Understanding Drift Protocol: Arthur Hayes as Project Advisor, a Decentralized Derivatives Market Based on Solana

With the rapid development of Blockchain technology, the landscape of the cryptocurrency market is quietly changing. Investors' demands for transparency, efficiency, and decentralization are becoming increasingly strong, and cryptocurrency trading, which was previously dominated entirely by centralized exchanges, is beginning to shift on-chain.

According to the latest data from Coingecko, the spot trading volume ratio between CEX and DEX has reached 55:45, with a small gap. In contrast, the derivatives trading market sees a daily average trading volume of hundreds of billions of dollars, but on-chain trading volume accounts for only 1%, leaving a growth space of tens of billions for on-chain derivatives trading.

Data Source: The Block

After continuous iteration and optimization, the current on-chain derivatives track mainly features two solutions:

First is the Vault model represented by GMX and Hyperliquid on Arbitrum, where LPs act as counterparties to traders, with Oracle feeding prices to determine trading prices.

Second is the order book model represented by dYdX, with off-chain matching and on-chain settlement, such as AEVO and Vertex.

Of course, with the development of the DEX market, many projects generally combine these two methods to further enhance user trading experience and further optimize and improve trading depth and liquidity, providing users with stable spot asset trading quotes and decentralized leverage contract products. For example, Drift Protocol, based on the Solana ecosystem, has performed brilliantly in the recent market, with a significant increase in user numbers and total TVL, attracting a lot of investor attention.

This article will delve into the core mechanisms and technical features of the on-chain derivatives protocol Drift Protocol in the Solana ecosystem, and how it addresses the risks faced by on-chain derivatives trading to provide a safe and reliable on-chain trading environment for traders.

About Drift Protocol

Drift Protocol is an open-source decentralized trading platform built on Solana, established in 2021, mainly providing users with a low-slippage, low-fee, and high-efficiency trading experience. Currently, Drift Protocol mainly offers four products: spot trading, perpetual contract trading, lending, and passive liquidity supply. Drift Protocol aims to improve capital efficiency while protecting user assets by establishing a complex cross-margin risk engine, and to become the liquidity layer for derivatives and spot trading in the Solana ecosystem.

Drift Protocol launched its V2 version in January 2022, adopting a new hybrid liquidity solution, significantly improving trading volume and user experience. On May 16, 2024, Drift Protocol initiated an airdrop, distributing 12% of the total supply to early users and supporters, achieving continuous breakthroughs in TVL and trading volume. According to DeFillama data, Drift's TVL currently ranks third among all on-chain derivatives platforms, making it an unignorable dark horse in the track.

Data Source: DeFillama

For trader users, fees are a very important indicator of loss in cryptocurrency derivatives trading. Drift Protocol has the advantage of low fees, helping users reduce trading friction and gain more profit. Currently, the perpetual trading taker fee for BTC, ETH, and SOL is only 0.025%. If investors stake 10K USDC in Drift Protocol's Insurance Fund, the fee can be reduced to 0.01%. For other tokens, Drift Protocol's trading fees are only 0.03%-0.1%. Combined with Drift Protocol's official rebate discounts and rewards, trading fees are already better than most CEX exchanges.

According to official data, Drift Protocol has accumulated a trading volume of $26 billion, processed over 17 million transactions, and accumulated over 190,000 users, achieving explosive continuous growth recently.

Data Source: Drift

Drift Protocol's project advisor Arthur Hayes is the CFO of BitMEX and the CIO of Maelstromfund. Drift has also attracted capital attention, with the project receiving two rounds of financing, including a seed round of $3.8 million from investors such as Multichain Capital and Jump, and $23.5 million in Series A financing in October 2023, with the institutions yet to be announced.

Drift Protocol Core Mechanisms

Unlike common on-chain derivatives trading solutions represented by Hyperliquid and dYdX, Drift V2 adopts a hybrid liquidity mechanism, integrating and optimizing both solutions to provide more collateral and reduce risk. Drift Protocol V2 mainly has four types of liquidity to ensure the best price for traders when executing orders:

• Just-in-Time (JIT) Auction Liquidity

• vAMM Liquidity

• Decentralized Order Book Liquidity

• Market Making Vaults

Just-in-Time (JIT) Auction Liquidity

When a user (Taker) submits a market order, it automatically triggers a personalized Dutch auction with a specific starting price, ending price, and duration. The auction forces market participants to compete to meet the user's needs at a price better than or equal to the current auction price. If no market makers participate after the initial window (about 5 seconds), the user can complete the transaction on Drift's AMM.

JIT auction is a supplementary liquidity mechanism that allows market makers (MM) to provide instant liquidity. Through this just-in-time method, traders can achieve a zero-slippage trading experience.

vAMM Liquidity

Drift's vAMM is the designated liquidity provider for trading. If a market order is not executed by JIT and meets the trigger price for vAMM execution, the trade will be executed by the vAMM pool.

In Drift V2, Backstop AMM Liquidity (BAL) is included, allowing users to add liquidity to specific pools and earn a share of the fees they accept. BAL further supplements vAMM's liquidity, reduces slippage, and improves order execution quality.

vAMM provides a continuous source of liquidity for all traders. Even without external market makers, Drift Protocol can support new markets without relying on external market makers to guide liquidity (though there is additional risk of unrealized PL being immediately available).

The protocol design also incorporates many safeguards, such as limiting risk exposure, effective market making, income pool utilization, and insurance fund rules to mitigate and isolate the risk of a single market. vAMM requires a reliable oracle for the spot reference asset of the perpetual market. For example, Drift's SOL-PERP perpetual market will reference the SOL/USD spot oracle as the price reference, combined with other channels to ensure the accuracy of the quote.

