In the world of finance, the Pareto principle is well-known: "The few hold much." However, this is not what we can observe in the metrics presented below regarding the top 5 derivatives protocols’ volume share over time - as the hierarchy is not yet defined, everything indicates the opportunity for the ascent of new leaders in the market. We are going to show you why Zaros is a candidate that you cannot ignore.

Perpetual Futures - DEXs need liquidity & a wide list of markets.

We know that trading perpetual futures onchain today is far from optimal: inefficient collateral liquidations, low variety of trading pairs, hard-to-use dApps, open interest imbalance… The list goes on and on… These characteristics combined with low available liquidity have a correlation to the fact that DeFi is merely a drop in the ocean of TradFi. DeFi TVL in August 2023 is around U$40B, which is nowhere near TradFi's capital markets, totaling U$100T capitalization.

Trading pairs variety on most perps DEXs today is low, a consequence of the suboptimal current liquidity provisioning models and risk management paths used by them.

Part of the solution involves solving the fragmented liquidity problem, and for doing so, a liquidity provisioning model capable of directing its liquidity in a market-agnostic way is needed. The second part of the solution is an improved risk assessment strategy that clusters correlated assets within risk tiers and applies a smart funding rate algorithm according to its category, which delegates each new perpetual market risk to the trader, enabling wider perpetual market variety while maintaining the pool economically sustainable.

This enables the implementation of a single liquidity pool responsible for designating liquidity within all perpetual markets, solving the liquidity fragmentation issue. Below we present how Zaros is implementing these concepts.

The core of the issue: low capital efficiency

Two of the main liquidity provisioning systems directed to perpetual futures trading are Synthetix and GMX. Both are releasing new versions soon, SNX v3 being in Alpha and GMX v2 being in Beta. We're going to provide a brief summary of the models, their pros and cons.

SNX v3 - Users can create pools where they select which markets they want to provide liquidity to – using whatever whitelisted assets they want (multi-collateral assets)– and collect fees. The Spartan Council provides an official pool for current markets, mainly backed by the SNX token.

• Pros: flexibility to provide collateral, create strategies based on trading pairs markets, and ability to follow other users’ strategies.

• Con: fragmented liquidity, TVL concentrated as SNX token.

GMX v2 - In the new model, volatile markets will be synthetically collateralized with long and short tokens (e.g ETH and USDC), backing the price of the given market's index token (e.g: ETH/USD, SOL/USD), which brings more flexibility and scalability.

Additionally, liquidity for each pair will be isolated, allowing liquidity providers to select the pairs they wish to commit liquidity to based on their risk appetite/returns.

• Pro: funding fees will make open interest more balanced like in Synthetix markets, making LPs less exposed to traders’ PnL.

• Con: fragmented liquidity, higher strategy complexity for LPs.

Both models introduce a more flexible market-making model but have in exchange a large likelihood of fragmenting liquidity across markets and collateral types, effects that can already be clearly seen on GMX v2. This results, for example, in markets like $PEPE and $DOGE with a high open interest ceiling while having less than 10% utilization.

Zaros is focused on solving the liquidity fragmentation problem that both models result in, focusing on using Liquid Staking Tokens (LSTs) - responsible for 40% of DeFi's TVL - and prominent stablecoins as sources of collateral for powering our perpetual futures markets. However, liquidity fragmentation is not only about what assets are accepted as collateral but about how the liquidity is destined for perpetual markets.

As mentioned above, there are three main characteristics we are convinced will impact significantly the capital efficiency for liquidity provisioning, open interest limits, flexibility, and asset variety for traders:

• A liquidity provisioning model capable of directing its liquidity in a market-agnostic way;

• Underlying asset risk clusterization method to define max open interest;

• Smart funding rate system;

We will address these topics’ outcomes for liquidity providers and traders in the next session.

Zaros: Perps powered by LSTs. LSTs powered by perps rewards.

