Mettalex is a decentralized exchange bringing commodity markets to DeFi. Mettalex will help holders of physical assets hedge their price risk, and speculators take leveraged positions in the otherwise illiquid markets. Oother beneficiaries of the exchange will be liquidity providers who will receive fee and market maker spreads for supplying liquidity to autonomous market makers. The protocol will hopefully solve some problems, such as liquidity and transparency which traditional commodity markets have.
One of the main components of the protocol is the position tokens. Position tokens which are minted and traded on the exchange track the price movement of a given asset. A $1 increase in the spot price of the commodity will increase the value of long token by $1; on the contrary, a $1 decrease in the commodity price will result in $1 drop in the value of short token.
Since the protocol doesn’t have margin requirements, position tokens don’t require any further funding after they have been bought. By the way, to make margin calls unnecessary is one of the benefits that Mettalex is bringing to commodity trading. Furthermore, because ordinary commodity derivatives have an expiry date, if you need to hold your position, you should roll them to the next contract. However, position tokens on Mettalex don’t expire. Therefore, you don’t need to roll them.
The protocol is also useful in that it will allow to tokenize commodity spread positions. The reference value for a spread will be the difference between the asset indices. Let’s say, you believe that platinum-gold spread will appreciate which means platinum premium over gold will increase. To profit from this, you would have to open position in both commodities on a centralized exchange, such as CME. Namely, you would go long platinum futures and short gold futures to buy the spread. But on Mettalex just buying a single spread token will be enough. (Now I’m not saying that this spread will be available on Mettalex; I was only giving an example).
Yet another advantage of positional tokens is that they give a trader a leveraged exposure if the token value differs from the spot price of the given commodity. Also, as mentioned above Mettalex solves the illiquidity problem. If there is enough liquidity in the pool, these tokens can be traded with ease for the exchange doesn’t depend on the external liquidity providers, such as LME, ICE or CME.
Though other exchanges are not necessary for providing liquidity for Mettalex, they are necessary for getting spot prices of commodities. Mettalex uses decentralized oracle network to derive price feed from various exchanges, such as Intercontinental Exchange, London Metal Exchange, and Chicago Mercantile Exchange. On top of providing a fair pricing mechanism, this is employed to determine when the price is trading outside of the predicted range. What is range and how is it determined? The next section answers this question.
Value of position tokens
Position tokens which derive their value from commodity prices are expected to trade in a range called delta. For example, if for a particular commodity this range is $400 — $600, then the delta is $200; the mean or center of the range is $500.
With position tokens you are not required the full value of the collateral to lock up. You only need to buy the collateral worth of the delta. For example, if a commodity trade range is determined to be $ 6,000 — $ 8,000 with the centre of $7,000 and delta of $2,000, you don’t have to lock up $7,000 to mint a pair of L/S (long / short) tokens; you’ll be able to mint a pair of position tokens by putting collateral with the value of $2,000 into the pool.
We can refer to the lower and upper bounds of the range as floor and cap prices respectively. Depositing $200 collateral will mint a pair of L/S (long / short) tokens. If they are minted when the commodity traded at $510, this will give you 510/100 = 5.1X leverage.
As the price moves in one direction, the incentive to buy exposure in the opposite direction increases. Let’s say, the spot price of our exemplary commodity increases to $530, buying a long token will give you a leverage of 530/120 = 4.4X because the value of the ling token will be $120 (530–510). On the other hand, if you are bold enough to buy a short token, you’ll get a leverage of 530/70 = 7.6X. This will incentivize traders to take an opposite direction to the spot price movement which can balance the liquidity.
Once the commodity price hits either end of the range, long and short tokens will settle as follows. If the spot price hits cap, then long token price will settle at collateral value while short token price will be worthless. If the spot price reaches floor, then long token price will be worthless while short token price will be equal to collateral value. Once either one of these events happens, trading of this pair halts, and the token pair settles. The collateral backed by the token pair will be returned to the token holders. Trading will only restart after the contract of the token pair is reinitialized with parameters based on the current spot price which will be the new center of the range which remains the same.
What do autonomous market makers and liquidity pools do?
Liquidity providers lock up collateral in pools which then are used by autonomous market makers. By supplying liquidity to autonomous market makers liquidity providers generate return from market making operations. You can provide liquidity either to a specific position token or to a central pool which supports all autonomous market makers.
Under normal market circumstances, liquidity providers don’t experience problems to withdraw their collateral if they want to. But occasionally they will have to wait because there may not be ample liquidity in the pool.
Autonomous market maker is an element of the whole system with which you interact when you buy a token pair. They also allow you to close your position by buying the opposite token of your position token. Autonomous market makers adjust the prices of position tokens according to liquidity demands and reference index, the spot price of a commodity which is fed from external providers.
To understand how the value of L and S tokens change based on liquidity demands and the spot prices, we should look at the mathematics of autonomous market makers. AMM pool in Mettalex contains stablecoins, and L and S tokens. So, the weights of the stablecoins, long and short tokens in the AMM pool should sum up to 1:
Wl + Ws + Wc = 1
where Wl, Ws and Wc represent the weight of long and short tokens, and stablecoins respectively.
Also, we know that the value of a pair of L and S tokens is equal to the collateral:
Pl + Ps = C,
where Pl, Ps represent the value of long and short tokens respectively, and C is the collateral value. With these constraints, we can derive formulas for the weight and the value of the tokens. The formula for calculating the long token weight is as follows:
Formula for short token weight:
Prices of long and short tokens are calculated by the following formulas:
Let’s say gold trades at $1,600 with the range of $1,400 — $1,800 on Mettalex DEX. The minimum amount required to mint a pair of L/S tokens is the delta which in this case is $400. A liquidity provider locks up $400 into the pool. By doing this he’ll create 200 stabelcoins, 1 Long and 1 Short token both of which are priced at $100.
If the gold price falls to $1,500, the value and weight of the position tokens will change as follows:
