Injective: An Interoperable Exchange Infrastructure Protocol for DeFi Markets

Last year, the crypto industry witnessed the broad expansion of decentralized markets. Teams entered the fray each with their own vision for DEX services of differentiated exchange infrastructures, covered markets and products, and UX priorities. And even those which looked similar on the surface diverged in remote design choices such as liquidity management, order clearing mechanism, and governance implementation.

Injective is a notable example with the launch of its mainnet back in November 2021. The Injective protocol provides the underlying fully decentralized orderbook exchange infrastructure for accessing cross-chain spot and derivative markets with zero gas fees, thanks to its unique technical architecture.

More specifically, this is an application-specific blockchain built with Cosmos SDK and designed to function as an interoperable decentralized exchange infrastructure layer. The architecture differs from other popular DEXs operating on Ethereum, Binance Smart Chain, or other Layer-1s since the protocol provides trading services on its own execution layer and allows third party exchanges to permissionlessly build on Injective. The choice aligns with their vision of robust decentralization and high capital efficiency through a shared orderbook. The short block time and instant finality granted by the underlying Tendermint core allow the protocol to handle high transaction demand while keeping the chain secure and trustless.

A Thorough Trading Experience

Prior to the launch of the mainnet, Injective underwent robust experimentation with a diverse set of products before making the transition. Apart from the eleven perpetual and spot markets currently online, the chain had also hosted markets for legacy assets such as synthetic stocks, oil, gas, gold, and forex futures on its Solstice testnet. Pending further governance, the community is willing to resurrect some of these markets in 2022 and introduce complementary products run on the orderbook model of liquidity.

Options, synthetics, betting dApps, or any other instrument that can leverage Injective’s matching mechanism can be built on top of the chain. Since the chain aspires to become a complete toolbox for decentralized financial markets, many other seemingly peripheral financial products like lending services and trading guilds can also be incorporated to enhance protocol services.

Along with their vision of robust decentralization, permissionless market creation becomes a rudimentary design choice for its operations. That’s why on the Injective Chain, community members can build novel financial products, kick-start pools for existing products, and start trading completely new markets without the supervision of a central authority. New market proposals do require governance approval for listing – yet, the protocol also allows users to circumvent that option by paying a listing fee, which recently dropped to 100 INJ (the native token) from 1000 INJ, making the process faster and more independent.

The permissionless state of market creation and concerns over protocol solvency drove Injective to adopt an isolated risk coverage model. Since Injective doesn’t want risk in one market to spill over to other markets, it requires each new pair to establish an insurance fund before trading is allowed to commence. Each pair is backed by these separate backstop pools ready to compensate for any deficit caused by market volatility. After underwriters set up the fund, users are able to contribute to the pool with their collateral tokens and benefit from the liquidation proceeds.

To prevent frontrunning and enhance the user experience, the protocol uses Frequent Batch Auctions (FBA) as its order clearing mechanism. In FBA, orders submitted to the mempool are executed at the end of each block (~1 second block time) and are not published on the order book until the auction process is complete. Veiling the information by implementing a delay time is how Injective aims to enhance the trading experience for traders and allow market makers to provide deeper liquidity at tighter spreads without needing to worry about high-frequency traders disrupting the market-making activities.

Knowing that liquidity and attention are among the most valuable resources in crypto, Injective’s mainnet launched with an incentive program called Astro designed to increase liquidity on order books and attract traders to the platform. The protocol is distributing 10 million INJ tokens ($120 million at the time of launch), from which 70% is allocated to users as trading rewards and 30% to liquidity providers under the Dedicated Market Maker (DMM) Program. The reward program is an ongoing activity, and the protocol is explicitly focusing on recruiting more market makers this year with the goal of establishing healthier order book depth for traders.

Source: Injective Exchange

It’s been only four months since the protocol launched its Canonical Chain mainnet. However, its first months have been compelling. In four months, the cumulative volume on the exchange passed $4.5 billion, where most of the volume came from derivative markets. The chain TVL peaked at $130 million, but the recent market trend took its toll on the protocol just like other DeFi platforms, driving the TVL down to $42 million. As of March 7, the protocol sits at $120 million.

Gasless Trading

Thanks to its technical design choices, the chain operates similarly to an engine. It delivers the core functionality but requires complementary parts in order to become accessible to the end-user. Currently, exchange applications built on the Injective Chain handle transactions by playing the role of information bridges between users and chain nodes.

Although the Injective Chain is built with Cosmos SDK, it uses custom Ethereum accounts with app-generated wallets and a bespoke implementation to parse EIP-712-typed data. Users submit their interaction requests by sending cryptographically signed messages to exchange DApps (relayers). Then these messages, a.k.a meta-transactions, are broadcast by the exchange DApp to a full Injective Chain node, where they get unwrapped and added into the mempool. The node checks the transaction and includes it in a block while ordering transaction execution according to their categorical importance — liquidation and order cancel requests are prioritized.

The unique transaction handling of the Injective Chain strongly favors the end-user as accessing the chain through an exchange DApp alleviates the burden of gas fees. Since exchanges broadcast signed messages to Injective Chain nodes, not the traders, all the fees related to chain interactions are covered by the exchange DApp, resulting in zero gas fees for traders. This allows users to trade on the exchange without having INJ in their accounts. Removing the hurdle of acquiring the chain’s native token is a significant enhancement of the UX. Injective doubles down on this feature by allocating a rebate pool of $100,000 to cover gas costs when users bridge funds from Ethereum for the first time.

