Chapter 2: Our Users (pt. 1) — Trading Firms
mrgn labs is writing on Substack. Here is the next chapter.
I will shred this universe down to its last atom and then, with the stones you've collected for me, create a new one teeming with life that knows not what it has lost, but only what it has been given. A grateful universe. — Thanos
The crypto market is vastly different from what it was just six months ago. At the start of the year, we saw high token inflation models mixed with liquidity mining incentives as a default model to attract usage and TVL. Users came in and took advantage of free money, providing protocol founders with false positives about their own PMF. As new capital dried up, protocols were left directionless, poorer, and smart retail dumped their inflated tokens in search of the next opportunity.
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If only protocols had taken proceeds from the previous round, told everyone they’ll distribute $1 for every 70 cents supplied, and juiced their yield with the same, trusty USDC they had just raised. Much better UX for retail, they’d face considerably less slippage on the open market.
This is a joke, but it’s essentially what happened. Charts like this ensued:
I remember this time. It was easy to get distracted by new venues attracting fake volume through fake liquidity. marginfi was built on the ethos of “connecting sources of liquidity”, so the team was also paying close attention. Staying vigilant on the venues with staying power was paramount to using engineering resources effectively while moving quickly.
The best way to cut through the noise is to go straight to your end users. We worked with users to ensure which initial DEXs mattered. We sought out what users were functionally using, not mercenarily farming. We combined this filtering mechanism with building strong relationships across the UTPs (underlying trading protocols) users identified. This approach is what’s led us to our current integration set.
With this article, I’ll focus on one of the primary user segments we’ve shaped our product around — trading firms. It’s worth noting, I’m talking about defi-native trading firms. Not the institutional stuff holding a Bitcoin ETF :)
Why are trading firms here? In short, defi markets are still extremely inefficient. Sophisticated traders have an opportunity to extract value from those inefficiencies, often making markets more efficient in the process. Firms are taking three general approaches:
e.g. MEV, Yield Farming, liquidity-as-a-service
There’s some seasonality bundled into these strategies. For example, yield farming becomes much more actionable in the bull market. In the bear market, we’ve seen most high-inflation models all but dry up entirely. Recognizing the “beta” in trading firms’ approach to defi is paramount to building a high utilization protocol.
It’s worth defining this user segment further. Defi-native trading firms currently fall into the archetype of mid-to-high frequency prop shops, quant driven, small-to-mid size (AUM), with a smaller team (headcount). They often have specialties across trading (e.g. market-making), and sometimes work with a confined segment of products (e.g. spot & perps, no options).
I love working with these people. They tend to be savages with no filter for BS. Many have scaled the ranks of tradfi and had the foresight to move quickly on crypto. Now they’re capitalizing on it.
These firms take an active approach to trading, so minimizing risk is essential. This is where marginfi comes in. Take “Firm X”. Firm X is always delta-neutral. That means Firm X constantly counters their delta exposure with offsetting hedges to minimize directional risk. The question naturally arises: how has Firm X remained delta-neutral on-chain while staying maximally capital efficient? (Ok, joking. A normal person would never ask that. We’re not interested in normal people, however.)
The answer is: they haven’t. Firm X has most likely taken two routes. 1) They’ve been hedging on-chain positions through off-chain venues (e.g. FTX or Binance). 2) They’ve been hedging on-chain positions with capital parked across other DEXs.
Both of these routes are missing critical, rudimentary advantages any off-chain trading venue will provide you by default. First, both of these routes require you to have capital parked on separate venues. If part of your capital is parked on a centralized venue, you’re also subject to deposit/withdrawal periods and excessive fees. Splitting capital across accounts handicaps available leverage, increases siloed liquidation risk, introduces trader complexity across multiple accounts, introduces new rules, fees, and exchange nuances… The minute you split your capital, you run into serious headaches.
Second, these routes eliminate a host of trading strategies. Take market-making, for example. Firms can’t collateralize inventory. Even simpler, firms can’t collateralize stable, yield-bearing positions on e.g. Solend to execute trades on e.g. Mango Markets. When basic strategies are unavailable simply due to capital fragmentation, serious traders go elsewhere.
On the flip side, unifying liquidity brings a host of trader-side advantages. I won’t give you the marginfi pitch here, but it’s an essential requirement for any trader taking advantage of opportunities across more than one exchange.
Now, enter a defi arena where new DEXs are constantly emerging. New products, new approaches, minimal standardization, minimal regulation. How have traders captured these opportunities? They’ve hired teams to work on it. Talking with these firms, its not uncommon for engineers to spend 1-2 months on a single DEX integration. With new DEXs emerging each month, traders now have to spend time critically evaluating the r/r of the DEX integration itself. Opportunities are either taken advantage of with broken capital efficiency, or they’re left behind.
This process, when repeated over and over, consolidates liquidity to existing venues and punishes the innovators. It’s a very anti-defi process, and we’re set on fixing it.
One account, standardized access to all liquidity venues, unlocked leverage against portfolio positions, automatic rebalancing, risk safeguards, trader tooling… we’re giving firms a rudimentary requirement in a new financial paradigm — a margin account. It may sound clear, but there’s a deeper reason that pushes us forward.
When crypto people talk about institutional adoption, they hint at a variety of things. They first hint at liquidity, which often brings resulting market efficiency, which often brings better infrastructural rails, which often creates a healthier financial arena. It’s not this linear, but it’s close. Now what if we combined this domino effect with easy access to new, emerging markets? Instead of just going to two places to trade perps, what if traders could go to 10? (Each with deeper liquidity around a different set of perp products)
In that world, exchanges would face healthier competition on their underlying tech, execution, experience… Traders could experience a unified, capital efficient environment where new integrations are no longer a bottleneck. Trading systems could connect to one interface instead of 50. Every part of the experience becomes more modular.
Zoom back in
This is part of the reason we’ve enjoyed working with trading firms. We’re removing the blockers for firms to effectively trade across defi. Let’s bring liquidity to the innovators.
On a tactical level, we’ve found mutual attraction with trading firms because they’re constantly moving across venues. In tradfi, they work with solutions like us every day (for e.g. composing a position between the NYSE and CBOE). As defi grows, I believe the same will be true with marginfi.
There’s some added benefits. Many firms are investors in the UTPs we connect. LedgerPrime is a partner/investor for 01 Exchange, QCP Capital is a partner/investor for Drift Protocol, and so on. When these firms come in as market-makers, they want the ability to hedge. Now, a solution exists.
Trading firms want to be trading firms that spend their time trading. Engineering work is better spent running strategies, fixing algorithms, and profiting… not building tooling just to get started.
This is just the start
We’re still getting started. mrgn recently raised deposit caps on our mainnet alpha, shipped python, rust, and typescript clients, then a community member added a go client. Firms are set up to run general funding rate arb, spread arb, interest rate arb, as well as a range of statistical arb across our perp venues.
We’ll be adding new venues soon 👀. Watch out for some emerging basis and conversion arb opportunities.
We’ve also been working on tooling. Jakob on our team is working through our data infrastructure as we speak… we can’t wait to share more there.
Finally, mrgn research is now alive. There’s a host of initiatives we’re working on behind the scenes in collaboration with firms. If this sounds interesting to you, contact me.
End of Chapter 2
When we get time, our team jumps in Substack and writes about defi. We spend most our time building. In fact, recently we became the first protocol to cross-margin derivative products, cross-DEX, in crypto. However, when we take off our building hats, we have lots of thoughts to share. This is our little hub of public knowledge.
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