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Wintermute AMA Recap

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On May 4th, we hosted a live AMA Spotlight with Evgeny Gaevoy, Founder & CEO and Yuriy Myronovych, Head of DeFi from Wintermute.

Evgeny and Yuriy discussed a variety of topics, including:

  • Their backgrounds and the story behind Wintermute

  • A deep into the business of market making and different strategies deployed

  • Differences in market making on DEXs vs CEXs

  • Wintermute’s strategy to manage inventory, risk, collateral, and credit

  • The future of market making in DeFi

A video interview is available here.

A redacted transcript is available below:

David (dYdX): Hey everyone, my name is David Gogel. I'm on the growth team at dYdX. I'm excited to be joined today by Evgeny Gaevoy, the founder and CEO of Wintermute, and Yuriy Myronovych, the head of DeFi at Wintermute, as well as Vijay, the Head of Business Development at dYdX. Over the next hour, we'll be discussing community questions about Wintermute and market-making on dYdX. Please submit any additional questions that you have on our Discord in the AMA channel, or in the YouTube live chat. Evgeny, Yuriy, thank you so much for joining us today. To kick things off, can you both introduce yourselves and tell us what the founding story behind Wintermute is. Evgeny, can you start, please?

Evgeny (Wintermute): My background is in traditional finance. So, prior to starting Wintermute, I worked at Optiver, which is one of the largest market making in traditional finance. At Optiver, what I was doing, I was building the ETF desk from scratch. And whilst I was there Optiver underwent a pretty big change from late stage startup to much more corporate. And there's all nice and not nice things with it. So at some point I decided it was time for me to leave and do something more exciting. And it was beginning of 2017 and crypto was starting climbing up, especially Bitcoin, and yeah, there's all this ICO craze and just a really perfect moment for me to start something.

And so, I teamed up with another software guy and we started Wintermute. And funnily enough, the first business case we were looking at was a market-making project. But as we started doing it in 2018, it was already crypto winter. And so we quickly had to pivot into more traditional market-making. And luckily for us, it worked, and the building and working was really good. And we actually ended up being one of the key market-makers in the crypto ecosystem, already last year. And so this year, growth has been phenomenal for us as well. And so sometime along the way, especially since 2019, we've been supporting dYdX liquidity-wise. And so we're quite happy to see this growth being mutual for both of us. And now to Yuriy.

Yuriy (Wintermute): Hello everyone. My name is Yuriy and I am leading DeFi efforts on the Wintermute side. Unlike Evgeny, I came from a software engineering background and a blockchain background. Probably the most well-known project that I worked for was Argent Wallet, which is currently used by quite a lot of people in the blockchain industry. But at some point, I figured out that, for me personally, it was way more interesting to play around with trading and generally be involved more heavily in the DeFi ecosystem. And that's when I joined Wintermute. That was about two years ago. Since then, Wintermute has grown quite a lot into DeFi, probably one of the biggest market-maker who works specifically in the DeFi space. I get quite excited to be on the call. dYdX was my first project that I had to integrate when I joined Wintermute. It’s been a fun journey since then.

David (dYdX): Thank you for sharing. To kick things off, Evgeny, could you describe what is market making, and the types of market making strategies that Wintermute deploys?

Evgeny (Wintermute): In a nutshell, market making is providing two-sided quotes to any given market. So basically, which is literally providing liquidity. So any time you want to trade, well, let's say a perpetual on dYdX, you can see bids and offers. With 95% probability it is going to be market makers, even more likely ours. The way they achieve it is to have advanced trade systems, which are hooked up to all kinds of other liquidity platforms, as well as pricing sources like liquidity pools, which give us all kinds of signals to be efficient and not get caught up on a big tick. But in a nutshell, it's basically providing liquidity.

The way we provide it, it's the most basic way. What you see on any centralized exchanges with bids and offers or if you look at AMMs, it can be providing liquidity to AMM pools. We are a pretty big OTC business as well, where thankfully counterparties can ask us for prices, which is also basically market making. And if you look at platforms like 1inch or Paraswap, it kind of works in the same way, because they're not only directing the flow to different pools, but they're also asking a bunch of private market makers for quotes, we are one of them as well. So there's also different ways market makers can help provide liquidity.