Overview

Zaros is a groundbreaking protocol that seamlessly places itself at the intersection of liquid staking and perpetual futures markets. With a vision focused on real yield and capital efficiency, Zaros empowers LSTs holders to boost their rewards by lending their liquidity for the creation of perps markets. The protocol is a massive upgrade to the world of onchain perpetual futures by introducing a USDC and LSTs collateral Vaults, and an over-collateralized stablecoin: zrsUSD.

The USDC Vault contract is connected with Zaros' Strategy Manager module, which deploys USDC collateral to the Balancer Strategy, connecting to the Balancer Vault in order to bootstrap spot liquidity for zrsUSD and allow the Market Manager contract to seamlessly support LSTs like Lido's stETH and Frax's sfrxETH. The LSTs Vaults manage a share of protocol-controlled zrsUSD. Traders can buy zrsUSD to leverage trade on Zaros' perpetual futures markets.

How the liquidity provisioning module works

The protocol is built using a modular architecture, powered by the EIP-2535 Diamonds pattern. Liquidity providers’ collateral is sent to one of the supported Vaults, as explained below, and it's used to back zrsUSD, our over-collateralized stablecoin. Perpetual futures markets use the zrsUSD credit to spin up liquidity for traders, allowing any asset supported by integrated oracles to be traded on Zaros, including but not limited to crypto, commodities, and FX. In exchange for the credit provided by LPs, integrated markets pay trading fees to each Vault.

How the trading module works

Each perpetual futures market is deployed as a standalone smart contract. Traders deposit collateral to their margin account calling the Perps Vault contract, which controls connected markets and trading accounts’ collateral. Users can then create leveraged positions on any of the supported Perpetual Futures contracts, either isolating their risk per market or enabling the cross-margin mode for more flexible risk management.

Synchronous liquidity and interoperability

Zaros leverages Chainlink's CCIP to enable cross-chain communication between its L1 liquidity engine and L2 deployed markets. It's a crucial piece to achieve the vision of providing traders synchronous, deep liquidity and boosting LP's rewards across deployments powering products at supported L2s.

By sending messages through CCIP, the smart contracts on Ethereum L1 are able to aggregate required data such as debt and fees to reward users providing LSTs or USDC while taking advantage of lower gas fees for traders using Zaros’ products on L2s.

Vaults’ debt and soft liquidations

Liquidity providers’ collateral is used to back trading activity on Zaros’ markets. Each collateral is allocated to its respective Vault, which needs to maintain a healthy collateralization ratio pre-defined by a risk analysis. Once an individual position in a Vault or the entire Vault reaches the liquidation threshold, the protocol enters a soft liquidation mode, allowing arbitrageurs to acquire collateral at a discount (defined by Zaros’ decay curve), having the Vault act as a custom Protocol Pool at the Balancer Vault.

Outcomes for liquidity providers and traders

For liquidity providers:

We already know Ethereum Liquid Staking Tokens are among the most reliable sources of onchain yield. But is it the best risk vs reward option? It depends on your perspective, considering LSTs APY are around 3-4% at the time of writing.

A good comparison to point out our understanding of product-market fit is that stETH holders already heavily borrow ETH on Aave to re-stake and leverage their rewards, counting with over U$500M of supplied collateral. Zaros could be a potential alternative for these users when for example the risk scenario is similar and our estimated APY is around 9.98%*.

*APY estimated using the 30d APY average for GMX by the time of writing.

The protocol's innovative ERC4626 strategy-based stablecoin mechanism (zrsUSD) allows it to seamlessly support LSTs like Lido's stETH and Frax's sfrxETH to bootstrap highly liquid leverage trading markets. By providing liquidity to Zaros’ perpetual futures markets using LSTs as collateral, LPs may boost staking rewards significantly.

For Traders:

Leverage trading on a wide range of assets

Zaros overcomes the limitations of DeFi trading by offering a wide range of oracle-based perps markets. We prioritize user experience, providing an easy-to-use platform for traders while supporting professional-grade tooling.

Smart Funding Algorithm

In order to achieve our vision of having Zaros become the number 1 place for leverage trading new crypto assets and other long tail markets, we have created the Smart Funding Algorithm, which is responsible for determining each supported market's funding rate.

