What is the Injective Protocol?
Injective Protocol is a layer 2 sidechain that is built on the Cosmos SDK that looks to enable permissionless trading on user-created derivatives. The protocol is built on Tendermint using the Cosmos-SDK.
What is a Consensus Mechanism and what does Injective Protocol use?
Consensus Mechanisms in layman’s terms is the process/method used to finalise the latest block of data on the blockchain. Injective Protocol uses a BFT-style Proof-of-Stake consensus method, in which a randomly selected validator proposes a new block. The block is then voted on by all the validators, which ultimately decides which blocks are included in the chain.
What is the Injective Protocol Dex?
The Injective Protocol is centered around their gas-less DEX which allows users to trade inter-chain derivatives on a user-friendly decentralised platform. The main types of derivatives offered on the platform are:
- Futures Contracts:
- Allow the user to buy/sell an asset at a predetermined future date at a predetermined price
- Perpetual Swaps:
- Allow the user to buy/sell an asset at a predetermined price in the future without an explicit expiry date.
- Spot Trade:
- As the name suggests, these are carried out on the spot.The user exchanges one asset for another asset at that moment in time.
In addition to these, Injective Protocol also plans to introduce options in the future, which could provide users with the opportunity to hedge their crypto investments and even explore passive income strategies such as covered calls during a bear market where asset appreciation doesn’t tend to occur.
The Tokenomics of the INJ Token
INJ, the native token of the Injective Protocol, has a total token supply of 100 million with a current circulating supply of 43.7 million on 4/11/2021 which is 43.7% of the total supply. Looking at the INJ token release schedule, the protocol aims for a token distribution as shown in the diagram above but currently the circulating supply is split up accordingly.
- 9% Binance Launch Pad Sale = 4.2 Million Tokens
- 2% of the Seed Sale = 1.6325 Million Tokens
- 5.56% Private Sale = 4.53 Million Tokens
- 3.33% Held by the Injective Protocol Team = 2.72 Million tokens
- 0.33% Held by Injective Protocol Advisors = 0.27 Million Tokens
- 12.44% Held for Injective Protocol Ecosystem Development = 10.15 Million Tokens 8.33% Held for Community Growth = 6.8 Million Tokens
Injective Protocol Token Release Schedule
As can be seen from the graph above, the Injective token release schedule is on a relatively linear schedule and so we can expect future token inflation to reduce as time goes on. This is because the release of roughly 10 million tokens per year is relatively constant and thus would represent a smaller and smaller portion of the total circulating supply as we move down the release schedule.
What is the use of the INJ Token?
The INJ token aims to act as a collateral asset for the derivatives that are traded on the DeFi exchange. This means that we can expect the price/demand for the INJ token to have a direct correlation with the platform’s ability to effectively scale and gain adoption within the DeFi community. Furthermore due to the Decentralised nature of the Injective protocol exchange, INJ tokens are also used in the governance system which allows users to shape the protocol by voting on future features and exchange parameters/upgrades.
The INJ token currently utilises a Tendermint-based Proof-of-Stake system to ensure the security of its transactions. The Proof-of-Stake system consists of both Validators and Delegators. Validators are in charge of running the node which verifies blocks on the Injective Protocol blockchain while delegators delegate their tokens to the validator’s pool to earn rewards.
What are INJ’s Staking Rewards?
Staking with the Injective Protocol has a baseline APR of 5% per year. Once your tokens are staked with a validator, an unstaking period of 21 days is required for your tokens to be unstaked. The Staking APY for Injective is bound between 4% and 10% to increase or decrease rewards for delegates. This means we could expect a $10,000 dollar investment to perform as shown in the graph below.
Want to plug in your own numbers? Check out the Injective staking calculator at https://www.stakingrewards.com/earn/injective-protocol/, where you can change the amount you invest, how long you invest for and compare your returns between being a delegator or a validator on the Injective Protocol.
How can you stake your INJ?
The Injective Protocol native token, INJ, can be staked straight on the Injective Hub which can be found at https://hub.injective.network/. Currently both Metamask and Ledger are supported which when connected to the Injective Hub allows you to move your ERC-20 INJ tokens to the Injective Chain and then choose between 24 validators. All of whom offer a 5% percent staking reward with commissions ranging from a 5% commission that places the final Reward APR at 4.75% to a 15% commission reducing the APR to 4.25%.
What are the risks associated with staking on the Injective Protocol?
Delegators and Validators can be negatively impacted by slashing events which are downtime and double-sign. Down-time is simply when a validator node is down and double-sign refers to double-spend or chain forks. Both of these, depending on how big the event was, can result in validators and delegators losing tokens from their node pool. However, the Injective Protocol is designed in such a way that delegators will receive their staking rewards even if their validator is down, which ultimately makes the slashing of staked tokens the only inherent risk for delegators.
Yield Farming Derivatives
The Injective Protocol currently also allows users to passively gain income through derivatives that track stable coin liquidity pools. Injective’s decentralised derivatives don’t need to trade the underlying asset and thus avoid the high fees that are normally associated with liquidity pools on layer 1 networks such as the Ethereum Network. Their collaboration with Formation Fi further improves the users’ risk to reward ratio by using algorithms to optimally balance the assets within the liquidity pool.
This allows users to trade and benefit from crypto derivative portfolios that can be composed of assets across multiple chains, offering a level of diversification that would be impractically expensive on a layer one yield farming platform that doesn’t employ derivatives. The rewards on such a platform would be extremely varied and thus impossible to summarise in this article as the potential portfolios would be limitless. Injective Protocol does, however, plan to do this by distributing a fixed amount of INJ token weighted by the liquidity each participant provides.
Market Creation Commissions
Since Injective Protocol allows users to be able to create their own derivatives markets by writing custom derivatives they believe other users would like to buy, sell or trade, the network looks to reward these users by providing them a percentage of the trading fees and also through community grants. It is currently unknown how this is going to precisely work on the Injective Protocol Network.
Problems that DEFI Exchanges face and how Injective looks to solve them
Front Running and Order Collisions
DEFI exchanges, due to time delays between blocks being finalised, run into an order collision problem where multiple market takers try to execute on a market maker’s order. This results in failed order executions as simply put, multiple users are trying to buy the one set of assets another user is trying to sell. Seamless order execution is ultimately impossible for DEXs that are built on-chain on the Ethereum network as the order book can only be completed once that block has been finalised onto the blockchain.
Users of a DEX might ultimately be unaware of the business of front-running orders. Similar to 0 commission trading platforms like RobinHood, front-runners on these DEXs are able to offer a higher gas fee so that their orders are executed before the original order, causing the original order to fail and allowing the front runner to then sell their order they just “stole” back to the original buyer at a profit. This issue is one that becomes exponentially more apparent as the DEX’s volume scales as there are more opportunities for front-runners to intercept orders and bleed users. In particular, miners on proof-of-work blockchains are able to process their own transactions at a 0 gas fee which further adds to the potential for unaware users of the DEX to be caught in these arbitrage middle man attacks.
So you might be thinking how the Injective Protocol solves this problem. Honestly Injective’s solution to this problem is deceptively simple and genius, when a user wants to take an order, they are given a variable delay function which gives them a “t value” for how long they spend solving it, after the current block reaches finality, the t values of the users are compared and the execution of the order is given to the user with the highest t value. Now this doesn’t solve the problem of order collision as multiple users can try to execute on the order but it does stop front-running from happening as your “gas fee” is the time spent on the VDF and so there is no way for a front runner intercepting an incoming order to have a higher t value.
Solving Liquidity through Liquidity Aggregation
One of the main features of decentralised exchanges is that they are decentralised, this means they don’t rely on a central body and thus tend to be slower and gain less adoption due to poorer user interfaces. Centralised exchanges have been around for longer, have lower fees and faster transactions which is why they tend to have much more liquidity as there is far less transactional friction than on DEXs. To try and solve these liquidity issues, DEX liquidity aggregators were created. These aggregators pool together the liquidity of multiple exchanges and run their orders from a central combined order book.
Hearing central when talking about decentralised exchanges is normally a big warning sign as it leaves users open to the downsides of centralised exchanges such as collusion, censorship of orders and in some cases the liquidity aggregator can front run the orders. Thus it seems like Centralised exchanges were able to solve their liquidity issues by addressing the transactional frictions of speed and cost which made way for more user adoption. The Injective DEX using its bridge is able to currently onboard both native tokens and ERC-20 tokens and provide users with a cheap and fast environment to trade on, which could give it a comparative advantage compared to DEXs like Sushiswap and Uniswap which are slow and have high fees.
Where can we see the Injective Protocol in the future
The Injective Protocol has the potential to be the go to place for trading derivatives under a trustless system. The main functionalities that derivatives offer are;
- Leveraged Trading
- Foreign Exchange Risk
- Asset-Less Cash Settlement Trades
The derivatives market is extremely large with the global derivatives market sitting at 640 trillion dollars as of 2019, a number which dwarfs the entire crypto market cap of 2.8 trillion(10/11/2021) . But the Injective DEX faces the significant hurdle of regulatory action against crypto as the over-the-counter derivatives market is one that is extremely regulated. This is why a more reasonable number to use would be the volume of the crypto derivatives market which was 3.2 trillion in June of 2021 which would suggest a conservative yearly volume would be in the 30-40 trillion ball park.
Currently the main use case of the INJ token is as collateral for derivatives traded on the exchange and to pay the 0.1% maker and 0.2% taker fee. Just using the fees would put the respective volume for the INJ token to process such volumes at between 90 and 120 million. With 60% of these fees being burnt we would see 60-90 million dollars worth of INJ burnt a year, largely reducing supply and thus driving up demand.
The Injective Protocol ultimately has the opportunity, if they are able to integrate fiat on-ramping, to replace the Binance Exchange which has a monthly volume of around 1 trillion USD in spot and 1.7 trillion USD in derivatives. With their 0.1% Maker and 0.1% Taker Fee, this leads to a monthly revenue of 5.4 Billion USD where 20% of this is burned as BNB. With INJ burning 60 % of fees as INJ, this would leave 2.16 Billion USD worth of trading fees returned to relayers on the protocol by providing users with an improved user-interface.
In conclusion, the Injective Protocol looks to provide users with the experience of a centralised exchange on a decentralised network. In the end, user experience is one of the most important factors when considering the mainstream adoption of new technology, the Injective DEX has the potential to be central derivatives and options market places for traders on both the retail and institutional level. What derivatives and options would you like to see on the Injective DEX? Do you think the majority will move away from CEXs to DEXs or will the better user experience of CEXs be something DEXs will never be able to achieve?