Vision
Why and How did we create the Chromatic protocol?
Following GMX’s success, there has been a proliferation of futures DEXs. However, the majority of them have merely added supplementary features to services that we’ve already seen before. As a result, public expectations for futures DEXs have been dwindling. The fact that DEXs still occupy a minor share in the crypto futures market underscores the inability of GMX and its replicated services to bring forth genuine innovation in the decentralized futures market.
The traditional futures markets have evolved over more than two centuries. Chromatic seeks to combine the wealth of experience accumulated in traditional financial markets with the decentralized principles enabled by blockchain technology to create real innovation in the modern financial markets.
TL;DR
In the crypto futures market, unlike traditional finance, roles such as exchange, broker, and market maker are often not well-differentiated, and many projects provide all those three services within a single futures DEX. However, we have an anticipation that in the crypto futures market, these roles will gradually separate, and a balance between supply and demand will be achieved through independent brokers and market makers within neutral exchanges.
Chromatic concentrates on the narrow role of the exchange at the core of futures trading, while also providing atomic DeFi development tools for various DeFi builders to offer creative broker and market-making services.
The goal of decentralization is to eliminate third parties to enhance efficiency and trust by leveraging blockchain technology to automate the roles of third parties. Two critical issues caused by third-party intermediaries that needs to be addressed in futures exchanges are 1) listing monopoly and 2) capital inefficiencies for forced liquidation.
Chromatic has achieved a permissionless listing by separating index and settlement tokens and introducing a dynamic fee system. This allows anyone to freely create a futures market. Additionally, through predefined Take Profit/Stop Loss features, the protocol automates margin calls and forced liquidations while removing unnecessary capital, such as an insurance fund.
While Chromatic has a strong vision and confidence in its role, it’s challenging to expect the voluntary participation of brokers and market makers in the current crypto winter season. That’s why Chromatic has taken the initiative to build and open-source reference projects for brokers and market makers. We plan to operate these projects directly during their early stages. However, as the crypto market warms up, and many outstanding brokers and market makers engage with Chromatic Protocol, we anticipate returning to our core role as a neutral exchange.
The genesis of Chromatic protocol was predicated on a fundamental query: What constitutes a futures Decentralized Exchange (DEX)? We dissected this concept using a methodical divide and conquer strategy. Breaking down a futures DEX, futures become the subject of exchange, and the act of exchange is divided into Decentralization and Exchange.
Exchange: A Critical Examination
An exchange serves as a pivotal intermediary in transactions. It should adeptly match buyers and sellers, facilitate the discovery of prices (exchange rates) predicated on supply and demand dynamics, and maintain unwavering neutrality to foster continuous participation. It should also exude trustworthiness and demonstrate sustainability. In the context of a futures exchange, the counterparts of the exchange are the taker (or trader) and the maker (or liquidity provider), with the subject of the exchange being the future outlook.
A Deeper Dissection of an Exchange
The concept of exchange can be further dissected into three components: brokers, who handle the taker (or trader) UX; exchanges in the narrow sense, which mediate between brokers and market makers; and market makers, who handle the maker (or liquidity provider) UX.
In traditional financial markets, these roles are well-defined. For example, exchanges like NYSE, NASDAQ, and CME focus on the role of exchange in the narrow sense, maintaining neutrality by not directly engaging in brokerage or market-making activities, and allowing various brokerages and market makers to participate.
However, in the crypto market, these roles are not as clearly defined. Centralized futures exchanges (like Binance, CoinBase) and even pioneers of decentralized futures exchanges often perform all three roles.
We predict that the crypto market will naturally evolve to resemble traditional financial markets, with exchanges focusing on their role in the narrow sense. We anticipate the emergence of various censorship-resistant decentralized projects for brokers and market makers and a few decentralized exchange protocols that can maintain neutrality and be trusted and used by these projects.
Therefore, we focused on creating a protocol that focuses on the function of exchange in the narrow sense, rather than a dApp-style futures DEX that performs all three roles. Ultimately, we anticipate that it will enable mass adoption by ordinary people who do not understand the value of decentralization, by allowing companies that comply with legal requirements (KYC, AML, qualified investor screening, Travel Rule, etc.) and handle taxation in each country to participate in the protocol.
