LlamaRisk indicates tentative support for the proposed integration with Derive. We believe the current perpetuals open interest in the venue may be too small considering the additional operational exposure. Moreover, based on the analysis presented below, we would like to pose additional questions to the Derive team. The following points need clarification:
- What are the current and historical price impact levels for opening/exiting perpetual positions?
- What is the capitalization level of the Security Module? Is it held on-chain or can otherwise be inspected?
- Does Derive plan on implementing Auto-Deleveraging as a safety function of the exchange?
- Does Derive reserve the right to change the Underlying Rate of perpetuals?
- What is the relationship between Lyra Technologies Corp and Lyra Trading Co? Which entity retains ultimate control over the off-chain order book?
- Are there plans to decentralize order book management? If so, what is the proposed timeline and mechanism?
- What are the alternative methods for accessing the protocol? Are there additional front-end integrations or support for aggregators?
- Who are the current service providers and how were they selected?
- What specific changes to the governance structure are being implemented with the migration to DRV?
- What entity is responsible for approving and launching new products?
- Are tools in place for wallet screening and transaction monitoring?
See our analysis of the futures platform performance and protocol in the dropdowns below:
Perpetual Futures Venue
Perpetual Futures Venue
Open Interest
In order to evaluate the suitability of onboarding collateral, it is firstly important to evaluate the stability and size of open interest available on the trading venue. The historical data indicates that the perpetual trading volumes have been trending upward since December.
Source: Derive Stats, 14th of January, 2025
Nonetheless, considering perpetual futures Open Interest, the current levels are very low, amounting to ~$17m of total OI. This may be a negligible amount for Ethena and may not be sufficient given the additional operational burden. The recommended maximal exposure equal to 10% of total OI would limit this integration to less than $2m.
Source: Derive, 14th of January, 2025
Funding Rates
It has already been outlined that funding rates on Derive have been on average trending higher than on other exchanges, including the CEXs already used by Ethena. Nonetheless, the funding rate volatility is higher, noted during brief periods of high funding rate fluctuations, uncorrelated to the funding rate changes in comparable CEXs.
While this mainly arises from volume and notional position size differences, it is important to analyze the underlying funding rate calculation processes for the perpetual venues that Ethena uses and compare that to Derive’s method.
Derive
The funding rate formula is presented below. Funding is settled every hour.
where Underlying Rate is fixed at 0.00125% (0.01% every 8 hours).
- Impact Bid Price (IBP) is the average fill price to execute the Impact Margin Notional on the Bid Price.
- Impact Ask Price (IAP) is the average fill price to execute the Impact Margin Notional on the Ask Price.
- Spot is the spot price of the underlying base asset.
Binance
On Binance, funding is recalculated and paid every 8 hours. Otherwise, this exchange has exactly the same calculation formula and the same 0.01% Interest Rate each funding period. Binance reserves the right to adjust the interest rate from time to time depending on market conditions.
Bybit
Bybit Funding Rate consists of the Premium Index P and the Interest Rate I. Bybit updates the Funding Rate every minute, and performs an N-hour Time-Weighted-Average-Price (TWAP) of the Funding Rate over the series of minute rates.
The current Funding granularity is 8 hours. The Interest Rate is 0.03%. During periods of significant market volatility, Bybit may temporarily adjust the upper and lower limits of the Funding Rate to encourage the Perpetual Contract’s price to return to a reasonable range.
OKX
The funding fee is settled every 8 hours on OKX. The funding fee settlement timing may be adjusted in real time according to market conditions. The funding rate is calculated as:
MA, also known as the moving average, refers to the average value of the premium index over the last N hours till present. “N hours” refers to the number of hours between each settlement period. If funding fees are settled every 8 hours, N = 8. Variables a and b are the upper and lower limits for the funding rate.
Derive Funding Rate Conclusion
The funding rate calculation mechanism on Derive is largely comparable to that of major CEXs currently used by Ethena, aside from differences in settlement granularity (1 vs. 8 hours). Therefore, the primary factors causing funding rate discrepancies are differences in user composition and trading behavior. Incentives offered by trading venues may also contribute to this variance. From a risk perspective, the correlation between funding rates across venues remains strong and is not expected to deviate substantially. As Derive matures and achieves higher open interest, its funding rate should align more closely with other venues.
Slippage Conditions
One important factor that contributes to the effective management of perpetual positions is the slippage incurred when exiting the perpetual contracts. While the maturity of Derive is not high, as the venue continues to grow, the price impact lowers. The historical slippage data is not presented by Derive but could be beneficial to make a clearer assessment.
Standard Safety Mechanisms
All Centralized exchanges use a set of standard safety mechanisms that are meant to protect the exchange from losses in case of extreme market volatility. They include:
- Insurance fund covers the excessive losses (negative equity) caused by positions closed at worse than bankruptcy prices. It mitigates the risk of auto-deleveraging. The insurance fund is collected from the residual margin of liquidated positions that are closed at better than bankruptcy prices.
