Original Title: Dragonfly: Understanding the Future of Next-Generation Automated Market Makers CoFiX and AMM
Written by: Haseeb Qureshi, Managing Partner of Dragonfly Capital, a blockchain venture capital firm
Currently, AMM (Automatic Market Maker) is the most successful product in the DeFi field. Uniswap’s transaction volume has proven that the permissionless AMM model is extremely powerful.
But an AMM model like Uniswap is too simple. Of course, simplicity is beautiful at first, and it is much easier to cold start and maintain a simple product, but it will eventually become a burden. The longer it takes, the harder it is for Uniswap to keep up with cutting-edge algorithms.
Uniswap considers only one variable when determining its pricing: the amount of assets currently in the pool . Really smart market makers are not only concerned about their own asset volume, but also about external trading volume, historical prices and real-time price fluctuations . These are the basis for correct pricing . This information is necessary to correctly price risk.
If you don’t know anything about an asset, then Uniswap is for you. However, even on the Uniswap platform, most of its trading volume relies on the largest trading pairs such as ETH/USDT. Competitive market making for these trading pairs will only become more complicated. In time, Uniswap’s one-size-fits-all pricing model will be surpassed by customization. I mentioned this in the previous article.
Uniswap’s synthetic “order book” VS. real order book. Source: Parsec Finance
The success of Uniswap makes it easy for everyone to overlook what AMM should be. AMM should not be just a token vending machine . AMM-automatic market maker, that is, an algorithm that simulates the operation of a real market maker. As AMM absorbs more data and combines with more advanced algorithms, they will eventually become agents in the decentralized world , and conduct market transactions as efficiently as we humans do today.
This is the inevitable direction of DeFi development-making AMMs become smarter and smarter until they are close to humans and can compete with centralized market makers. Today, this vision seems out of reach.
Fortunately, CoFiX is here.
Computable Finance
CoFiX is a next-generation AMM that borrows data from external oracles and effectively integrates it with pricing algorithms. By considering historical volatility and comparing the parameters of other specific trading pairs, CoFiX’s pricing function is closer to smart market makers . By providing better spreads during the stable period and being more conservative under market volatility, CoFiX can become a more profitable market maker while providing more competitive pricing than Uniswap.
While doing all of this, CoFiX minimized impermanence losses and did not give up the profits to arbitrageurs.
You may ask: Why does CoFiX couple AMM with the oracle? Isn’t Uniswap better? It doesn’t use any oracles at all, does it?
This is the problem.
Take a liquid trading pair like ETH/USDT. A rational market maker will concentrate its liquidity near the mid-market price. However, Uniswap always keeps a large part of its total assets at the end, just like there are limited price orders in the entire order book, and the depth in either direction is amazing. This is its unchanging product rule.
As of September 28, 2020, Uniswap’s ETH/USDT “Depth Map”
When volatility is low, Uniswap may be more willing to concentrate liquidity near market prices. But Uniswap does not know when the volatility is low!
To make matters worse, Uniswap doesn’t even know the mid-market price!
Uniswap cannot respond to external changes, regardless of price or fluctuations. When encountering large transactions, Uniswap has no choice but to assume that external market prices will also change.
Unable to get rid of the fog of this war, Uniswap relies too much on its scale, hoping that the spread will not be too bad, and transaction fees can make up for impermanent losses.
Attention, the Uniswap agreement has locked up 2 billion US dollars! It sounds good, but it also shows that its capital efficiency is too low. This means that Uniswap’s daily trading volume is only about 30% , which is very low for cryptocurrency market makers.
CoFiX uses an external oracle, so it knows the mid-market price, price continuity, and historical fluctuations (unlike DODO or Bancor V2, these protocols only use mid-price). This allows CoFiX to be infinitely close to the decision of the real market maker.
Details are always the key. Which oracle does CoFiX use? How reliable is this oracle?