Decentralization: A Paradigm Shift
To ensure the trust, neutrality, and sustainability of an exchange, the current modus operandi relies on trusted 3rd parties. However, the existence of a 3rd party inherently introduces inefficiencies and potential bias. If we could eliminate the 3rd party using blockchain technology, we could simultaneously achieve efficiency, neutrality, and trustworthiness.
Deep Dive into Decentralization in Futures DEX
The first goal of decentralization is to remove 3rd parties to increase both efficiency and trustworthiness. This requires the use of blockchain technology to automate all the roles of the 3rd parties.
We believe that just transferring the roles of the 3rd parties to a DAO is not true decentralization. Although the role of a DAO may be necessary in the early stages of a project, we believe that the role of a DAO should ultimately be minimized to treasury management.Therefore, we examined the roles that could be automated within the exchange, rather than transferring required roles to a DAO.
We found that a listing is not automated. In a futures exchange, anyone should be able to call a specific function of a contract to list permissionlessly, but it is not easy to find such cases. There are several factors that make permissionless listing difficult.
Firstly, The viability of listing greatly depends on active market making. If market making does not occur, listing assets is meaningless. To solve this, we adopted a pool-based AMM method instead of an order book. The market making of the order book is difficult to automate on-chain, whereas the utility of the pool-based AMM has already been proven in spot DEXs.
Unlike spot markets, in futures, the subject of listing is ambiguous. To bring clarity to this matter, we decomposed the index and settlement token and clearly defined the subject of the listing. For detailed information on the separation of underlying Index and settlement token, please refer to our GitBook or Medium post.
We also had to carefully consider the possibility of abuse. Malicious players could issue tokens and register indices with an oracle. They could list tokens permissionlessly and raise funds from broad audiences through the AMM. Other current projects rely on fixed fees (or a variable fee based on a mechanical formula) based on oracle prices which allows malicious players to calculate the potential profit they can make in advance, by taking high leverage short positions, and dumping the issued quantities. To solve this, we devised a dynamic fee system based on market demand and supply. As a bonus, we were able to provide an indirect price discovery function that most current oracle-based futures DEXs could not guarantee. For detailed information on our dynamic fee system based on market demand and supply, please refer to our GitBook or Medium post.
Also, a margin call and forced liquidation were not automated. To solve this issue, which is more complicated in perpetual futures, we devised a predefined TP/SL method. For detailed information on predefined TP/SL, please refer to our GitBook or Medium post.
We implemented these automatable elements on-chain to create the Chromatic protocol. However, complete automation without 3rd parties has not yet been achieved, and there are certain aspects where DAO intervention remains necessary. These include setting the protocol fee and designating the settlement token. If automation works efficiently, we expect the protocol fee to converge toward zero. Other minor parameters, such as the minimum investment amount, also need to be set by DAO.
Our ultimate goal is to create our protocol that operates seamlessly and autonomously with minimal DAO intervention. In other words, our job is to create a protocol that can exist and run well even without us. To use an engine development analogy, even an engine that runs automatically needs to be cranked manually for the first few cycles. We want to make it clear that our role is only to crank those first few spins.
The Reality of Go To Market
We have strong confidence in the vision outlined for the protocol. And we believe that focusing solely on the role of a narrow exchange protocol is the best way to maintain neutrality and encourage participation from various brokers and market makers. However, given the current harsh crypto environment, it’s not realistic to assume that just because we build a great protocol, that will automatically lead to the natural involvement of a wide array of brokers and market makers.
Therefore, we have built and open-sourced reference projects for brokers and market makers. We also plan to operate these projects in the early stages to demonstrate their functionalities. However, to stay true to our role as a reference, we aim to limit these projects to minimal specifications and operations.
We plan to focus on decentralized payment method (e.g., Binance’s Coin-M) rather than following the conventional practice in the futures market with stablecoin settlements like USDT or USDC, which should be handled by institutional companies. We aim to prioritize settlements through BTC and ETH.
However, since our direct operation of brokers and market makers could affect neutrality, we plan to either make them independent projects or close them once the protocol is running smoothly.
We are also preparing for a public sale to raise funds for the development and establishment of the protocol.
In conclusion, the creation of the Chromatic protocol was driven by a deep understanding of the future of DEX and a commitment to achieving true decentralization. By focusing on the role of the exchange in the narrow sense and automating as many elements as possible, we aim to create a protocol that can operate efficiently and trustworthily without the need for a 3rd party or a DAO. Through this, we hope to pave the way for the future of DEX and contribute to the mass adoption of blockchain technology.
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