Author: Chris Powers

Uniswap v4 and Ambient Finance: Fresh hope for passive LPs

https://doseofdefi.substack.com/p/uniswap-v4-and-ambient-finance-fresh

Dose of DeFi will be off for the rest of the summer and back in the fall. Research ideas and suggestions welcome just hit reply. Have a safe and happy for summer.

– Chris

Automated-market makers (AMMs) are the greatest innovation DeFi has ever seen. Decentralized exchanges were created to allow non-custodial trading, but AMMs took this further with pooled liquidity, which enables passive market making and always ensures there’s a counterparty to trade with. And unlike lending, there’s no dependence on off-chain infrastructure like oracles.

Uniswap launched in the fall of 2018 and by DeFi summer in 2020, it was clear that AMMs had found product-market-fit, by offering permissionless liquidity bootstrapping for any token. Yet the problems with AMMs were also soon clear: namely MEV and the aptly-named ‘impermanent loss’, which has since been rebranded into the more technical ‘loss versus rebalancing (LVR)’. To simplify, when prices move, arbitrageurs trade against passive liquidity providers (LPs) that are still quoting stale prices, leading to consistent losses. Additionally, the public and permissionless liquidity pools in AMMs make these exchanges highly vulnerable to the dark forest of MEV.

The order book versus AMM argument has gotten old. Yes, order books should theoretically be more efficient, but the stubborn real-world success of AMMs implies there is clearly demand.

Now, with the mainnet launch of Ambient Finance (formerly CrocSwap) and the public release of Uniswap v4, there’s hope that the full potential of AMMs can be realized. The remaining question though, is whether two conflicting visions can be reconciled: Can AMMs simultaneously be both the playing field for sophisticated high-frequency traders and a reliable place for passive DeFi investors to park their assets?

AMMs’ toxic flow woes

Market makers do not make directional bets. Their business is buying and selling an asset quickly, earning their take not from asset appreciation, but from trading fees. The shorter amount of time they have to take price exposure to an asset, the better.

Market makers will sell to anyone – but they do have favorites. The ideal counterparty is an uninformed investor looking to sell at market price, as a market maker usually feels confident that they can quickly sell into the broader market at a similar price. A market maker’s least favorite counterparties are fellow sharks and market makers. They’re not trading because they want asset ownership, but because there’s some price arbitrage to be squeezed. This is toxic flow because the PnL is hurt more than the extra trading fees generated.

For automated market makers, most toxic flow comes from sudden CEX price changes. Every time the price of ETH moves on Binance, there’s a race to trade against AMM LPs which have not updated their prices. Ambient Finance’s 0xfbifemboy estimated that $100m was lost by USDC/ETH LPs on Uniswap v3 to arbitrageurs in the 12 months leading up to September 2022 during the five minutes after major price movements on Binance.

Liquidity with strings attached

In Uniswap v3, liquidity providers could customize the pool and the price range for their liquidity. V4 introduces more customizable features to pool creation known as hooks – arguably its most attractive new feature:

Hooks are externally deployed contracts that execute some developer-defined logic at a specified point in a pool’s execution. These hooks allow integrators to create a concentrated liquidity pool with flexible and customizable execution. Hooks can modify po9ol parameters, or add new features and functionality. Example functionalities that could be implemented with hooks include:

  • Executing large orders over time through TWAMM

  • Onchain limit orders that fill at tick prices

  • Volatility-shifting dynamic fees

  • Mechanisms to internalize MEV for liquidity providers

  • Median, truncated, or other custom oracle implementation.

Individually, none of these functionalities solve the issues facing AMMs, but they provide the tools to design a more efficient system. Going back to the example of toxic flow, a liquidity pool in v4 could dynamically raise the swap fees during times of high volatility or protect itself by using an external oracle that would update the pool’s prices more quickly, or allow certain addresses to trade with the pool.

Ambient has a similar feature through its protocol gating and permissioned pools, although these must be approved by protocol governance. Essentially, liquidity can unionize and program the specific terms it will trade with the market. This helps tilt the balance towards LPs trying to earn a return.

General gas cost improvements

Uniswap v4 and Ambient introduce a myriad of efficiency upgrades, thanks to the five years of real life experience in DEXs, particularly in optimizing gas usage in smart contracts. The most important design choice is the singleton smart contract architecture, used by both Uniswap v4 and Ambient. In the previous versions of Uniswap, each pool has its own smart contract, which means significant transaction costs when shifting tokens from one pool to another. Balancer v2 was the first to put all tokens in a single contract, which introduces additional security concerns in return for lower gas costs.

Uniswap v4 and Ambient also both feature ERC-1155 flash accounting, which allows gasless trading (only paying gas costs when adding/removing from the pool). Ambient differs from Uniswap in its fee accumulation. Fees are automatically converted to Ambient LPs (traditional 50/50 Uniswap v2 LP positions), instead of in the native asset and with the need to be claimed.

