Vega aims to open and decentralise markets, by fully automating the processes and incentives for trading and settling financial products, in a trust-minimising distributed network of pseudonymous participants. This requires a carefully designed mechanism of economic rewards and penalties, and a protocol that balances permissionless innovation with protection for markets and participants.
The concepts behind such a system are described in brief below.
Trading and settlement are designed to be fair and predictable for all participants. Trading on open markets will use a defined trading mode unless market conditions dictate otherwise, for example, when an auction period is used to identify the fair price after large moves, or when protective measures are required due to low liquidity. Positions are settled continuously as they are closed, when products generate interim cashflows, and finally at expiry of the instrument, when collateral held in margin is also released. We are defining a position resolution algorithm to fairly handle situations where there is a shortfall in the available collateral and no remaining funds in the market’s insurance pool.
Instruments, which are traded on a Vega network, are defined by a combination of a product, risk model, and their required parameters. They are traded either in open markets or over the counter (OTC), depending on the type of instrument and level of market making support. Open markets are created by market makers and match trades between any willing and sufficiently collateralised participants, whereas OTC trading occurs on a more ad-hoc basis. Trading modes include continuous trading on a limit order book, discrete trading via frequent batch auctions and request for quote.
Smart products are a special type of smart contract designed to allow the creation of a wide range of financial products from a toolkit of standard features and economic primitives. They are written at a higher level of abstraction than most smart contracts, making them easier to develop and test, and better suited to static analysis and automated risk modelling.
Collateral is managed by Vega networks via links to other blockchains, with funds deposited by paying into a smart contract on the host chain. It can be used as margin for orders and positions, meaning the required funds will be allocated to a market until they are no longer needed and are then released. Allocated funds can’t be withdrawn or used for trading in other markets. Withdrawals are requested with a Vega transaction which, if successful, results in a transaction for the host chain that has been signed by a quorum of Vega nodes, and will cause the funds to be released to the requested destination address.
Risk management is of particular importance for pseudonymous trading, as there is no practical recourse if a participant owes more than they have, or is allowed to withdraw more than is rightfully theirs. To mitigate this, trading is margined, with risk models that have been selected and calibrated for a zero recovery rate environment. Margin requirements take into account the slippage incurred when closing a position, and positions that present an unacceptably high risk of loss to the network are closed automatically. The rules are designed so that on average, closeouts will occur with a net positive margin remaining allocated to the position. This is added to an insurance pool that is used to cover the difference when a closeout leaves a negative balance. This mechanic ensures that most markets, and the network as a whole, will become safer over time.
Market governance is necessary to ensure that the network can operate and grow unencumbered and without manual intervention whilst minimising the risk posed by bad actors. Vega’s market governance features are designed around the concept of stake weighted voting, with various actions such as the creation and closure of markets, and the setting of parameters that influence their behaviour being the main focus of on-chain governance.
We are transforming how financial markets work, so no one gets to stack the odds against anyone else. On Vega Protocol, markets are open and fair, fees are shared by market makers–not owners–and governance decisions are made by the community.
What we’re doing isn’t easy. Building a fast, decentralised system is hard. Ensuring it’s fair without a central owner is complex. But we’re not intimidated by challenges. We’re motivated by them.
We can’t do this without an active community. Tell us what you think. Keep an eye out for our protocol whitepaper, and follow our progress on Twitter.