David (dYdX): There's different types of market making strategies. Can you talk about Wintermute's market making strategies? Do you generally always stay market neutral? And if not, what would shift that?

Evgeny (Wintermute): Generally, the core of the business is being market neutral at any given moment. We do, with certain positions that we acquire from OTC trading we might run it for longer, like for hours or sometimes a day. But yeah, the core business is always market neutral. Occasionally with certain other activities, which are not necessarily market making, if you're doing farming, it's pretty tough to stay market neutral with certain tokens, because it's literally impossible to hedge that exposure. We did a pretty big foray into venture investment as well. And that's obviously great to get long positions on any tokens we purchase. But that's basically outside of our market making mandate.

David (dYdX): You mentioned that Wintermute is active across a number of different DeFi protocols. Can you give us a sense of what the split or focus is around different types of products, for example, spot versus derivatives?

Evgeny (Wintermute): We don't necessarily see it this way. It's all kind of part of one big machine for us. So basically the whole team is looking at all the products combined. So basically, if something fails or something trades a lot that has potential issues in effectiveness. So we don't make a big differentiation between spot and other products.

David (dYdX): Can you describe what market depth is and why it's important to the health of an order book?

Evgeny (Wintermute): Basically, it comes down to the concept of liquidity builds liquidity. So, if you have really good market depth, it effectively enables a lot of different market strategies from active market participants who also take a really short term or long term positions, or look in technical analysis, and graphs, and whatnot. And effectively, as they start trading, that effectively enables more liquidity to come in. Basically, the market makers start to see more volumes then will naturally jump into the order book and it will be even more liquid.

So it's basically kind of like self-reinforcing mechanics. But it needs to be kick-started with one of the market makers initially, because otherwise, if there are no market makers to start with, not much will happen because there'll be a bunch of long only orders in the order book but without much trading. So you need just kick-starting liquidity and that's what we've been really happy to do with a lot of platforms we're working with.

David (dYdX): You mentioned that market makers are critical to help bootstrap liquidity on markets. Can you describe how market makers play a role in making crypto markets more efficient over the long run?

Evgeny (Wintermute): Basically, what I described is a good way of showing it. Another important component of course, is basically being able to provide liquidity when it's needed the most, like when there are really large moves in the market when, there are flash crashes, or something extraordinary happening. With perpetuals, another big component is the funding rates. And there's a lot of traders who like different perpetual exchanges, simply because there is arbitrage to be made with funding rates. And that's also where market makers are really helpful because they help bring those rates in line between different exchanges, between different protocols which does affect longer term price stability and trust in any given exchange by the users.

David (dYdX): Got it. So Wintermute is often quoted as one of the leading market makers in DeFi. I'm curious what are some of the success metrics that define a best in class market maker and how does Wintermute score along these metrics?

Evgeny (Wintermute): What we like to believe on our side, it's basically a combination of technology. Well, basically technology is the first bit, and especially in DeFi it's super important to be on top of everything. There is so many things happening. I don't know, you have dYX launching, we have Uniswap v3 launch as well. There are a lot of things to get connected to, and it's often a big decision that the market maker needs to do, whether to invest time and effort into supporting a given protocol, but it's also you need to do it properly and you need to it kind of advanced in terms of the technology level. You cannot just like make a lot of shortcuts because it can all get destroyed if you miscode something.

And you also need to be able to integrate with as many key exchanges as possible to be able to provide the best and fast prices. And for us, it always was a priority. So it was one of the foundations of the team from early on to build the best technology, especially in DeFi, this was our focus from day one. Second bit is the people and culture in general, and that's basically making sure that you hire all the right talents in all kinds of roles, basically those really junior traders, senior traders, senior developers, just making sure that it's the right people that also work really well together as a property. And also not being too disruptive in terms of overall culture. Culture is something we pride ourselves on a lot because we did put a lot of effort into making sure it's set up really properly. There is a much bigger degree of cooperation compared to competitions that we know exists in other traded firms. It's completely un-siloed. So there is no such thing as one trade team competing against other trading team, in certain ways. We do really well on that one because, on any given day you can see people... It's also crypto, right? So people have to work 24/7, but they also need to know that they're giving their best years to a company that also appreciates them, and that's what we do.

