Introduction

In traditional finance, derivatives trading is the largest market, and the same holds true in the cryptocurrency industry. The trading volume of the crypto derivatives market has reached trillions of yuan, with perpetual contracts being the largest traded product. As cryptocurrency businesses mature, the derivatives markets on centralized exchanges (CEX) have gradually come closer to traditional finance, while decentralized derivatives markets are still in their infancy. Currently, the majority of derivatives trading volume is concentrated on centralized exchanges such as Binance, OKX, BitMEX, and Bybit. OKX and BitMEX were once the main hubs for futures trading, but their trading volume has significantly decreased due to regulatory issues. However, these exchanges still account for over 90% of the derivatives market share.

Following the speculative boom in 2020, perpetual contracts have become the dominant product in the derivatives market, both on CEX and DEX platforms. However, the trading mechanism of perpetual contracts is more complex than spot trading and involves a series of risk management processes, including margin and liquidation mechanisms, which place higher demands on network performance and Gas. The high Gas fees and performance limitations of Ethereum have hindered the development of the perpetual contract space. With the rise of new public blockchains and the improvement of Layer2 infrastructure, the decentralized perpetual contract market saw rapid growth in 2021. Most protocols chose to build on Layer1 blockchains with higher TPS or on Layer2, further intensifying the competition for market share and trading volume.

In terms of derivatives trading, it is still difficult to shake the dominance of centralized exchanges in the short term. Order book-based decentralized perpetual contract platforms offer a trading experience close to that of centralized exchanges, better aligning with traders’ habits and needs. The order book trading model remains the mainstream in the current market. The order book model requires high performance for matching and trading, relying on market makers to provide liquidity through orders, with real-time trading prices generated by market dynamics. The order book model provides a similar trading experience to CEX, making it suitable for high liquidity markets, though project cold starts are challenging. Its advantage lies in large orders being less affected by slippage.

Hyperliquid is an order book derivatives trading market built on its own Layer1 blockchain. With the application chain as its entry point, the project has shown good recent development momentum and high airdrop interest in the market. This article will explain its product operational logic and analyze its current development status.

What is Hyperliquid?

Hyperliquid combines CEX and DeFi to create a derivatives trading market built on the Hyperliquid L1 native chain, using an order book trading model. Its key selling points are low latency and high throughput. Currently, the platform supports contract trading, spot trading, and pre-launch trading. Between 2020 and 2022, the team was a market maker for several centralized exchanges. The protocol launched on the Arbitrum Goerli testnet in 2022. The team is small, consisting of 5 engineers and 3 non-technical members, all of whom are graduates from prestigious universities such as Harvard, MIT, and Caltech, with a background in high-frequency trading and quantitative experience.

The team has not yet conducted any fundraising activities and has not issued a token. There is high airdrop interest in the market, and the community is large. The protocol launched a points reward program at the end of last year, distributing points to traders weekly. Users widely believe these points correspond to airdrop value. Recently, the project has shown strong growth, with daily trading volume exceeding $800 million, and business performance has been good.

Operational Logic

Hyperliquid uses an application chain as its entry point and employs an optimized Tendermint consensus mechanism to build Hyperliquid L1. Its architecture incorporates a staking and penalty mechanism similar to Cosmos, creating a derivatives market with an order book trading model on its native chain. By using its own L1, no Gas fees are required, which results in faster transaction speeds. The user experience is similar to a typical CEX, with all data stored in the platform’s database, and market-making transaction records implemented with on-chain storage.

Currently, the platform only supports cross-chain funds through Arbitrum. The Hyperliquid protocol operates a native bridge protected by the same set of validators as Hyperliquid L1. User deposits are confirmed after signing with L1 validators, and each withdrawal is signed by validators as a separate L1 transaction. Withdrawals are hosted on L1, and during the withdrawal process, users do not need to pay Gas fees on Arbitrum, but a 1 USDC fee is charged on Hyperliquid.

Hyperliquid L1 also offers native EVM support and integrates with native L1 components (such as HIP-1 assets, spot trading, perpetual contract trading, and other DeFi primitives), facilitating development on other EVM chains.

The Hyperliquid platform adopts a fully on-chain order book model. Currently, it supports contract trading, spot trading, and pre-launch trading, focusing on the perpetual contract trading market.

Source: app.hyperliquid.xyz

Pricing Method

Most DEXs rely on oracles like Chainlink to provide price feeds. Hyperliquid also depends on oracles for price data. For perpetual contracts, the oracle updates the price of each contract’s underlying asset every three seconds, and these prices are used to determine funding rates. For spot trading, each validator calculates the spot oracle price by considering the weighted median prices from multiple exchanges, such as Binance, OKX, Bybit, Kraken, Kucoin, Gate IO, and MEXC, with respective weightings of 2, 2, 1, 1, 1, and 1.

Liquidity

Hyperliquid decentralizes market-making by setting up vaults. Users can create their own vaults and become vault creators, essentially enabling copy trading. Users can deposit funds into these vaults and automatically replicate the trading strategies of the vault leader, sharing profits in the process. Vault creators receive 10% of the profits earned.

The top-ranked vault, HLP, is endorsed by Hyperliquid and is responsible for the platform’s liquidity provision and liquidation. Previously, liquidity provision and liquidation were separated into two different vaults, but to improve the vault’s APY performance, liquidation has been merged into the market-making vault. HLP allows community members to provide collateral for Hyper Vaults and share in the protocol’s profits.

Margin

The protocol offers cross-margin and isolated margin, with cross-margin being the default. Cross-margin allows collateral to be shared across all positions, maximizing capital efficiency. Isolated margin restricts collateral to specific assets, protecting other positions from liquidation.

Liquidation

The final price used for liquidation is the weighted median price submitted by each validator. The decision-making power of the validators depends on their staking power, with the weight of each validator’s contribution being proportional to their staked amount. However, since the platform’s native token has not been released yet, liquidation is currently managed by the platform.

Trading Products

In addition to mainstream tokens, Hyperliquid introduces two innovative products: custom L1 perpetual contracts and index perpetual contracts.

The Uniswap perpetual contract is designed for projects not listed on CEXs or for tokenless anticipated futures trading, with prices confirmed via Uniswap v2 or v3 oracles.

The index perpetual contract targets pre-launch trading tokens that lack spot prices. Its price is determined by an algorithmic formula, with validators periodically submitting the results of the index formula to Hyperliquid L1. These submissions are processed by the system, and the median value is used to calculate the price of unlisted tokens. Currently, the formulation and execution of this formula are relatively centralized.

HIP Protocol

The HIP protocol is Hyperliquid’s proposal for product improvements, specifically for changes to new features. Any community member can participate in proposals and share their ideas on improving the product. Currently, the protocol is not fully community-owned and is operated by the team, so these standards are proposed by the team. There are currently HIP-1 and HIP-2.

HIP-1 is the native token standard for spot trading on the protocol, similar to ERC-20 tokens on Ethereum. Tokens that comply with this standard can establish an on-chain spot order book on the Hyperliquid platform and be used for perpetual contract trading.

HIP-2 provides liquidity for HIP-1 tokens, offering liquidity guidance for early-stage tokens.

Economic Model

Hyperliquid has not yet issued a token, but the market is highly anticipating an airdrop.

The team launched a points reward program on November 1, 2023, which will run for six months. The first phase of the points reward program concluded on May 1, 2024. Each week, 1 million points were distributed to users who contributed to the Hyperliquid protocol. Points can be earned by successfully completing trades and holding positions on the DEX. Additionally, on October 31, 2023, the team took a special snapshot of users in the closed alpha phase. The points for these users will be distributed on April 15, 2024.

The points criteria are regularly updated, and the points distribution is held weekly. Currently, the ongoing L1 phase points program began on May 29, 2024, and is set to run for four months, with 700,000 points distributed each week. Due to high user expectations for an airdrop of the protocol’s token, and with no token issuance yet, the team has been continually increasing the points issuance, diluting the potential value of the airdrop, leading to dissatisfaction within the community.

Current Development Status

According to the data on the official website, the protocol is showing positive development. The daily trading volume has surpassed $800 million, the total number of users has exceeded 200,000, and the platform supports 137 types of assets.

Source: hyperliquid.xyz

Since its launch, the protocol has accumulated a trading volume of $38.4 billion, with deposits nearing $4 billion.

Source: stats.hyperliquid.xyz

In addition to building an on-chain derivatives trading platform, Hyperliquid is committed to creating a DeFi ecosystem built on its own L1 chain. This includes tools such as the token deployment trading bot Hypurrfan and pvp.trade, the on-chain monitoring tool Hypurrscan, and the lending platform HyperLend. However, these applications are still in the speculative stage, and the team has a lot of work ahead to bring them to fruition.

Conclusion

Hyperliquid combines CEX and DeFi by building its own L1 application chain to create an order book derivatives trading market. The product is logically sound in design and has certain innovative advantages. The user experience is similar to a CEX, with recent developments showing positive momentum. The market has high expectations for an airdrop, and the project has significant growth potential.