Decentralization on all fronts is a top priority for the Injective community. That’s why the consensus mechanism, backend infrastructure, governance, and the exchange DAppsare designed to disburse centralized points of failure. Although most of the protocols aim to decentralize their frontend, users are most familiar with the decentralization of the backend and governance. They don’t use alternative access points to interact with the protocol, which practically centralizes the front-end.

As a Layer-1 for DeFi markets, Injective allows customizable exchange DApps to be built on top of the protocol and incentivizes the creation of multiple gateways for users. Exchanges are rewarded with 40% of trading fees collected through their front-end in return for handling transactions. Injective ecosystem welcomes new operators to handle this intermediary mining role with a reasonably costless hardware requirement.

Currently, there are six exchanges built on top of the Injective Chain: Picasso Exchange, MarsX, Unlimited Exchange, Lunatics Exchange, Inj Dojo Exchange, and Injective Pro which is provided by the core team.

All these exchanges are connected to the same markets via a shared orderbook but differ in how they provide access. For instance, in contrast to the Injective Pro relayer, Picasso exchange offers a swap mechanism for the spot markets with a UI akin to AMM DEXs. And MarsX chooses to give access to two of the perp markets, whereas other exchanges show all four. Exchanges built on Injective aren’t identical frontend access points but carry specialized value offerings, resulting in improved user experience, tailored products for different geographies, and increased decentralization.

Exchange DApps are necessary agents for daily users, but they are not indispensable. A trader can always opt to interact with the chain through API rather than an exchange frontend. In fact, providing a smooth API service to traders is as essential to the protocol as offering exchange DApps. It is the most convenient way for big players to interact with the chain as it’s built to onboard market makers and foster institutional adoption. An increase in API trading activity practically enhances decentralization as users operate as independent broadcasters. By using API, traders need to cover a minimal amount for gas fees as they don’t use a separate exchange service to broadcast their transactions. However, they only pay 60% of the trading fees in return. Considering the low gas costs on the chain, the 40% exchange discount on trading fees makes API trading a more financially lucrative choice for high-volume traders.

Injective’s Core Interoperability

As the protocol aims to rule the liquidity on multiple chains, find them, bring them, and bind them in one chain through various products that can benefit from order book trading, the chain allows traders to communicate with other IBC-enabled chains through its IBC integration and the Ethereum mainnet through the cross-chain Injective Bridge.

This connectedness allows the platform to amass liquidity through seamless bidirectional token transfers and support cross-chain trading of the tokens originated from separate ecosystems. The chain already allows transfers between the Terra, Cosmos Hub, and Ethereum networks – and with the introduction of EVM-compatibility expected this year, Injective is shooting for further developer acquisition and a populated ecosystem built on top of the execution layer.

INJ tokenomics

The native token INJ was initially released as an ERC-20 token and then migrated over to its own chain. INJ is a multipurpose token, functioning like a bolt (or gear) positioned in the most critical areas of a complex engine:

1. The security of the chain depends on INJ: As Injective’s Tendermint consensus is based on delegated proof-of-stake, block producers need to stake INJ in order to validate blocks and get rewarded with INJ for their contribution. Currently, the minimum amount required to be a validator is 1 INJ.
2. Governance of the exchange also means governance of the chain: INJ holders vote on exchange improvements, parameter alterations, and new feature implementations, as well as chain updates and inflationary reward mechanisms. As it is crucial for the chain to maintain its security and governance efficiency, Injective Protocol incentivizes staking by offering trading fee discounts. With the Injective VIP program, INJ stakers enjoy a trading fee discount proportional to the amount staked.
3. It’s used for trading fee auctioning: After distributing 40% of the trading fees to exchange DApps, Injective conducts a buyback with the remaining 60%. The protocol conducts weekly auctions where participants bid on the fees of that week with INJ. The auction winner gets a basket of tokens and profits from the arbitrage opportunity, while protocol uses the proceeds to buy and burn INJ.

The maximum supply for INJ was initially set to 100 million. However, since the block rewards are compensated by minting new tokens, there is inflationary pressure on this number, turning it into a soft cap and an anchor value for the desired supply.

In theory, the total INJ supply can exceed the anchor value. The weekly supply burns create a deflationary effect and offset the supply increase caused by token minting to a certain extent. To be more precise, 5% yearly inflation on 13 million staked INJ equals 650,000 INJ minting in a year while the total burning in the eight weeks alone was 204,000, netting out to approximately 1,326,000  INJ burned a year, accounting for 1.325% of total supply.

Moving Forward

With solid execution, Injective can further its reach behind the tailwinds of the Injective community, increased adoption of the Cosmos ecosystem, and continued growth of decentralized exchanges. Facilitating the introduction of novel products such as insurance dApps and trading guilds can enhance the user experience, increase the value accrual to the token, and make Injective a more comprehensive toolbox for decentralized markets.

One can argue that being an application-specific blockchain might prevent a DeFi platform from accessing the concentrated liquidity of a highly populated Layer 1 and the native toolbox coming with it. With its bridges to Ethereum and IBC-enabled chains and soon-to-be-implemented EVM compatibility, Injective Protocol possesses the necessary fundamentals to avoid these kinds of hindrances. Should Injective become a hotspot for decentralized chain development, there is a chance the protocol becomes the accepted infrastructure for cross-chain trading services and power tomorrow’s decentralized markets.

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