Tools to protect against MEV

The last few years of development in the MEV space have shown that you can’t uniformly protect against MEV. Inefficiencies will emerge and sharks will be there ready to pounce. It’s a constant cat and mouse game. Permissioned pools in Ambient and hooks in Uniswap v4 are significant tools in the arsenal for LPs and swappers to protect against MEV, because they create programmable ways to intermediate between swappers and LPs. MEV minimization and extraction will still take place through batch auctions, SUAVE, or some other intents matching protocol, but with the customizable pools in Ambient and Uniswap v4, LPs can now demand a piece of the pie. Dynamic fees will also help a lot.

The bifurcation of the DeFi user base

Early on, DeFi seemed to be a continuation of the passive investing revolution. Just as Vanguard showed that active stock picking was worse than just sitting on a general basket of stocks, DeFi would eventually show that active market making was inferior to passive liquidity provisioning controlled by smart contracts. In this world, anyone could be a market maker, not just the Wall Street Elite.

More recently, MEV can trace its lineage to the Flash Boys revolution and the rise of electronic trading in the early 2000s. Uniswap v3 fits better in this lineage. Most average DeFi users don’t LP on Uniswap v3; it’s too complicated to benefit from the capital efficiency advantages. The vision that third-party apps, like Gelato, would be a usable rebalancing interface for retail users never fully materialized.

Uniswap v4 and Ambient aim to be universal protocols, ones that don’t just cater to HFT firms or passive liquidity bros. Yet it remains unclear whether the goal will be to go after the most widely-traded tokens (ETH) or the long-tail of smaller tokens? The burden of connecting these disparate groups will fall to new AMM designers.

Over the last few years, the AMM pendulum has clearly swung to sophisticated traders. Yet AMMs (and DeFi more broadly) will only thrive if there are passive, profitable, and verifiable ways for everyday users to earn yield on-chain. 

Odds and Ends

  • Different ways to access the 3.49% Dai Savings Rate Link

  • Token Terminal: Overview of DeFi asset management Link

  • Restaking protocol Eigenlayer launches, maxes out with $16m in deposits Link

  • Frax to launch its own Layer 2 rollup Link

  • Synthetix lists stETH Perps Link

Thoughts and Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in Jacksonville, Florida next to the St. John’s river. Hope everyone gets some beach time this summer.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. All content is for informational purposes and is not intended as investment advice.

Higher Dai rates means more revenue for Maker

https://doseofdefi.substack.com/p/higher-dai-rates-means-more-revenue

ICYMI: Check out last month’s post on the expanded ecosystems that Ethereum rollups are building.

Chart of the week: The upside of higher rates

Maker has had a busy 2023. It reduced its direct exposure to USDC to just under 10%. Instead, it is reinvesting USDC is has acquired via the PSM into off-chain assets (okay Real World Assets) that generate a higher yield. It has more than $1.2bn invested into short-term treasuries from MIP65 Monetalis Clydesdale Tracker with an estimated yield of 4%. More recently, on June 1 it started earning 2.6% on a deal to re-invest $500m with Coinbase Custody. On top of this, MakerDAO governance is in the midst of a massive rate-hike campaign (I guess the Fed made it look like so much fun). An executive passed on May 1 that raised the stability fee for WBTC vaults to 4.9% and then another executive passed two weeks later that raised ETH and ETH LSD rates to as high as 1.75%. Those are small compared to the upcoming hikes that have already passed initial governance polls. These changes, which are expected to be included on the on-chain executive vote later this month, would raise ETH and LSD Dai borrowing costs to 3.5% and WBTC’s to nearly 6%.

Given Maker’s business model, these higher yields on stablecoin assets and higher interest rates on borrowing will significantly increase its revenue (as can already be seen by the chart above). Some of this revenue will be paid back to Dai holders as MakerDAO governance also plans to increase the Dai Savings Rate to 3.49%. The hope is that the easy yield on Dai will keep investors from fleeing DeFi to the easy, safe and higher yields in TradFi. The downside risk is that borrowers abandon Dai and go to other credit platforms with lower (market-driven) rates.

Related – DeFi Llama News: Rune Christensen on his Endgame plan

Tweet of the week: Looking for a rallying cry

It was a momentous week for crypto regulation. After years of dancing around and hinting at enforcement, the SEC is coming after the largest names in crypto, Binance and Coinbase. The Binance case will be jucier, but the fate of Coinbase will be far more revealing for the future of crypto. The case is likely to take 2-4 years to run its way through the courts and the bright lines drawn by the SEC might spur legislation from Congress over that time period. The only question left is if the SEC is going to also go after a DeFi protocol (presumably Uniswap).