And finally, as things like approach to risk is really critical as well to market makers, especially when it comes to perpetuals. Market makers can get liquidated just like anyone else. If anything, they run a much bigger risk in that regard because the positions we run because of different funding rate arbitrages can be substantial. And then basically managing your collateral levels between exchanges, but also managing your exposures making sure you are truly delta neutral to the whole markets. That's very critical because you need to make it to the end of the day and not just make a lot of money. And so for market makers, it's a much more surgically precise business compared to just normal trading because we are making literally millions of trades every day. And you just need to make sure that those trades are not going to bankrupt the company, if something goes wrong in the the quote for instance.

David (dYdX): Switching gears a little market, crypto markets run 24 hours a day, seven days a week, 365 days a year. Some of the big price swings happen in the wee hours when people are asleep. Could describe what a day in the life of a market maker looks like.

Evgeny (Wintermute): Yeah, what's annoying about those wee hours is that we find ourselves based in Europe, which is probably the worst time zone to trade from because when stuff happens it happens during Asian hours, for some reason, well, for obvious reasons, but basically it comes to whoever is on evening shift or night shift on that particular day to deal with this mess and also call other colleagues and wake up enough people to actually act on it. But I guess a typical day of a junior trader, is you wake up, you take over whatever mess is left for you by the night guy, fixing some things like fixing components that went out, making sure that all positions are running smoothly.

And then during the day it's basically reacting to what's happened in the market. Looking at where the opportunities are, looking at what trades the most, making sure that we size up on the certain opportunities that we see. And at the same time, because we don't have pure trading roles at Wintermute, so all of the traders that we have they're supporting as well. So when it's quiet, t most traders have like one or two engineering projects that they're working to improve current systems, integrate with a new exchange, all those kinds of things. So it's basically either monitoring the markets if it's busy, or if it's not busy coding stuff.

Vijay (dYdX): It's great to get a sense of that. So switching gears a bit, wanted to talk a little bit about how you guys view decentralized exchanges versus the centralized exchanges and the mechanics of what goes on behind the scenes for you guys. So to kick things off, Yuriy, how is market making different for you at the highest level in terms of looking at the centralized exchanges versus a lot of the decentralized exchanges that are coming about now and seeing growing volumes?

Yuriy (Wintermute): That's an interesting question. On a high level, to us, there is no significant difference in terms of how the trading is going there, because here and there we are providing liquidity for users to execute their trades. However, the differences come into play more at the technical level, or integration level, and on the asset management level, because working closer to the blockchain has its own downsides. You have to worry about gas, what's going on on the blockchain, how the assets are transferred from the blockchain. So you have extra complexity.

However, you also have quite a few benefits. For example, you don't have to worry if you will be able to withdraw your assets from the exchange, because you know that all the funds are secured by the underlying blockchain. So you have that reassurance that the assets always belong to you, even if they are technically on the exchange right now. So on centralized exchange, it's completely normal for independent traders and the same even for market makers to wait for hours for their withdrawals. Where in DeFi you just send the transaction if you want it done in the next 15 seconds, you just put a very high gas price and there it is, it's done. It's very nice. It's very predictable and it's very easy to work with.

Vijay (dYdX): And do you see that as effectively helping to improve the overall collateral efficiency of the trading systems and operations?

Yuriy (Wintermute): Oh, definitely, because on the market maker side, we have to price in all the risks and if there are any issues moving funds around that just goes directly into the prices that users have to pay at the end of the day for the liquidity. And if it's working out of the box on DeFi, then it's much easier for users as well as it is for us.

Vijay (dYdX): And in terms of the technical connections, is that something that in terms of coding to the APIs or the smart contracts in DeFi, how has that been compared to connecting to the centralized exchange APIs?

Yuriy (Wintermute): It's definitely more interesting and more entertaining from the development perspective. You have way more creativity there and you have to adapt to a lot of protocols and how they do things. And especially DeFi is a little bit of a Wild West where different protocols can work in completely different manners. Like you have AMM, you have orderbook-based exchanges, or you have some crazy mix of neither of those and some other categories. And you have to adapt all those to your internal trading system that you use in house. Whereas centralized exchanges are pretty much all the same with small differences in the APIs. So in that sense, DeFi is definitely more fun and I can say our development team definitely enjoys coding for DeFi more.

Vijay (dYdX): That's great. So wanted to talk a little bit about market neutrality and how you guys see the role of perpetuals and maintaining that. Do you see perpetuals as an efficient instrument to stay market neutral? Or what role specifically do those play in your strategies? And what are the different kinds of cross product and cross exchange arbitrages that you see and focus on?

Yuriy (Wintermute): On the market neutrality, generally speaking as a market maker, we always try to be market neutral and whenever it happens that we end up running a position of being unable to match buyers and sellers effectively. That's pretty much always kind of a problem for us because this is not our business and not something that we want to be doing. We never want to take the other side of a trade from a person who is actually executing the trade. So we always strive to be market neutral and we always try to match buyers and sellers perfectly. It's not always possible, but from our internal stats, as long as you can reduce the time that you hold the position for below the seconds, then that's good enough.

Evgeny (Wintermute): In terms of how important perpetual are to market makers, there is one big aspect that we utilize a lot and it's what makes dYdX in particular really great. It does allow us to be market neutral with trading certain products, because it's not always possible to borrow certain tokens. And then what you can do, you can just go long spot and short perpetual, and that gives you inventory in spot to trade but it also makes sure that you're market neutral and there's funding rates, especially on centralized exchanges being really positive. It also means that you get paid to do that, which is a great position to be in.

Vijay (dYdX): That makes sense. And in terms of the arbitrage opportunities that you are looking at, are there specific framings of that, that are particularly attractive to you? In terms of arbitrage around the funding rate or cross exchange arbitrage for the same product or the cash and carry trade, or is there kind of a specific variety of the arbitrage trade that you focus on? Or would you say you are looking pretty broad?

Yuriy (Wintermute): We don't really look at the market from that perspective as we don't really focus on arbitrage and we don't have specific strategies to take advantage of arbitrage. But as a market maker, it kind of happens naturally to provide liquidity in multiple places, then that liquidity kind of balances out the supply and demand. So from our side, we don't really do arbitrage, but we focus more on providing liquidity.

Vijay (dYdX): Got it. And how do you think about managing the inventory and the risk behind the trading operation and what role does credit play as part of that?

Yuriy (Wintermute): Inventory and risk, yes the most annoying components in our trading system, I guess. Yes, managing risk is always the hardest because there are always situations when you want to satisfy the demand, but for some reason you can't, maybe because the market is more volatile than you would like, maybe you already got yourself into a position that you don't want to be in, and in that situation you always go back to market neutrality and make sure that your risk parameters are working for you and bringing you back to the neutral position that you want to be in. So risk for us is a tool to make sure that we are staying market neutral.

Vijay (dYdX): Got it. And so what role does credit play in terms of the balance sheet that you guys maintain and is that something that you prefer to use?

Evgeny (Wintermute): I can answer this one. It's pretty important and it's not very straightforward to borrow capital in crypto. You can see it from funding rates because you can see like in traditional finance it's all zero or negative and in crypto it's all like 20, 30, 40, 50, 100% sometimes to borrow dollars, or DAI or any fiat equivalent. And it all affects how much any market maker can deploy on a platform as well, because there is no such as unlimited capital for anyone. So you just have to allocate the capital properly to every centralized exchange, every decentralized exchange, every layer 1, for instance, as well.

So being able to borrow this inventory and move this inventory around is continuously the one big challenge for any market maker to solve. Even the biggest market makers out there don't have enough capital to serve the whole market, which kind of creates a lot of opportunities for smaller market makers to stick around for a while I would say.

