DODO, CoFiX, Bancor whose impermanent loss solution is better?

Original title: "DODO, CoFiX, Bancor, whose impermanent loss solution is better? 》

Original source: Blockchain Institute

AMM is the most successful DeFi world The DEX solution, AMM makes the professional behavior of market making extremely simple, even ordinary users can make market making to earn commission income, so AMM is also called "automatic market maker".

The AMM represented by Uniswap has achieved great success, but in practice we found that such a simple market making In actual operation, market-making funds may be lost, which is generally called "impermanent loss".

Participating in market making may result in capital loss, which is relative to not participating in market making. That is, if the funds are just placed there, the value after a period of time will be greater than the value after participating in market making.

It is generally believed that there are two reasons for the loss, the arbitrage loss and the loss caused by the price fluctuation of the asset itself.

Impermanent loss may cause very large losses if there is a large price fluctuation, so if there is no additional Incentives, the average user is not willing to make a market.

Therefore, there have been projects providing incentives for users who make markets on Uniswap very early. The liquidity mining started on Compound, and the mining of Compound is generally considered to be the first of its kind to start DeFi liquidity mining. At present, there are still many projects that provide liquidity incentives for market-making funds, but the incentives are often unsustainable.

For professional market makers and ordinary users, impermanence loss is a big mountain in front of them The market-making willingness of professional market makers and ordinary users.

At present, some DEXs in the industry are trying to solve the problem of impermanence loss. Today, DODO, CoFix, and Bancor are the solutions As an example, do a comparative analysis to see which solution is more feasible.

One, DODO

DODO is a newcomer to DEX, and has been recognized by many institutions and professionals in the industry. The list of institutions can be listed on one page. Some people say that half of the currency circle has invested in DODO, which shows the degree of recognition of DODO.

DODO uses Chainlink oracles to feed prices, and the PMM algorithm can make the transaction curve smoother. As can be seen from the curve of DODO in the figure below, the transaction curve of DODO is close to a straight line near the price, which will significantly reduce slippage and improve capital efficiency, because funds will be more concentrated near the price as the algorithm is adjusted.

Regarding the risks caused by price fluctuations, for example, you deposit 1 ETH on Uniswap and 380 USDT, if the price of ETH doubles to 760 U, the amount of ETH you can get back must be less than 1. But in DODO, the binding relationship of assets is actually decoupled. Users can choose a single currency to make the market. If you deposit 1 ETH, even if the price of ETH doubles, the amount of ETH you can withdraw will still be 1, that is, Fluctuations in asset prices themselves will have no effect on the number of your assets.

About arbitrage loss, when the accuracy of the oracle quotation is not high enough, DODO will face the risk of arbitrage loss. The loss of LP on DODO some time ago also came from this. However, if the accuracy of the oracle quotation is high enough, the possibility of being arbitraged will be greatly reduced.

If extreme situations are encountered, arbitrage losses will be inevitable. DODO’s solution is to regulate market making through parameter adjustment depth. Just like in a centralized exchange, if the market encounters an extreme market, the market maker will withdraw the order and wait and see. The parameter adjustment of DODO can achieve the effect of reducing the depth of the order to reduce the loss of arbitrage.

What can be added about DODO is that the current DODO is only an initial version, and what DODO wants to do is to make a professional market merchants into the world of AMM. In the upcoming version, DODO will implement an adjustable market-making model for professional market makers. Its unique feature is that the combination of professional market-maker model and AMM smooth curve will greatly improve market-making efficiency and capital utilization. At the same time, the introduction of professional market makers will be more conducive to competing for pricing power for DEX.

Second, CoFiX

CoFiX also introduced an oracle as a price feeding solution, and the oracle it uses is Nest.

The CoFiX model is actually relatively simple, and it solves the arbitrage loss by introducing the Nest oracle machine.

As for the risks arising from changes in asset prices, CoFiX’s solution is hedging. CoFiX provides a dedicated hedging tool, hedging The tool can monitor asset changes in real time, and perform corresponding hedging operations on centralized exchanges, which can theoretically keep the number of assets always in a positive growth state. Solved the embarrassing situation of ETH price rising, constantly selling ETH, ETH price falling, full of ETH.

At the same time, because of the introduction of oracles, CoFiX has achieved a special situation, that is, zero slippage in transactions. This will be a great advantage when there are enough locked-up funds in the pool. But if the pool is not big enough, there is a possibility that the pool will be bought out by a large amount of money.

What effect does this achieve? Basically, the entire pool is providing depth for your single transaction, which may not be possible for any centralized exchange or AMM.

However, the launch of CoFiX trading pairs depends on the development of Nest oracles, which currently have a relatively high quotation density The trading pairs are only ETH/USDT and HBTC/ETH, and currently CoFiX can only trade ETH, HBTC, and USDT.

But in fact, the development of CoFiX will reversely promote the increase of transaction pair quotation density, because every transaction on CoFiX will call For the Nest oracle machine, most of the calling fee will be allocated to the miners, which will motivate the miners to quote, so as to meet the requirements for CoFiX to go online, and thus obtain dividends. (Correction: The distribution plan of Nest call fees has been updated recently. At present, 20% of the part allocated to miners has been cancelled, and all of them will be injected into the dividend pool. All NEST holders will distribute income according to their position ratio every Friday.)

Third, Bancor

Bancor is an established project , is also the pioneer of the AMM model in the currency circle, but the pioneer failed to carry it forward. On the contrary, Uniswap has achieved huge growth using AMM.

Bancor proposed a plan to solve the impermanent loss of AMM in July, but after 3 months of no movement, it suddenly A new solution is proposed (not yet implemented), a new solution that has nothing to do with the previous version.

The plan proposed by Bancor in July is similar to DODO’s plan. Solve the problem of impermanence loss, but in fact it is more about solving the problem of arbitrage loss. In Bancor's new plan, arbitrage losses and price fluctuation losses are combined to solve the problem.

The scheme it uses is called "flexible supply scheme". In the new version of the Bancor protocol, 100% liquidity protection will be provided for market-making funds over 3 months, assuming you provide TKN with $100 of liquidity (the new version of the Bancor protocol supports single-currency market-making), if 3 After a month, the price of TKN doubles and is worth $200, so you can also raise TKN worth $200.

The source of funds for liquidity protection is BNT issued by the system, and the cost is borne by all holders bear. The core here is that the long-term market-making profits are greater than the impermanent losses, then the system will not pay costs, or pay a small amount of costs.

At the same time, BNT also has a destruction mechanism, which is related to the principle of its single currency market making. All transactions in the Bancor protocol Both are trading pairs with BNT tokens. There is no ETH/USDT trading pair in the Bancor protocol, only ETH/BNT, BNT/USDT trading pairs, and transactions between other tokens need to be transferred through BNT.

The new version of the Bancor protocol supports single currency market making (not yet), if the user deposits TKN into the TKN pool, this If no user deposits BNT at that time, the system will mint BNT of corresponding value and inject it into the pool, and these BNT will also receive service fee income.

When a user injects BNT into the pool, the minting part of the system will be included in the transaction fee Destroyed together, if the transaction fee of 10 BNT has been obtained at the time of destruction, 110 BNT will be destroyed. Mint 100 and burn 110, which achieves deflation.

But this part of BNT also faces arbitrage losses, so it is required that the market-making gains should be greater than the arbitrage losses. At the same time, the prerequisite for the balance of the liquidity protection part is that the liquidity income must be greater than the impermanence loss, or be equal, otherwise the system must continue to issue more BNT to make up for the user's market-making losses. The transaction volume here will be a key indicator. Without transactions, there will be no income. It will be more difficult to cover impermanent losses with less income.

Fourth, summary   

This paper compares the solutions proposed by three DEXs for impermanence loss.

According to the information released so far, CoFiX’s design plan proposes arbitrage losses and losses caused by asset price changes In order to deal with it, in theory, hedging can achieve a positive growth in the number of assets.

DODO can also avoid most of the arbitrage losses through oracle and algorithm parameter adjustment, and asset price changes It will not cause losses to users, and this is a relatively thorough solution.

Bancor uses flexible supply methods to issue additional tokens by the system to provide structural protection for market-making funds. In the long run, the income of market-making funds will be greater than the loss of impermanence. Of course, Bancor does not protect all coins. It has a whitelist mechanism. Otherwise, it will provide liquidity protection for zero coins, and BNT will be compensated to zero. But Bancor has also designed a deflation mechanism, the core of which is that the market-making benefits are greater than the impermanent losses.

From the perspective of market-making complexity, DODO and CoFiX provide more suitable scenarios for professional market makers, but In fact, they are no longer the brainless market-making AMMs that everyone understands.  

Maybe We are witnessing the arrival of the era of "professional market maker + AMM " .

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