I appreciate the tweet above from the patron saint of Crypto Twitter, because it underscores what makes blockchains and DeFi different. Now, we must communicate those use cases and the future promise to the broader political system.

Odds and Ends

  • Uniswap introduces FLAIR, a metric to measure LP performance Link

  • PoolTogether lawsuit dismissed by US judge Link

  • Paradigm comment on SEC’s proposed redefinition of exchange Link

  • House Republicans propose comprehensive crypto market structure bill Link

  • 72% of MEV searcher revenue went to validators Link

  • Catalyst, a new cross-chain AMM Link

  • Token Terminal: On-chain derivative market share Link

  • crvUSD onboards stETH as collateral Link

Thoughts and Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in a Nashville before its too hot.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. All content is for informational purposes and is not intended as investment advice.

High transaction fees and MEV star jaredfromsubway.eth

https://doseofdefi.substack.com/p/high-transaction-fees-and-mev-star

ICYMI: Check out last month’s post, which dives into the restaking market and what the future of ETH yield products might look like.

Chart of the week: BTC & ETH fees soar

Ethereum fees have been higher than normal the last few weeks. According to ultra sound money, fees have averaged 59 gwei over the last 30 days and 108 gwei over the last week versus an average of 24.7 gwei since The Merge last September. The chart above from Coin Metrics’ latest “State of the Network” also highlights the recent increase in Bitcoin fees, caused by the success of ordinals and the BRC-20 standard (imitation is the highest form of flattery).

On Ethereum, high gas fees are from the surging $PEPE memecoin (like Doge or Shibu but Pepe instead). This has led to the highest gas expenditure (in ETH terms) from Uniswap since May 2021:

Tweet of the week: Star MEV bot’s secrets

The biggest gas guzzler of the last few weeks is the mysterious jaredfromsubway.eth MEV bot, whose name is a reference to its heavy use of sandwich attacks to unsuspecting users. Flashbots Bert Miller’s tweet above is one in a longer thread looking at jaredfromsubway.eth’s on-chain activity. It has been particularly active in the PEPE trading frenzy.

EigenPhi estimated that jaredfromsubway.eth has raked in over $7m in profit since April 17. EigenPhi’s newsletter had two posts this week focused on jaredfromsubway.eth, one on data from its trades (including a chart that shows 60% of Ethereum blocks since April 17 have had a transaction from jaredfromsubway.eth) and the other detailing the flow of transaction ordering.

Odds & Ends

  • Rick protocol Cozy launches v2 on Optimism Link

  • Spark Protocol launches on Maker Protocol, offering enhanced features Link

  • Blend launches Blur, an oracle-free NFT lending platform Link

  • Synthetix perps see $4bn in volume over seven weeks Link

  • Arbitrum DAO receives 3.4k ETH ($6m) from sequencer revenue Link

  • Curve to redeploy crvUSD stablecoin after ‘mistake in deployment script’ Link

  • Rune unveils 5 phases of Maker end game Link

  • GFX Labs makes another push to turn on Uniswap protocol fees Link

Thoughts & Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in a rainy Nashville. Grateful for my mother and my baby’s mama.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. All content is for informational purposes and is not intended as investment advice.

High transaction fees and MEV star jaredfromsubway.eth

https://doseofdefi.substack.com/p/high-transaction-fees-and-mev-star

ICYMI: Check out last month’s post, which dives into the restaking market and what the future of ETH yield products might look like.

Chart of the week: BTC & ETH fees soar

Ethereum fees have been higher than normal the last few weeks. According to ultra sound money, fees have averaged 59 gwei over the last 30 days and 108 gwei over the last week versus an average of 24.7 gwei since The Merge last September. The chart above from Coin Metrics’ latest “State of the Network” also highlights the recent increase in Bitcoin fees, caused by the success of ordinals and the BRC-20 standard (imitation is the highest form of flattery).

On Ethereum, high gas fees are from the surging $PEPE memecoin (like Doge or Shibu but Pepe instead). This has led to the highest gas expenditure (in ETH terms) from Uniswap since May 2021:

Tweet of the week: Star MEV bot’s secrets

The biggest gas guzzler of the last few weeks is the mysterious jaredfromsubway.eth MEV bot, whose name is a reference to its heavy use of sandwich attacks to unsuspecting users. Flashbots Bert Miller’s tweet above is one in a longer thread looking at jaredfromsubway.eth’s on-chain activity. It has been particularly active in the PEPE trading frenzy.

EigenPhi estimated that jaredfromsubway.eth has raked in over $7m in profit since April 17. EigenPhi’s newsletter had two posts this week focused on jaredfromsubway.eth, one on data from its trades (including a chart that shows 60% of Ethereum blocks since April 17 have had a transaction from jaredfromsubway.eth) and the other detailing the flow of transaction ordering.