Vijay (dYdX): So let's move to the topic of flash crashes and how you guys handle those. So obviously, the rapid price increases and decreases are quite common in crypto and in fact, in the last couple of weeks, we've had a couple of them. And then of course in the last couple of days, a strong rally. So how do you ensure that you are able to provide liquidity on market conditions and more specifically what's your playbook during a market crash? Walk us through the order of operations that you employ or what the fire drill kind of looks like when you have a major market move.

Yuriy (Wintermute): Well, it's very important for market makers to monitor the market conditions and let's say, in general, adapt to the market. When a market crashes or spikes. It is rarely pleasant for us. We would much more prefer to have a stable and predictable market, but whenever there is a spike, either up or down, it's more like an extreme situation where we have to adapt. We have to adjust our trading systems. We have to potentially go wider in the order book to make sure that we don't get run over. It's generally kind of a stressful experience for individual traders or any algo traders, the same as it is for market makers. And that's why we see the highest load on our risk, either manual risk components or automated risk that's when it kicks in and works the most.

Evgeny (Wintermute): This is a key priority. We are really conservative, when it comes to flash crashes in general, like really big market moves. Basically, a lot of our systems will just go out and will be restarted by respective traders or developers, which we do prefer because it's really tough to make a system that will perform really well in those circumstances because not only is it really abnormal price moves, which can result in all your pricing being really out of whack, but it also means that you potentially have to move a lot of collateral around for exchanges. Well centralized exchanges will be especially horrible because their prices will be off, their balances will be off, a lot of things, bad things can happen, and it's close to impossible to build a system that will properly prepare you for that and allow uninterrupted, 24/7 trading no matter what happens. So we're basically being really conservative, get ourselves out of the market and go in as quickly as possible once we think it's safe.

Vijay (dYdX): That makes sense. So just to wrap up this section, what would you say are the biggest risks for market makers or the ones that kind of keep you up at night? And obviously, we've covered a few, but is there one that you'd say that you are always thinking about or is it kind of a technology risk or more of an operational risk?

Yuriy (Wintermute): So I will probably name even two, not just one, it's the security of funds, especially on the blockchain. But it's kind of similar to the centralized exchanges as well in the way that you have to trust your funds to centralized exchange and they have full custody of it. So that's probably the worst one. And the second one after that is it's just a very volatile crypto market.

Evgeny (Wintermute): And in that regard, DeFi's much better because it's much more controllable. We are much more sure about the risks that we see on DeFi because obviously we can control it. We set up the security on our side, which is actually done really well. We cannot control anything that's on centralized exchanges. If somebody hacks them or if some exchange gets under investigation and just shuts down, that's it. There's nothing we can do about it.

Vijay (dYdX): So wanted to spend a few minutes just talking more specifically about your experience on dYdX and the market environment on the decks. Can you describe your experience integrating with the dYdX layer 2 perpetuals API and how it compares to other centralized exchanges?

Yuriy (Wintermute): So for Layer 2, the API is I would say more similar to the centralized exchanges API, more to tier one exchanges like Coinbase, Binance. From my side, I can say it was a nice change going away from representing things in the API the same way blockchain represents it, like for example, we don't have WEI to deal with or to convert different currencies to the values that are native to the blockchain. And the whole API is more streamlined and much easier to use. So on our side, it was pretty easy to integrate it. I don't think we saw any issues. And obviously, having libraries that were built by your team for different languages, definitely helps.

Vijay (dYdX): And how much does cross margining help you in terms of capital efficiency and what role does that play from a market structure standpoint?

Yuriy (Wintermute): Cross margining is great. We totally love it because we have to trade in multiple markets. Pretty much we have to trade in every market on Layer 2 currently. Without cross margining we would need to keep maybe five times higher collateral values altogether than we have to keep with cross margin. For example, we don't have to worry that on some day people would want to trade, just Ether let's say, or go long or short Ether, that would spike a lot and we would need to post a lot of additional collateral, but just because it's cross margined, it's kind of smoothed a bit. And if we post extra collateral, it can be used on any buyer that needs it. So it's much easier for us and I guess it's much easier for users as well because they can easily switch between different parts if they wish to.

Vijay (dYdX): And in terms of how you approach your technology stack, do you build everything in house generally, or are there cases where you may rely on say, an aggregator as either an API aggregator or prime brokers who provide a capital function as well?

