their positions.

  3. Focus on Crypto-Native Assets: Drift aims to be the go-to platform for trading emerging D-Pin and AI-related assets on Solana.

However, Heaney acknowledges that the GMX-style model used by Jupiter can offer higher leverage in some cases, which may appeal to certain traders.

The Vision for Drift's Future

Looking ahead, Drift has ambitious goals for its growth and development. Cindy Leow shares their long-term vision:

"So I think really that somewhere I just took last year that we wanted to take on finance in the matter of years. We wanted to be on a path of decentralization in order to get to the central exchange performance as well as to make sure that we continue to be accessible to users all over the world."

The team aims to reach 30 million users, rivaling the user base of centralized exchanges like Binance. However, they recognize that their path to achieving this goal will differ from that of centralized platforms. Key focus areas include:

  1. Building and incentivizing different front-ends and user experiences to cater to various audience segments.
  2. Maintaining a commitment to decentralization and community ownership.
  3. Continuous technological scaling to keep pace with Solana's growth.

Chris Heaney envisions Drift becoming the "CME for crypto native assets" hosted on Solana, serving as a core DeFi derivatives protocol that supports the entire Solana crypto economy.

Upcoming Developments and Closing Thoughts

As Drift continues to evolve, several exciting developments are on the horizon:

  1. Decentralization Efforts: The team is preparing to embark on a path towards greater decentralization, involving the community in governance and protocol ownership.

  2. Pre-Listing Markets: Drift is set to launch pre-listing markets, allowing users to trade on tokens before they're officially listed.

  3. Light UI Launch: A simplified user interface is in the works, aimed at making the platform more accessible to a broader audience.

  4. Expansion into Spot Trading: The team is exploring the possibility of applying their just-in-time liquidity technology to spot markets.

As the DeFi landscape on Solana continues to evolve, Drift Protocol stands at the forefront of innovation in on-chain perpetual futures trading. By combining advanced technology, user-centric design, and a commitment to decentralization, Drift is well-positioned to play a pivotal role in the future of decentralized finance on Solana.

Facts + Figures

  • Drift Protocol launched its first product in November 2021, with V2 following in November 2022.
  • Drift has over 100,000 users and $250 million in Total Value Locked (TVL).
  • The platform processes between $100 million to $200 million in daily trading volume.
  • Drift's open interest recently reached $140 million.
  • The protocol has experienced less than $50,000 in bankruptcies while generating millions in revenue for its insurance fund.
  • Drift utilizes only about 3.5% of Solana's block space while processing around $200 million in daily volume.
  • The platform aims to reach 30 million users, comparable to centralized exchanges like Binance.
  • Solana perpetual futures have seen premiums between 100% to 200% annualized in recent months.
  • Drift offers trading on a wide range of assets, including pre-launch markets for upcoming tokens.
  • The team is launching a new "light mode" UI to simplify the trading experience for users.
  • Drift is exploring integration with platforms like Telegram bots for easier trading access.
  • The protocol employs a multi-pronged approach to liquidity, including a virtual AMM and active market makers.
  • Drift's insurance fund serves as a backstop for market stability and user protection.
  • The platform offers cross-collateral functionality, allowing users to leverage various assets.
  • Drift is focusing on becoming the go-to platform for trading emerging D-Pin and AI-related assets on Solana.

Questions Answered

What are perpetual futures and why are they popular in crypto?

Perpetual futures, or "perps," are synthetic contracts that allow traders to speculate on asset prices without an expiration date. They're popular in crypto because they enable trading on various assets across different blockchains without the need for complex bridging. Additionally, perps offer a simpler trading experience compared to options, making them more accessible to a wider range of users.

How does Drift manage risks associated with leveraged trading?

Drift employs several risk management strategies for leveraged trading. These include dynamic leverage adjustments based on user size and market conditions, global leverage caps, and a sophisticated P&L settlement system. The platform also maintains an insurance fund to cover potential losses and uses a virtual AMM as a backstop liquidity provider. These measures help ensure the stability and sustainability of the protocol.

What sets Drift apart from other perpetual futures platforms on Solana?

Drift differentiates itself through its cross-collateral functionality, allowing users to leverage various assets as collateral. The platform also offers a wider range of trading pairs, including long-tail assets and pre-launch markets. Additionally, Drift maintains fully on-chain order books, enhancing censorship resistance and decentralization. The protocol's focus on just-in-time liquidity also allows for efficient use of Solana's block space.

How is Drift addressing the challenge of attracting market makers to Solana?

To attract market makers, Drift implemented a maker rewards program that incentivizes liquidity provision. This program rewards three key aspects: just-in-time liquidity, maker volume, and order book liquidity. The team has also worked on educating market makers about Solana's unique characteristics and the benefits of integrating with the platform. These efforts have successfully attracted both institutional and community-driven market makers.

What are Drift's plans for future growth and development?

Drift aims to rival centralized exchanges like Binance by targeting 30 million users. The team plans to achieve this through several strategies, including simplifying the user experience with a new "light mode" UI, exploring integrations with platforms like Telegram bots, and focusing on localization in key markets. Drift is also working on further decentralization efforts and expanding into new areas such as spot trading, while maintaining its position as a core DeFi derivatives protocol on Solana.

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