Decentralized Order Book Liquidity

Drift's decentralized order book is supported by Keeper Bot robots. Keeper robots are responsible for recording, storing, matching, and executing submitted limit orders. Each Keeper robot has its own off-chain order book. Orders are sorted by attributes such as price, time, and position size. When an order reaches the trigger price, the Keeper will submit the trade against the DAMM. In return, the Keeper earns trading fees based on a mathematically determined ratio.

If buy and sell orders have exactly the same parameters, the Keeper can directly match them without going through the vAMM, maximizing efficiency.

Market Making Vaults

Mark

Market Making Vaults is a delta-neutral market-making and liquidity provision strategy. By integrating Circuit's Market Making Vaults, Drift Protocol further enhances liquidity and trading experience, capturing more returns for liquidity providers.

This strategy generates returns uncorrelated with the overall market performance by hedging the price fluctuations of the underlying assets. Users can deposit USDC into the Vaults and earn returns based on the market-making activities executed by Circuit on Drift Protocol. Currently, the Supercharger Vaults APY is 47.06%, and the Turbocharger Vault APY is 36%.

Introduction to Drift Protocol Features

Perpetual Trading

1. Open the official website and log in using the Phantom wallet.

2. After logging in, you can enter the perpetual contract trading interface. First, you need to activate your account and deposit assets. Click on "Deposit" on the page to activate. Activating the account requires a small amount of SOL.

3. You can switch between the professional version (Pro) and the simplified version (Lite) at the bottom left corner of the page, and set RPC and trading gas settings, etc.

4. After depositing assets, you can select the trading target, input the price and leverage ratio to place an order. The leverage ratio can currently reach up to 20x. The trading varieties include most of the mainstream cryptocurrencies.

Spot Margin Trading

Select "Trade——Spot" from the top left menu to enter the spot margin trading page. Drift offers up to 5x leverage, and for stablecoins USDT-USDC, it offers up to 10x leverage.

By default, margin is disabled. Users who need leverage can enable margin mode through settings. Before enabling margin mode, a sub-account needs to be set up. Funds in each sub-account are independent and do not affect the main account or other sub-accounts. The activation funds will be refunded when the activated sub-account is deleted.

Click the settings icon at the top right corner of the page to enter the Settings page. Select Margin/Leverage to set it up.

After completion, you can select the corresponding leverage ratio for margin trading.

Swap Trading

Drift Protocol also provides Swap spot trading through cooperation with Jupiter. Similarly, Swap trading can also offer up to 5x leverage, requiring the opening of a sub-account.

Insurance Vault and Market Maker Vault

By depositing funds into the insurance vault, users can earn fees from perpetual trading, borrowing, and liquidation, ensuring the solvency of the protocol. Stakers can receive rewards from the income pool, with the current USDC APR yield reaching around 37%.

The Market Maker Vault is a delta-neutral market-making and liquidity provision strategy provided by Circuit, which can significantly increase investors' returns. Deposited funds have a 7-day redemption period.

Drift Draw Rewards

Drift Draw is a lottery event where each $1 traded by a Taker can earn up to 10 tickets. A draw is held every Monday at 2:00 PM UTC, randomly selecting one of three prize pools to allocate to the winning users. Three lucky users will be randomly selected for the top prize, and 30 users will receive special consolation prizes. Currently, the prize pool for the next draw has reached $280,000.

Tokenomics

The primary purpose of the DRIFT governance token is to grant Drift users actual ownership of the protocol and give them the right to speak and vote on the future development of the protocol through Drift DAO. By distributing power and decision-making rights throughout the ecosystem rather than centralizing them, Drift ensures sustainable and healthy development alongside the most active participants.

The total supply of DRIFT is 1 billion, with 53% allocated to the community, of which 43% is for ecosystem development and trading rewards, and 10% for Launchpad airdrops; 25% for protocol development; and 22% for protocol contributors.

On May 16, $DRIFT officially started its airdrop, distributing 120 million tokens to over 150,000 early users and supporting users to deposit $DRIFT into the protocol as collateral. The airdrop ends on August 17, 2024. The launch of the $DRIFT token has also garnered widespread attention in the industry, with the token already listed on major CEX exchanges such as Coinbase, Gate.io, KuCoin, and Huobi.

The Future Potential of Drift

The revival and continuous prosperity of the Solana ecosystem have brought more liquidity and users on-chain, as well as increased trading demand. According to Coingecko data, four out of the top ten DEXs are native to the Solana ecosystem, with Jupiter, Orca, and Raydium ranking first, third, and fourth, respectively. This indirectly reflects that trading on the Solana chain has surpassed ETH, becoming the most active public chain.

By adopting the core mechanism of liquidity fusion, Drift Protocol has initially demonstrated its immense potential, achieving significant improvements in TVL, trading volume, and user numbers. Currently, Drift is the top-ranked derivatives protocol on the Solana chain in terms of TVL and trading volume. In the future, Drift is likely to become the liquidity layer of the entire Solana ecosystem, powering the ecosystem.

Additionally, Drift's support for the Solana ecosystem is very rapid. Currently, popular tokens in the Solana ecosystem, such as WIF, W, TNSR, KMNO, etc., can all be traded on Drift. This also shows that Drift's support for popular tokens in the Solana ecosystem is very fast, which is a key factor in gaining rapid user growth. With the arrival of the bull market, the cryptocurrency market will once again experience rapid development, providing Drift with an important opportunity to achieve a breakthrough.

In Conclusion

The bull market has just begun. In the future, with the help of Solana's efficient and low-cost infrastructure, as well as active on-chain users and trading, Drift will continue to capture more liquidity and trading demand, growing strongly with the entire ecosystem, and potentially surpassing EVM-based derivatives protocols.