Yuriy (Wintermute): We almost never rely on any sort of third party as aggregator or APIs. And there are two reasons for that. First of all, it's extra risk because if something goes down we are liable for that. We have obligations to be in the market and to provide service, whereas the third party don't necessarily have those financial obligations. So it would be our problem if it goes down, but not necessarily the third-party problem that's failed to provide the API. And the second thing, all the technology stack or technology solutions that we currently use, they have to be in real time, and really fast, and really responsive. We work on millisecond levels, so it's really hard to find any existing solutions that we can use in the market currently. I don't think we even saw many that we would want to use or that are good enough and work at that level. So we are more or less forced to build everything in house.

Evgeny (Wintermute): It's kind of like a shortcut you can take when you just start up. When we started, we used this python library called CCXT for connecting to a lot of centralized exchanges we didn't have capacity to connect to, but yeah, as it grows the market maker just needs to develop everything in house.

Vijay (dYdX): What is your view on the market depth, the spreads, and the pricing in DeFi and DyDX? How do you think those metrics compare to centralized exchanges now and how do you see that evolving into the future?

Yuriy (Wintermute): It's quite interesting to see that there is actually more liquidity to execute instantaneous trades on DeFi currently than there is on centralized exchanges. If you look at centralized exchange order book, even if you combine several other books, you won't always find millions of liquidity as you can find it on DeFi really, really easily. And quite often when market-makers partner with an exchange, it's always up to the agreement and to the exchange to incentivize market makers to contribute specific volumes in the order book. And it's up to that relationship with the market maker how well it's defined and structured, and that kind of defines how big the presence of the market maker will be in the order book. So from our side, if I would compare dYdX to a centralized exchange, we probably provide multiples of liquidity on dYdX, maybe three, four times more than we normally provide, even on tier one exchanges.

David (dYdX): That's super helpful. Jumping on the forward looking line of questioning, obviously with the rise of AMMs, traditional market-makers are becoming disintermediated by liquidity pools. And there's been quite a lot of innovation on the AMM side and most recently Uniswap V3 in some ways returns to order book principles, and so wanted to get your take on Uniswap V3, liquidity pools more broadly. What do you think of these and how do you see the role of market-makers shifting in DeFi going forward?

Evgeny (Wintermute): I personally find it really ironic that there's so called talks of disintermediation and everything. Uniswap realized that it's not really straightforward to just open it up for people and liquidity. There is a significant liquidity now in Uniswap, but Uniswap V3 is pretty much coming back to this order book model, which can be an improvement on what we currently have in the centralized exchanges and centralized order books, but it's still much closer to that, than what it used to be. And it proves that you cannot just disintermediate, at least advanced market makers, just like that. Our business is very complex. You need to manage technology, risk, and capital. It's really a properly complex business and it will take a really long time until we will see enough building blocks in DeFi, for instance, to actually properly replace us. So I don't think it's coming any time soon. I'm quite curious how the V3 experiment will work and we are actually looking forward to providing liquidity on Uniswap now because it’s going to be much more capital efficient.

David (dYdX): Wintermute is obviously one of the leading market makers on a number of DeFi protocols. As the nature of these DeFi protocols evolve, other than providing liquidity, has Wintermute participated in governance? And if so in what capacity have you participated in the development and future of these DeFi protocols?

Evgeny (Wintermute): YFirst of all, we really love governance as a feature. I think it's really awesome that protocols enabled for more voices to be heard and to actively participate, especially as a token holder. We do plan to be more and more active in that perspective and we are already quite active a few... For instance, a few months ago we actually signed a few market making contracts with 3 protocols purely by addressing the relative communities and basically putting in a snapshot.

And I found the whole process really cool and I think we will continue doing it because the protocols are fun to do this way and I think it's really transparent and progressive. It's the proper way to do it I think. We will definitely continue to be involved in any governance votes that are relevant to the business, whether it's like a trading platform, or custodian platform, or something like this.

