Hyperliquid's CLOB

 The latest horrid DEX simulacrum is Hyperlink, a perp CLOB emphasizing shit coins. It runs on its own dapp-specific L1 using a version of Tendermint, the favorite consensus mechanism for those prioritizing speed. 

I listened to a Flirting with Models podcast with founder Jeff Yan, where he spoke with Corey Hoffstein, a quantitative long-term equity portfolio manager. Hoffstein’s background and demeanor prevented him from calling out Yan’s BS, which is fine because most good podcast hosts are credulous and agreeable; otherwise, no one would go on their shows. Yan spouts many typical crypto/market maker cliches among those trying to impress people who are vaguely familiar with the issues. For example, when talking about his earlier trading experience, he said he ‘was surprised how inefficient markets were.’ This is a great phrase because it implies one was outsmarting people, an alpha generator, and it does exist, so it is possible.

Yet, one should provide several good examples to demonstrate you are more than just bloviating. In crypto, there was the famous Kimchi premium, where coins traded at 10% in Asian countries. This inefficiency persisted because it required trusted partners in the US and Japan or Korea to make the trade, which is non-trivial. In any case, it was over by early 2018 and required connections instead of savvy. Nonetheless, many Sam Bankman-Fried interviewers were blown away by SBF’s singular arbitrage example, presumably one of his many clever trades. Looking back at Alameda’s tax returns and the fact that most FTX traders left FTX throughout 2018 (no bonus pool), this was likely his only profitable trade outside of buying coins in the 2021 bubble with customer funds (see here for more). Thus, we have FTX exec Sam Trabucco bragging about their other genius trade idea, buying Doge when Elon Musk tweeted about it. The Kimchi premium was the only inefficiency Yan mentioned on the podcast.

When Yan was asked about the difference between maker and taker high-frequency strategies, Yan stated that a taker strategy might make only one trade a day. An HFT taker strategy involves sniping the top of the book before an LP can cancel. By definition, it can’t do this to a large volume, as the top of the book is not big. The edge is the spread at best. That’s a large amount of risk and capital, adding up to a couple of bucks per day. He described a strategy that has never existed because it makes no sense: a once-a-day HFT taker strategy.

Yan highlighted that Hyperlink’s L1 can do things that would otherwise be impossible and emphasized updating a perp account for hourly funding payments. This is pointless. Given the horizon of perp traders—days, weeks—crediting their accounts hourly instead of waiting until the position is closed is pointless. A 50% funding rate is a 1% potential boost for a week-long position, which would be long for perps. No rational trader will be excited by having that trivial amount accelerated into hourly payments. Again, this highlights Yan’s cluelessness.

Yan says he then decided to build an exchange on his own L1 because of the Impermanent Loss problem in AMMs. I agree that Uniswap’s AMMs are unsustainable because they lose more money to this expense, but CLOBs on blockchains are not the solution. A fast L1 will still be slow because the CEXs are centralized, and co-located servers can respond to exchange messages within 5 microseconds. A centralized L1 is pointless, like a private permissioned blockchain. With decentralization, you have geographic diversity among validators, which takes you to 100 milliseconds if you restrict yourself to one hemisphere. It will always be a price follower for coins listed on CEXs, so its market makers will be scalped just like they are on AMMs. However, their select market makers will make money, but not for the reasons they state. [As for the unlisted coins, there is no need for speed, as they are less correlated with the big two that move secondary crypto coins around (ETH and BTC).]

The main problem with a dapp-specific L1 is that the chain validators and the protocol are equal partners, as the gas and trade fees all support that one dapp. The incentives of the DEX and L1 insiders are perfectly aligned, so insider collusion is the default assumption. They probably give insiders a latency advantage by giving them effective co-location, and prioritization in sequencing transactions within a block. However, as officially a decentralized L1, this would be unacknowledged.  As LP cancellations are explicitly prioritized over trades, the Hyperlink insiders can make consistent money-making markets, unlike in Uniswap. 

Hyperlink conspicuously claims to be decentralized. Yet they currently have centralized control over their L1 validators, bridge, their oracle, and whoever is running their primary market-making strategy (currently working pro bono because that’s what trustless anonymous crypto insiders do!). They restrict IP access to avoid US regulators, which would not be possible on a genuinely decentralized dapp. While Binance and Bitmex almost surely have insiders making their markets with privileged access, they at least have the decency not to pretend these are decentralized exchanges.

Its disingenuous design encourages the worst in crypto, which is saying something. For example, it wasn’t until SBF created his unregulated offshore exchange FTX that things took off for SBF. He claimed to be trading $300MM/day when he approached VCs for funding in July 2019, though you won’t find more than a handful of talk about their exchange on Reddit or other forums where people talk about their crypto activities. FTX released a White Paper on how many crypto exchanges were faking volume to boost interest, which is a great way to learn about these tactics—and what not to do—and disarm people who might accuse you of faking your trading metrics. As we now know, SBF and his team were like Alex Mashinsky, liars who emphasized their unique integrity and decentralization, making them safer and morally superior to his competitors. We should not be surprised that SBF and Mashinsky moved on to stealing customer funds to gamble on shit coins because that’s what liars do, like the scorpion on the frog; it’s in their nature.

Their L1 does not have a native token, so it just takes USDC collateral from Arbitrum to bridge to their chain. Users thus have the hacking risk of the Arbitrum and Hyperlink bridge and worry about USDC censorship (if you get flagged, your USDC is effectively zeroed out). With just their trusted version of USDC, the famously fraudulent perp finance rate is the only mechanism that ties their perp prices to spot prices on off-chain assets. Yan mentioned this was discovered in trad-fi, indicating he probably heard stories about how Nobel Laureate Robert Shiller introduced a different version in 1991. He probably does not realize that the Bitmex perp/spot funding rate mechanism is nothing like Shiller’s perpetual real-estate futures contract, which, in any case, never caught on in trad-fi because it was fatally flawed. Many perps work fine without the perp/spot funding rate ruse, highlighting its irrelevance. The perp funding rate mechanism is just an excuse to comfort traders to believe these perp prices are not mere Shelling points but are tied down by arbitrage (see here for more on that).

If you go to Hyperliquid’s Discord or search them on YouTube, most of the content is focused on schemes to get free money via rewards, giving them tokens from their airdrop. Everyone is wash trading to collect points, as there are no fees or gas costs. There’s also a referral program, and I’m sure many have gamed that, as it’s easy to create seemingly unrelated accounts on the blockchain. Their fake trading is already twice that of Bitmex and ten times that of GMX ($1B/day—heh).

If you stick around for the airdrop, take your money and run.