The XPL Incident: A Glimpse into the Future of Perpetual Protocols and the $30 Billion Profit-Sharing Market

###A Look Back at the XPL Surge

In the early hours of August 26, XPL experienced a dramatic price surge on the Hyperliquid platform:

At 05:36, large buy orders flooded the market, with individual transactions ranging from tens to hundreds of thousands of dollars, rapidly driving up XPL's price.

Between 05:36 and 05:55, the mark price, determined by internal market matching, far outpaced the external market reference, causing numerous short positions to fall below maintenance margins. This triggered a cascade of liquidations, creating a feedback loop of "order book sweeps → liquidations → further sweeps," continually pushing XPL's price higher.

By 05:55, the price had skyrocketed nearly 200% in just over ten minutes. Some traders capitalized on this surge, with one account reportedly gaining over $16 million in a single minute. Conversely, several short positions were liquidated, resulting in million-dollar losses within minutes.

At 05:56, the market stabilized and XPL contract trading resumed normal operations, but not before many short traders had suffered substantial losses.

This event highlights not just an isolated platform issue, but rather exposes the structural risks inherent in DeFi perpetual contracts as a whole.

###The Aftermath and Its Implications

The incident resulted in significant gains for some traders while causing heavy losses for others, particularly those holding short positions. Even traders with low-leverage hedging strategies were affected.

Many believed that 1x leverage hedging was "risk-free." However, this event proved otherwise, as even well-collateralized 1x leveraged short positions faced liquidation during the surge, leading to substantial losses. This has led some users to swear off such segregated markets entirely. However, the reality is far more nuanced.

###Structural Flaws in the Order Book Model

While much of the post-incident discussion centered on "single oracle dependency" or "lack of position limits," these points miss the core issue.

The perpetual protocol can be implemented in various ways:

1. Order book-driven
2. Peer-to-Pool
3. AMM/Hybrid models

The problem lies specifically with the order book implementation, which has several structural flaws:

####Effective Depth and Token Distribution

The order book may appear deep, but its actual effective depth depends on token distribution. When tokens are concentrated among a few large players, even small price movements can trigger a chain reaction.

####Price Anchoring Relies on Internal Transactions

In thin markets, order book transactions directly influence the mark price. Even with an oracle, if the external spot anchor is weak, this reliance becomes a vulnerability.

####Positive Feedback Loop Between Liquidations and Order Book

Liquidation orders enter the order book, further pushing prices and triggering more liquidations. In markets with low liquidity, this creates an "inevitable stampede" rather than an isolated incident.

Measures like "setting position limits for individual users" are largely ineffective, as positions can be split across multiple accounts or wallets, leaving market-level risks unaddressed.

###The Core Function of Perpetual Contracts

When a trader goes long on ETH, two scenarios can unfold:

• In a spot transaction, the trader pays 1000 USDT to buy ETH directly.
• In a perpetual contract, the trader pays a 1000 USDT margin to open a leveraged position worth 10,000 USDT, amplifying both potential profits and risks.

Two key questions arise:

1. Where does the profit come from? Profits must come from counterparties (short sellers) or the capital pool provided by liquidity providers.

2. Who determines the price? In traditional markets, order book transactions directly reflect prices. In on-chain perpetuals, most protocols rely on centralized exchange oracle prices.

###Challenges with the Oracle Model

Oracle prices typically derive from centralized exchange spot transactions, meaning on-chain transaction volume doesn't influence the price.

While oracle delays are a concern, a more fundamental issue is the disconnect between on-chain position sizes and external spot market activity. This means on-chain transaction demand cannot affect prices, leading to risk accumulation within the system.

###The Role of Basis and Funding Rates

To address price differences between spot and futures markets, perpetual contracts employ a funding rate mechanism:

• Excessive long positions lead to positive funding rates, where longs pay shorts.
• Excessive short positions result in negative funding rates, where shorts pay longs.

In theory, this should anchor contract prices to spot prices. However, for on-chain perpetuals, especially those for less popular assets, contract prices may deviate from spot prices for extended periods, creating a quasi-independent "shadow market."

###The Illusion of On-Chain Depth

Many assume that only less popular assets are susceptible to manipulation, but the reality is that even top-tier assets have limited on-chain spot trading depth.

For example, on leading decentralized exchanges, even major tokens often have liquidity depth of only a few million dollars within a 0.5% price range. This means that the threshold for price manipulation is lower than many realize, even for popular tokens.

###Future Protocol Design Directions

The XPL incident highlights that the issue isn't a platform-specific vulnerability, but a structural contradiction between existing order book systems and on-chain liquidity.

Future perpetual protocols should consider:

1. Preemptive risk control: Simulating market health before executing trades and adjusting accordingly.
2. Spot pool linkage: Connecting contract positions with spot pools to buffer risk accumulation.
3. LP protection prioritization: Integrating LP risk management mechanisms at the protocol level.

###Market Opportunities and Innovations

The perpetual swap market generates over $30 billion in annual fees. Traditionally, this has been shared among a handful of centralized exchanges and professional market makers. Next-generation protocols incorporating AMM technology could democratize this market, allowing more participants to share in these profits.

Some projects are already exploring innovative approaches. For instance, one platform is experimenting with combining pre-execution risk control, dynamic funding rates, and market freezes in extreme situations with LP pooling and profit sharing.

###Conclusion

The XPL incident serves as a reminder that the true risk lies not in price charts, but in protocol design.

The next generation of perpetual protocols must address both risk management and benefit distribution. Those that successfully tackle both aspects will have the opportunity to redefine the DeFi perpetual contract market, potentially shifting the $30 billion market share to a broader audience.

The challenge ahead is to design protocols that effectively manage price discovery, risk, and LP protection while eliminating the possibility of extreme market events. This evolution could democratize access to a market traditionally dominated by a select few, marking a significant step forward in the DeFi landscape.