David (dYdX): That's great. There's a lot of innovation in DeFi and sometimes it feels like the pace of innovation is accelerating. I'm curious, Evgeny and Yuriy, if you have a view on what is the future of DeFi? What's next? And where do you see kind of opportunity in the broader DeFi market?

Yuriy (Wintermute): It's quite exciting to see that DeFi is moving really fast. It's probably safe to say that DeFi is covering 10 years in one year over traditional finance. You can even compare the evolution of trading on the DeFi to CeFi, CeFi didn't really change in the last 10 years, where on DeFi we have literally up to 50 different projects that are experimenting with different rules to trading on AMM, on any sort of order book based exchanges, on any sort of futures, options, or any other more complex trading derivatives. It's quite exciting to see how it's going forward. We do believe that we're just scratching the surface of what can be done and what can be achieved. I think the most important thing is how easy it is to build and experiment because in traditional finance, the experiments are extremely costly and it takes years and years to try a new product, but in DeFi you can throw things together and build it in literally one week with three people and that's just amazing. That's the foundation for building a better financial future because if you can't experiment, then you can’t improve and I think that's the biggest strength of DeFi.

Evgeny (Wintermute): My view kind of builds on all that. Especially when we’re looking at all kinds of derivative products on DeFi, that's super cool. Once thing we'll see is a lot of different options protocols popping up this year and properly developing. But one thing that is not being talked about that much, but I actually feel super bullish about is actually indexed products. So what we see in traditional finance, the highest traded product is the S&P future, not the underlying stock, so it will be super cool to see those kinds of products, like perpetual and DeFi index being listed on dYdX, for instance. think if that happens and it should happen at some point, DeFi can actually for a change beat centralized exchanges with go to market. So that will be super cool in my book.

David (dYdX): Awesome. That covers all of the questions that we received ahead of time from our community. If anyone that's watching live has any additional questions just submit them in the live chat on YouTube and we'll be sure to address them. Yuriy, a question relates to one of the comments you made earlier around security of and safety of funds. Can you share more about how Wintermute actually secures its funds and how that's different in DeFi versus in CeFi.

Yuriy (Wintermute): On CeFi you don't really have any options pretty much, the centralized exchange owns your funds. While likely on DeFi there are not that many existing solutions and you have to come up with your own. However, you have an ability to do so. And a few things that are definitely helpful for any business would be more contracts and multi-sigs, probably this would answer or solve a lot of security issues. Because of smart contract's flexibility you can implement your own multi-sigs, that tailor to your own individual needs, that is probably the strongest feature.

Vijay (dYdX): Another question that we've got from viewers is how would one get started in DeFi market making with mostly CeFi or traditional training experience? And what would you say are the biggest differences between the two as well as the top exchanges to start on?

Yuriy (Wintermute): Well, luckily DeFi is very heavily fragmented and for a lot of new protocols they might not be big enough or do not have enough rolling liquidity or attention for a bigger market maker to start participating in. And that opens a lot of opportunities for smaller market makers who want to try themselves in the business to work with those smaller projects and protocols and helping them grow and growing together with them.

In terms of how to start, there is no easy answer there. You just have to stop sleeping and reading everything you can find about how smart contracts work, how the DeFi world works, and how this protocol works. That's pretty much the only thing.

Evgeny (Wintermute): I mean the closest you have is really dYdX when it comes to Ethereum. You have Serum on Solana as well, which is also a central limit order book. Those are your first two options to play with, because they are probably the closest. And then second closest, I guess, would be to try to integrate with RFQ platforms, aggregator platforms like Paraswap for instance, because then it's also basically market making in a way and you can respond to quote requests and be a market maker in that sense. Everything is obviously quite competitive, but it doesn't hurt to try.

David (dYdX): Another question we got, I think relates more to market making on AMMs, but do you have a view on LP arbitrageurs taking advantage of the impermanent loss problem in liquidity pools?

Yuriy (Wintermute): This is a pretty complex problem. The issue was liquidity provision to AMMs is the fact that you don't control the price and that you don't control the pricing function. You have to rely on the AMM to provide you with those. And if you're not happy with the price, you can't really do anything because withdrawing liquidity is really expensive. So in the current generation of AMMs, you have to come up with some really creative solutions, how you can hedge that kind of risk and how you can solve impermanent loss, because effectively impermanent loss is the fact that you don't control the price. Unfortunately there is no really simple answer. We have seen people trying to do it in many different ways. Potentially you can use for example, options to hedge your impermanent loss, or you can go more the route of delta hedging. There are quite a few solutions out there that are covered in the media, but none of those solutions are ideal and that's why we are looking forward to new inventions in the AMM space to see how that can be solved.

David (dYdX): Another question relates to Wintermute's history of raising capital. How did Wintermute raise capital for the firm and would you recommend taking a similar path for smaller market makers? The broader question is how does a market maker fund itself and how can that scale over time?

Evgeny (Wintermute): That's a great question. Basically two options you have as a market maker is to go proprietary trade routes and that's what chose ultimately. If you look at companies like Optiver, for instance, those are proprietary trading firms. They don't have any outside capital. They just trade their own capital and doing great. Or you can create like a hedge fund, basically taking on outside money, and paying them with 80/20, or 50/50, or whatever arrangements you can find.

The way it worked or us, early on, we decided to go with the proprietary trade route, so the first round we raised was an equity round. In crypto the main challenge is it’s very difficult to get leverage, which is not captive to any given platform, any given exchange. It's possible to get capital on a centralized exchange from a centralized exchange. With some of them you can get an agreement like this. Nut it's pretty tough to get capital, which you can freely move around between exchanges, or DeFi, whatever. You need to be properly, well, not necessarily properly big, but you need to have a proper track record to achieve that.

We started with equity investments and we actually took some of the capital as a profit on a profit sharing basis being sort of like in between the hedge funds and prop trading, but then once we actually did the proof of concept and once we started making money, then we actually returned all the money to profit share investors and shifted to unsecured lending because unsecured lenders were fine with us taking more and more of those loans. So that was our path, like it was bumpy, but we are in a very good place now and if you start you need to know where you're going with this because prop trading allows you for much longer term thinking and basically, building as well. And, you can afford a losing year as well if you invested because investors won’t withdraw money. While if you're a hedge fund or like the fund structure, you can potentially get much more capital from the very beginning and scale much faster, but you obviously need to give up a lot of upside for this.

Vijay (dYdX): This will be the last question that we have time for. Can you speak to the total notional volume traded by youon DeFi versus traditional exchanges or some measure of the percentage or split between those two, if you don't have the numbers off the top of your head?

Yuriy (Wintermute): It's an interesting question. I think about 20 to 30% of our current volume is coming from DeFi. And that might sound as a low number at first glance, but you have to take into account that the majority of the trading volume is happening on layer 1 where you have to pay for every single trade that you're making. So if you compare that 20% of the volume is the volume that we have to pay a lot for, and the other 80% is pretty much free volume on centralized exchanges where you can trade back and forth for almost zero cost. Then from that perspective, it suddenly makes DeFi look way more competitive because in that sense it's actually way more impressive that you can have 20% of very high cost volume coming from DeFi.

And we really look forward to any sort of Layer 2 systems coming into play, just like dYdX Layer 2 perpetuals. This is really the only solution for Layer 1 blockchains going forward because we don't think that being Layer 1 is scalable anymore. It has to be Layer 2. It has to happen and projects who realize that first will be the leaders in the industry.

David (dYdX): Awesome. Evgeny, Yuriy, Vijay, thank you all for your time. That wraps up all the time we have for this AMA. You can follow dYdX and Wintermute on Twitter @dYdXprotocol or @Wintermute_T, and be sure to check out our new perpetuals on Layer 2 at dydx.exchange. We currently support nine markets. You can go long or short with up to 25 times leverage on a number of market pairs on dYdX. Thank you for watching and thanks for the great questions. And Evgeny, Yuriy, thank you so much for your time.


About dYdX

dYdX is the developer of a leading decentralized exchange on a mission to build open, secure, and powerful financial products. dYdX runs on audited smart contracts on Ethereum, which eliminates the need to trust a central exchange while trading. We combine the security and transparency of a decentralized exchange, with the speed and usability of a centralized exchange.