It is computed by taking into account off-chain volatility, provided by custom Chainlink Functions created by Zaros’ Core Contributors, and an asset risk tier classification provided by the risk team. With this model, the protocol is able to quickly allocate liquidity to new and experimental markets, balancing the risk with more or less aggressive funding rates on dynamic scenarios.

Margin collateral types

At Zaros, LST token holders are treated as first-class citizens. Alongside the core modules, Zaros’ leverage trading markets also support LSTs as margin collateral, unlocking use cases such as delta-neutral algorithmic stablecoins, or simply letting users arbitrage staking rewards and funding rates.

Low-latency oracles

Orders are settled in an asynchronous flow, using Chainlink's onchain price feed in combination with a partner low-latency Oracle that can't be disclosed as of today. Future articles will discuss how Zaros innovates to provide the lowest price impacts and fees on DEXs.

The usage of Low-latency oracles results in a variety of benefits that help DeFi to achieve the same or even better UX than CeFi, including:

• Faster order execution;

• Better settlement price;

• Front-running protection

eClusters

Zaros’ liquidity provisioning model allows supplying markets in groups so that liquidity is not fragmented among just a few tokens. This enables listing a wider variety of perpetual futures markets since many markets can be grouped within the same risk and, consequently, available liquidity range.

One of the variables used by the Zaros system is the correlation between assets. The use of correlation to bring more capital efficiency has already been employed in AAVE v3's eMode, which is designed to maximize capital efficiency when collateral and borrowed assets are correlated in price. On the other side, Hierarchical Risk Parity is a well-known technique for building diversified portfolios. Our idea is to explore the technique in reverse, that is, to seek clusters that do not represent diversification, therefore, are strong candidates to participate in the same liquidity cluster.

References: Spearman’s rank correlation and fractional differentiation.

In the picture, BTC, ETH, and BNB are highly correlated, which means that they are strong candidates to participate in the same liquidity share of the pool. On the other hand, pax gold is an asset with no correlation inside the cluster, which means that its risk/liquidity provisioning should be treated separately. Furthermore, ada, dot, sol, and xrp have moderate to strong correlations, so they can be grouped together in the same liquidity cluster.

Along with the Smart Funding Rate, the liquidity clusters delegate the risk to the trader, as it imposes a dynamic funding rate depending on the cluster's risks, open Interest Imbalance, and the latest volatility of the assets. This means more liquidity and markets variety for the trader and fewer risks for LPs.

Liquidity Engine Infrastructure

Although as Zaros Labs we are building the main products on top of the Liquidity Engine composed of Zaros’ core modules, we have plans to support third-party dApps and partner protocols in the future that want to connect to the protocol's liquidity, markets, or leverage the boosted rewards Zaros provides to LSTs token holders. Other DEXs and liquidity protocols will be able to build new products and mechanisms on top of Zaros, such as ERC4626 vaults performing atomic funding arbitrage between different derivatives protocols. If you are a protocol or a developer, we'd love to have a chat. Feel free to send a DM to the Zaros Labs Twitter page or email pedro@zaros.fi.

Core Contributors

The founders, Guilherme Bettanin and Pedro Bergamini (0xPedro) met in 2017 and started trading crypto together in the same year. Pedro is a seasoned blockchain professional, with significant contributions in the industry. With over four years of experience in blockchain projects, Pedro has also served as the Head of Blockchain for Illuvium, the pioneering AAA crypto game. During his time there, he successfully deployed smart contracts securing over $1 billion of TVL on Ethereum. Guilherme Bettanin brings his expertise in marketing and e-commerce growth to the blockchain industry. With 5 years of experience in e-commerce and 2 years of experience in blockchain projects, Guilherme has co-founded an investment DAO and startup accelerator. His contributions to the industry are cherished, and he is dedicated to driving innovation, growth, and user experience in the blockchain space, focused on onboarding TradFi users to DeFi.

Zaros is now a team of 14 core contributors and its vision is to become the preferred liquidity hub for protocols and end-users who operate with onchain derivatives.

For more information on Zaros, please visit www.zaros.fi, follow our Twitter, and join our community on Discord.