Hyperliquid Integration Review
Summary
LlamaRisk indicates overall support for the proposed integration with Hyperliquid but prefers to abstain from the decision until the questions forwarded by the Risk Committee are answered. The analysis presented below also prompts additional questions to the Hyperliquid team. The following points need clarification:
- Whether the audits covered the DEX contracts’ code, in addition to the Hyperliquid bridge contract.
- Whether Hyperliquid has the authority to adjust parameters for perpetual trading.
LlamaRisk believes that in the absence of an audit for Hyperliquid DEX contracts, the integration of Hyperliquid should not be considered. Therefore, we will support the proposal only if audits are performed on all contracts on the most recent version of the protocol.
See full analysis details below:
Hyperliquid Network
Hyperliquid Network
The Hyperliquid DEX and on-chain order book execution is enabled by Hyperliquid L1 network, an optimized Layer 1 blockchain. Utilizing a custom consensus algorithm called HyperBFT, the network supports a transaction throughput of up to 100,000 orders per second and achieves block finality in under a second.
Validators Diversification
Hyperliquid’s validator set was initially centralized under the control of its core team. While the organization has announced an initiative toward greater decentralization by inviting external validators—such as ChorusOne and Luganodes—to participate in the testnet, the limited number of external validators is insufficient to assert that adequate decentralization has been achieved.
Source: Dune, 5th November, 2024
Nevertheless, progressive improvements in validator diversification are anticipated over time, particularly following the mainnet launch, which may attract a broader spectrum of validators.
Network Maturity
Hyperliquid represents a nascent Layer 1 blockchain that has yet to undergo extensive audits and rigorous testing. Thus far, only Zellic has contributed two security reports. There is an absence of comprehensive evaluations from other esteemed auditing firms, and the network has not yet demonstrated resilience or stability over an extended period. In addition, it is unclear whether the audits also covered the code of DEX contracts in addition to the Hyperliquid bridge contract:
Source: Zellic Hyperliquid Smart Contract Patch Review, 27th November, 2023
The limited operational history and lack of third-party scrutiny raise concerns about the protocol’s robustness and reliability. If the Hyperliquid DEX has not undergone an audit, this significant oversight would make Llamarisk strongly opposed to its integration.
Possible Geoblocking
Under the Terms of Use, Hyperliquid reserves the unilateral right, without prior notice to users, to suspend or terminate their participation in any feature of the Interface at its sole discretion. This authority encompasses situations where Hyperliquid determines or suspects that a user’s engagement with the Interface is unauthorized, deceptive, fraudulent, unlawful, or intentionally undermines the Interface’s purposes. It can be reasonably inferred that these provisions implicitly include access from restricted jurisdictions. Notably, the Terms do not expressly identify or enumerate any restricted jurisdictions, leaving ambiguity regarding potential geoblocking measures.
Perpetual Futures Venue
Perpetual Futures Venue
A key feature of the Hyperliquid ecosystem is Hyperliquid DEX, a decentralized exchange providing an onchain order book for perpetual contracts. This DEX exemplifies Hyperliquid’s focus on delivering a responsive and open financial system, with future expansions planned for native token standards, spot trading, and permissionless liquidity pools.
Open Interest
In order to evaluate the suitability of onboarded collaterals, it is firstly important to evaluate the stability and size of open interest available on the trading venue. The historical data indicates that open interest for assets of interest has varied over time but the overall OI trend is upwards.
Source: Hyperliquid Stats, 5th November, 2024
In the past 3 months, the OI for BTC has never been lower than $150M and currently fluctuates around $350M. Nonetheless, the OI for ETH has been in the $200M level with a brief period of lower $125M OI. The overall ETH OI growth has been stalling, however, this is in line with the aggregate market situation where the same OI consolidation can be observed. Moreover, SOL has recently reached the $100M level and trends above it for the past 2 months.
All of that indicates that the Open Interest levels are sufficient and stable enough to consider onboarding USDe collateral. Since the OI evolution on Hyperliquid is similar to overall market trends, the position management strategy employed by Ethena would be similar to that already used for different CEXs.
Funding Rates
It has already been outlined that funding rates on Hyperliquid have constantly been trending higher than on other exchanges, including the CEXs already used by Ethena.
Source: Hyperliquid Stats, 5th November, 2024
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 Hyperliquid’s method.
Hyperliquid
The funding rate formula applies to an 8-hour funding rate. However, funding is paid every hour at one-eighth of the computed rate for each hour.
where the Interest Rate is fixed at 0.01% every 8 hours.
- Impact Bid Price is the average fill price to execute the Impact Margin Notional on the Bid Price.
- Impact Ask Price is the average fill price to execute the Impact Margin Notional on the Ask Price.
- Price Index is the weighted median of CEX spot prices for each asset, with weights depending on the liquidity of the CEX.
Binance
On Binance, funding is recalculated and paid every 8 hours. Otherwise, this exchange uses 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.
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 the 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.
The funding rate calculation mechanism on Hyperliquid is largely comparable to that of major CEXs currently used by Ethena, aside from minor differences in recalculation granularity. 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 Hyperliquid matures and achieves higher open interest, its funding rate should align more closely with other venues.
Slippage Conditions
One important factor contributing to the effective management of perpetual positions is the slippage incurred when exiting the perpetual contracts. While the maturity of Hyperliquid DEX is not high, as the venue continues to grow, the price impact continues to decrease. The historical slippage incurred for a $100K position is the following:
Source: Hyperliquid Stats, 5th November, 2024
It can be observed that after the initial volatility just after Hyperliquid was released, growing volumes and open interest led to sharp declines in slippage levels. The most prominent slippage instance was during high market stress on the 5th of August, 2024 where SOL was projected to incur 0.04% of slippage for a $100K trade. While the potential worst-case impact for Ethena could be higher (due to larger trade sizes), it can be safely assumed that the trades could be executed within the 1% slippage range should the Open Interest levels remain similar.
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.
Hyperliquid has implemented auto-delevarging, however, no insurance fund is deployed and it remains unclear whether Hyperliquid reserves a right to change perpetual trading parameters.