You don’t want to miss NEST
NEST may be the largest DeFi project that has completely disappeared from the perspective of the Western cryptocurrency world. NEST can be said to be China’s largest community-driven DeFi project. In the past 6 months, even before the recent DeFi bull market, NEST was the fastest train that consumes the most gas on Ethereum. Despite the DeFi wave, today NEST is still one of the top 5 in Ethereum gas consumption , ranking ahead of Chainlink.
As of September 28, 2020, NEST is the largest gas consumer on Ethereum. Source: EthGasStation
The NEST oracle is the secret weapon of CoFiX. So, what is NEST?
The mechanism of NEST is actually very simple. The main operating rules are:
Suppose someone quoted ETH/USDT as “1 ETH equals 350 USDT”. To support this claim, you must place an order of 1 ETH + 350 USDT. At the same time, anyone can support or question the offer. If the price is right, then the market price will not change.
However, if the quote is incorrect, for example, the real price of ETH is 375 USDT, then the arbitrageur can pay 350 USDT to buy cheap ETH and sell it off-market. However, to place an arbitrage order, the arbitrageur needs to issue a larger number of orders. In other words, now they need to publish 2 ETH/750 USDT, after all, they claim that this is the real price. (If the quotation they want fluctuates by more than 10%, the algorithm requires them to post 10 times the order.) If they post an incorrect price, others may come to eat the order and increase the amount of the posted order.
Until a certain order has never been questioned and confirmed within a certain period of time, the game is not over. In this way, a quotation for the oracle was obtained. As a reward, the publisher of this price will receive NEST tokens. This is how the NEST token is “minted”. (Please note that the current minimum quotation amount is 10 ETH.)
The core is: in an efficient market, the unclaimed two-way quotation is an oracle price. If there is no arbitrage for this quotation, it can be regarded as the correct price. This provides an elegant and simple oracle design for any asset that has been tokenized on the chain.
And it really works! NEST currently quotes the price of ETH/USDT approximately every 2.5 minutes, and when the network is not so crowded, it quotes approximately every 4 blocks .
Frequency of quotes on September 26, 2020. Source: NEST WeChat Group
This is much more immediacy than Chainlink. Chainlink nodes are updated approximately every 45 minutes (the implicit SLA is updated every 3 hours or every 0.5% of price fluctuations). We have seen that most AMMs that use external oracles rely on Chainlink, including DODO and Bancor V2. DODO has already seen traders use the insufficient update of Chainlink oracles for arbitrage, which has caused liquidity providers to bear a large amount of impermanent losses
By borrowing the powerful functions and consistency of NEST, CoFiX can provide more stringent quotations and more competitive spreads, reducing impermanence losses.
NEST’s offer is very concentrated (September 26, 2020). Source: NEST WeChat Group
NEST is a DeFi project in China, so it has not attracted much attention in the Western world. However, it has become the strongest community-driven oracle we have ever seen. You can think of NEST as the YFI of Chinese oracles, completely decentralized and initiated by a group of energetic and active developers. It is time for NEST and its ecology to be recognized in Western communities.
If you want to learn more about NEST, you can read these documents ().
Release date
CoFiX will be launched soon (click for the full white paper), and 90% of the tokens will be distributed to users through liquidity mining and transaction mining . Like NEST, CoFiX also has a decentralized community. All members are committed to the prosperity and development of CoFiX. Many community members are anonymous. This project is full of vitality, and we hope to see more Western friends participate in it. The encryption community should be global, and CoFiX is also looking forward to joining the Western DeFi community.
Two years ago, DeFi was just a paradise for hackers and amateurs. Now that DeFi has gradually matured, some of the problems in the infant stage will soon disappear. We are very happy to see CoFiX pushing AMM forward.
If you are interested in participating, developing a platform together, trading on an exchange, or providing assets for liquidity mining, please check the official documentation and join the Telegram community.
DeFi is global, and we will participate with you.
Disclosure of related interests: Dragonfly Capital invested in CoFiX and held a position in NEST.
Source link:
