Over the past two weeks, Digitex Futures CEO Adam Todd put forward two key proposals. In this AMA, he explains how we reached the decision to proceed with the Liquidation Engine and Insurance Fund and what it involves. He also details the latest market maker proposal in full. Be sure to check it out and as always, if you want to catch the highlights, you can read the key takeaways below.
How to Deal with Liquidating Positions
Adam explains that any futures exchange has to have a system for liquidating positions and guaranteeing that the exchange can always meet its liabilities if and when the high leverage traders “get blown out” in particularly volatile markets.
When this happens, the exchange loses money. So in order to claw back some of that loss, we need a way of addressing this type of situation so that we can continue operating a functional exchange.
What the Liquidation Engine does is essentially intervene with high leverage traders with insufficient account balances. They suffer a penalty that is placed into an Insurance Fund. You can read more details about the Liquidation Engine here.
Adam has narrowed down how to deal with these types of situations to three options. We could do what BitMEX does and let the Insurance Fund build up over time, which doesn’t seem like an optimal use of the tokens. We could burn the excess tokens, which doesn’t seem to be too popular, or we could go with a third option proposed yesterday.
In this option, we start off with a big insurance fund of 100 million DGTX (which is 10% of the DGTX supply that was originally allocated to the market makers). Then, as the fund goes above that and the Liquidation Engine starts registering an excess of tokens, instead of burning them, we give them to the market makers to lose.
This means that the fund always stays at 100 million DGTX. If it were to drop below 100 million, we would simply dial back the market maker losses to ensure the fund always maintains this level.
Why Is The Market Makers Losing Money a Good Idea?
The market makers losing money allows us to create very liquid markets with these tokens through highly active market making. Market makers that can lose money can be much more active and place a lot more trades than if they were trying to break even or make a profit.
These types of active markets will attract traders. The fact that the market makers are losing money as well is a bonus. It gives traders the chance to win the tokens that the market makers are losing.
While we could keep the tokens in the fund and let them build up by a small percentage over time, Adam says that this idea will bring back much bigger returns. Why?
Because we will effectively be giving away the tokens to traders. If the market makers are designed to lose this creates a mechanical edge in favor of the trader, that could attract potentially millions of traders–and far greater returns.
“Digitex will be the only exchange to actually work in favor of traders. What’s the effect of a million traders coming in? All of them have to buy DGXT to trade.”
Some people mentioned that taking tokens away through the Liquidation Engine and giving them back through the market makers means that we’re not technically giving them away. However, Adam explains that that’s not technically true because there are going to be two different sets of traders on the exchange.
The Liquidation Engine intervenes with high risk highly leveraged traders who force the exchange to take over their positions. There has to be a penalty for this as it is a big risk vector for the exchange. That has to be accepted, and the exchange has to make money on some liquidations to make up for the times that it loses money on liquidations.
We are giving the tokens back to the short term scalping trader that never come into contact with the Liquidation Engine. Adam says:
“You can trade full time, stop yourself out, trade in a way that will target what the market makers are doing, short term scalping style, no fees to worry about.”
The Liquidation Engine and the Market Makers Have Separate Roles
The Liquidation Engine and the market makers are doing two separate things. The tokens are coming from one style of trader and going to another style of trader. And in the process, we’re creating highly liquid markets through active market making. Adam says:
“It’s innovative, it’s new, and it’s another reason to pull traders to Digitex and not other exchanges… Remember that there is no preferential treatment to third-party market makers, either.”
Digitex Futures is the exact opposite of the traditional fee charging exchange that gives preferential treatment to third-party market makers. There are no fees to worry about and there is an actual mechanical edge working in your favor.
The Top Questions from the AMA
Adam explains that we decided to pivot from the idea of token burning and token minting. He concedes that some community members liked it and others didn’t, which is why we put it forward as a proposal. Here, he answers your questions on the whole process.
1. In the event of a liquidation cascade, how quickly can the insurance fund mint excess tokens needed for ADLs?
This was a good point. The fund probably couldn’t mint tokens quickly enough to cover its losses without there being a delay. We decided that was one of the disadvantages with the token burning and minting idea. We also realized that if we had to mint when the time came, it wouldn’t work trustlessly, so that was another issue.
2. Why not use tokens to cover exchange costs rather than burn them?
Adam explains that this would bring in a conflict of interest since the exchange would be trying to make money from its users to fund itself. We would rather burn the excess tokens than use them for profit-making. These two elements need to be kept separate.
3. How do the DAO holders know how much an insurance fund minimum should be required?
This is a good question. We don’t have all the answers and this is partly why we decided to combine the market makers with the Insurance Fund. If we start with 100 million DGTX in the fund (10 percent of all supply of DGTX) we believe that should be more than enough. Adam remarks, “imagine if you had a Bitcoin fund, and you had 10 percent of all the supply of bitcoins, it would be huge.”
4. Can the DGTX obtained though liquidations be used to promote the exchange by way of bonuses for people referring to other users?
Adam agrees that this is an interesting concept, instead of burning them, we would use them to fund an affiliate program, that is one idea.
He doesn’t shoot the idea down, but says that for now, he prefers the idea of giving them to the market makers to lose since this will create liquid markets. However, this is a good example of a proposal that can be voted on when we become a proper DAO.
5. The derivative market is already unstable as it is. Insurance funds were invented by exchanges to minimize these risks when the price moves too fast and lots of traders get liquidated. Destroying it to just pump the price by burning is not a good idea.
Adam agrees. This is a key reason why we decided that keeping the fund at 100 million DGTX rather than burning the excess is a better idea.
6. Will the $1 tick size be put back to $5 or even $10 with the current volatility?
Yes, probably. The dollar tick size is redundant, Adam agrees, $5 is much better and more stable. The price won’t be so volatile it will be easier to scalp and differentiate again.
7. Why not just use the insurance fund as an insurance fund, rather than a cookie jar?
To this question, Adam laughs and replies that the exchange is not incentivized to liquidate people. We are not making profits on liquidations or using the fund as a cookie jar since we are giving the tokens away.
It’s not an incentive to hunt down high leverage traders, and the advantages of using the tokens to create more liquid markets are potentially huge.
8. Coinbase experienced a brief outage Wednesday afternoon, with both its website and API rendered temporarily inaccessible, as the price of bitcoin dropped more than $1,700 in the span of 15 minutes. How is DGTX going to avoid outage issues (like Coinbase’s) from occurring?
Adam pauses for a moment before replying, “The only way I can answer that is to get the best developers you can get and we’ve finally done that… I’ll admit that we’ve made a few mistakes with the development process… But what doesn’t kill you makes you stronger, right? We are now in a very very strong position. You just hire the best people you can and that’s what we have done.”
9. How will Digitex create revenue other than mint tokens?
Minting tokens is our revenue model as explained in the white paper, however it is not scheduled until 2021 and there are plenty of other ways to create revenue.
One of the ways is our Digitex Treasury. On top of that, we’ve got IEOs when we come out with the spot market. IEOs are going to make us a fortune, Adam says, since many tokens are going to pay high listing fees to get in the exchange.
“You can make a lot of money from a large crowd of active traders other than charging commissions.”
10. Does the team intend on publishing the entire code base of the exchange or certain elements that are not proprietary?
Adam replies that all the “Ethereum scaling stuff” and noncustodial side of things will be put on Github and we will put out as much open source code as possible. He explains that SmartDec is on the “sharp edge of things” researching how to scale Ethereum and that we owe it to the community to publish and open-source that code and those findings.
11. What proportion of DGDAO tokens will be given to DGTX tokens?
Adam says that this is not a fixed amount. The amount of tokens that are distributed is fixed at around 450,000 DGDAO tokens per day. However, the proportion depends on how many DGTX tokens are held in the exchange at the time. The fewer tokens, the more DGDAO they will receive and vice versa.
12. What if the Insurance Fund can’t keep up with the losses of the market makers?
Adam reassures that this will not happen since we can tweak the operational peramaters of the market makers at any time and very easily control the rate at which they lose money. We can adjust the size of trade, the bid-offer spread; there is a whole manner of ways we can adjust them to ensure that we know how much they are going to lose.
13. What’s driving these recent changes?
Adam chuckles as he explains that it’s no secret that development is taking longer than we hoped. But in the meantime, you have to stay relevant and stay innovative.
He says that Bitoin.com recently used Digitex as an example of an innovative model that has the potential to do big things alongside Binance.
Moreover, all these “changes” are not really changes. These are all key areas of the exchange that needed addressing and now that we have development firmly on track, he is able to dedicate time to them.
He closes the AMA by saying that he couldn’t be happier with the development team. SmartDec is made up of some extremely intelligent people, most of which have or are studying PhDs.
“We have 13 people working on the Digitex exchange right now. We have the implementation, the ability to execute, we’re in a strong place right now, we have the funds, everything is here.”
While Adam has moved to Moscow to work side by side with the team, don’t forget that you can catch him in Barcelona next week at the Barcelona Trading Conference. The tickets are free so come on down and say hello! And be sure to keep all your feedback coming on our socials and let us know what you think of this proposal and the job we’re doing.