0/ A thread on spot vs derivative trading and Layer 1 vs Layer 2

Ethereum only in this thread. No Solana or Serum

1/ Spot exchanges don't deal with collateral mgmt, whereas derivatives exchanges do. This means that they have to include at least one "deposit" transaction before the user can actually put on a deriv position

2/ Spot doesn't deal with any of this. Just a simple atomic swap

This is why DEX aggregators like 1inch, matcha, etc work so well for spot

3/ Users don't just trade using a single spot DEX

The entire point of aggregators is to get the price price from all available liquidity pools!

So what happens if the spot DEXs move into layer 2s?

4/ Well, I'm not sure, but the answer is probably that slippage increases (liquidity fragments), and latency increases (move assets between layer 2s)

5/ DeFi traders are used to magical, atomic spot trades though. So this is going to be a huge step backwards in UX

6/ Meanwhile, derivatives exchanges have to deal with a deposit before they can begin trading anyways

This is why you don't see derivative exchanges available on DEX aggregators (not intractable problem for DEX ags, but much harder to interface with derivs)

7/ So derivative exchanges already don't benefit from the presence DEX aggregators

So they are going to quickly move to layer 2 to reduce gas fees

8/ This is going to create a few interesting impacts

a) gas will be cheaper inside of a L2 deriv exchange than L1 spot exchange. users are going to increasingly feel "locked in" to the derivative exchange they choose to opt into

Gas entry/exit costs are going to be steep

9/ Each deriv exchange is going to then feel like current CEX model in terms of deposit/withdraw

While DEX version will be non-custodial, it will be much more gas expensive (even CEX withdrawal fees are $1-2)

10/

b) Spot DEXs will be forced to split liquidity, or give up market share to L2 derivative exchanges

Let's take Curve as an example. a lot of people use curve for both going in/out of sUSD, and USDC/USDT

Very different kinds of users and different flows of capital

11/ It seems Synthetix is going to L2

So what does Curve do? Does it move to Layer 2? The same layer 2? What about its USDC/USDT users?

12/ In this example, I think the least bad option is for Curve is to fork liquidity and operate two separate pools: one on layer 1, and one on Synthetix layer 2

This is obviously bad for sUSD users, and for USDC/USDT users

13/ It also probably creates problems for liquidity mining incentives, unless there are two entirely separate CRV tokens (which creates even more problems)

14/ The net conclusion here is that I think we'll see derivatives adopt layer 2 faster than spot

And this will create interesting dynamics for both the spot and the layer 2 markets

15/ Also remember that a meaningful percentage of traffic is still people shuttling assets between CEXs, which all happens on layer 1

16/ I don't think the storm above even begins to capture all of the dynamics in play. It's going to get even more convoluted as this stuff rolls out

{fin}