- Auto-deleveraging strictly ensures that the platform stays solvent. If a user’s account value or isolated position value becomes negative, the users on the opposite side of the position are ranked by unrealized PnL and leverage used. Those traders’ positions are closed at the previous oracle price against the now underwater user, ensuring that the platform has no bad debt.
- Ability to adjust interest and other parameters is an element that could be invoked in case of extreme market conditions in order to protect the exchange from losses.
Derive has implemented a mechanism similar to an insurance fund, called the Security Module. It houses reserved funds that are used to pay off insolvent debt in the event of trader bankruptcy. In return for backstopping the system, the protocol (via the managers), charges fees to traders which are used to grow the Security Module. However, the current size of the Security Module is unclear. It is also unclear whether the other two mechanisms are available or planned to be implemented.
Protocol Architecture
Protocol Architecture
Derive Chain serves as the settlement layer for the protocol, built upon the OP Stack. L2Beat currently categorizes Derive Chain as “Optimium,” although a pending transition to the “Others” category reflects concerns over a dysfunctional proof system and the absence of a data availability bridge. The chain’s dependency on Celestia for data availability and reliance on a single entity for sequencing poses high concentration risks. Furthermore, malicious sequencer actions could result in significant fund loss.
The Derive Protocol, deployed on Derive Chain, enables self-custodial margin trading and operates under the governance of Derive DAO. Users primarily access the protocol via a web-based application operated by Lyra Technologies Corp, which features an off-chain order book managed by Lyra Trading Co. Although the documentation identifies the web app as a primary access point, it also describes alternative methods for on-chain interaction, detailed in a manual onboarding guide.
A security review conducted by Sigma Prime on the Derive smart contracts identified one critical and two high-severity issues.
- Bids Can Be Blocked By Depositing Tokens To Liquidator (Critical): Closed
- Withdrawals Can Be Forcefully Initialised By Anyone (High Severity): Resolved
- Precision Loss in CashAsset.withdraw() (High Severity): Open
The documentation contemplates Service Providers - individuals or groups contributing to the growth and maintenance of the Derive ecosystem. While there is an outline for applications and review, no records exist of past or ongoing elections. Lyra Foundation is currently responsible for contracting external service providers, including infrastructure operators like the sequencer and order book managers, as well as market makers.
Governance
Governance
Derive DAO, as the successor to Lyra DAO, is in charge of protocol governance. The legacy governance token, LYRA, allowed holders of staked tokens (stLYRA) to propose and vote on decisions via an AAVE V2-based governance architecture. However, LYRA has been deprecated in favor of DRV, with a formal recommendation against purchasing LYRA due to its lack of transition rights to DRV. All LYRA holders as per the snapshot of May 8th, 2024 are entitled to a 1:1 migration to DRV.
Source: Derive Docs, January 14th, 2025
Governance activity appears limited, with only three Snapshot votes on DIP proposals recorded in the past three months.
The DAO retains the authority to approve new collateral assets, but the decision-making process for new product launches (e.g., the forthcoming spot product) remains unclear.
Legal Terms
Legal Terms
Derive API supports both on-chain and pure order book requests. Terms of Use governed by and construed in accordance with the laws of Panama apply to any use of Derive API. These Terms allow the application operator to modify or restrict user access in response to breaches, including suspected inaccuracies in user representations or warranties.
Standard disclaimers apply, with users assuming all risks associated with derivatives trading and crypto transactions. Derive disclaims liability for any indirect, incidental, or consequential damages, including loss of profits, business, or data, limiting its liability to the extent permitted by applicable law.
To connect a wallet, users must sign an on-chain message affirming wallet ownership and accepting the Terms of Use and Privacy Policy. Importantly, users must declare that they are neither residents nor citizens of any restricted country, including Australia, Canada, and the United States, alongside high-risk jurisdictions. Sanctions lists from the United Nations, European Union, United Kingdom, United States, and Australia are observed to achieve the necessary level of compliance. Attempts to bypass restrictions, such as via VPNs, are considered violations.
Source: https://www.derive.xyz/, January 14th, 2025
Derive supports both Embedded Wallets and Self-Hosted Wallets. The Embedded Wallet is a non-custodial solution utilizing a 2/2 MPC scheme, where private keys are split into shards. One shard is generated by the provider, while the other is created in the user’s browser via the Derive SDK. While Derive does not store shards, it maintains limited backup data for recovery purposes. Increased attention is recommended for embedded wallet usage due to the involvement of additional parties, which expands operational responsibilities. As long as it is unclear which provider is employed to offer embedded wallet features, a self-hosted wallet shall remain the preferred option for enhanced security.