Odds & Ends

  • Rick protocol Cozy launches v2 on Optimism Link

  • Spark Protocol launches on Maker Protocol, offering enhanced features Link

  • Blend launches Blur, an oracle-free NFT lending platform Link

  • Synthetix perps see $4bn in volume over seven weeks Link

  • Arbitrum DAO receives 3.4k ETH ($6m) from sequencer revenue Link

  • Curve to redeploy crvUSD stablecoin after ‘mistake in deployment script’ Link

  • Rune unveils 5 phases of Maker end game Link

  • GFX Labs makes another push to turn on Uniswap protocol fees Link

Thoughts & Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in a rainy Nashville. Grateful for my mother and my baby’s mama.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. All content is for informational purposes and is not intended as investment advice.

After Shapella, a new dawn for ETH yield products

https://doseofdefi.substack.com/p/after-shapella-a-new-dawn-for-eth

Ethereum’s Shapella upgrade earlier this month was the culmination of a nearly decade-long effort to shift to proof-of-stake (PoS). The upgrade, which enables withdrawals of staked ETH, followed the launch of the Beacon Chain in November 2020 and the Merge last September, when the proof-of-work chain was finally laid to rest.

In 2019 and 2020, DeFi blossomed on Ethereum, with plain old vanilla ETH supplying more than half of TVL during those two years. ETH holders could only earn yield by lending or LPing on an AMM. Ethereum’s shift to PoS then created new opportunities to earn yield with ETH. 

Soon after the launch of the Beacon Chain, we started to see a preview of such yield opportunities, in the form of liquid staking derivatives (LSDs) – although some are trying to rebrand to LSTs (liquid staking tokens). Specific examples include Lido’s stETH, Coinbase’s cbETH, and Rocketpool’s rETH, all of which allow access to ETH staking yield by simply holding a token. LSDs have grown consistently over the past two years – irrespective of the price of ETH – and their popularity is set to accelerate now that withdrawals have been enabled by Shapella. 

Yet these tokens are just the start. The much-anticipated EigenLayer, which enables ETH restaking to earn additional yield, launched on testnet earlier this month. The protocol could drastically lower the cost of building complex applications on Ethereum. And it might also usher in a new era of ETH staking tokens, which would redefine the core base of assets for DeFi protocols.

The ETF-ization of ETH yield

There’s already high-profile backing of this idea of an ETH-staking-token era. At the MEVnomics.wtf online summit last month, Gauntlet founder Tarun Chitra laid out a compelling vision:

“There will inevitably be some notion of ETF-ization, where people will want different classes of ETH yield. There will be:

  • The most high grade ETH yield that is just pure staking.

  • Slightly riskier [and higher] ETH yield, which is staking plus submitting oracle updates.

  • Slightly higher risky version [of ETH yield] with data availability plus oracle updates.

I can imagine people fractionalizing [for] what level of ETH [yield] risk do you want.”

This future assumes the widespread adoption of Eigenlayer’s ETH restaking protocol. EigenLayer would enable Ethereum validators to provide other infrastructure services in return for additional rewards. EigenLayer does not enable the tokenization of these additional rewards, but neither does Ethereum for staked ETH (and that didn’t stop the LSD market from forming). A deeper analysis of the LSD market (as follows) will help illustrate how the rise of restaking products – or the ETF-ization of ETH yield as Tarun calls it ​​– will play out. 

LSDs: Lido’s dominance

When DeFi arrived as a meme and a market in 2019, there were three clear market segments: lending, DEXs and stablecoins. LSDs have cemented themselves as the fourth major market in the DeFi space.

Lido (stETH) raced to an early lead and has not looked back. It onboarded dozens of well-known validator companies and then focused on DeFi integrations. It also launched a Curve stable pool and showered it with LDO token incentives to build on-chain liquidity. Throughout 2021 and early 2022, this strong on-chain liquidity helped stETH maintain a 1:1 peg with ETH, despite the fact that stETH can only be redeemed for ETH through Lido after withdrawals are enabled (expected next month).

Once on-chain liquidity was established, Lido then moved to integrate stETH into lending protocols. Aave also added it as collateral in February 2022. This led to a popular recursive borrowing strategy: supply stETH as collateral, borrow ETH against the stETH, buy stETH with borrowed ETH. Rinse and repeat. This became a great leveraged ETH-staking strategy, but ran into problems in the days of market volatility during the Terra and 3AC collapse, when stETH depegged from ETH.

LSDs: The best of the rest

  • Coinbase has the second largest LSD, cbETH, mirroring its second place in the stablecoin market with USDC. cbETH launched in October 2022 with the advantage of being able to attract the large swath of retail and institutional investors that custody ETH on Coinbase. Just as its fiat onramp makes it a major player in the stablecoin market, the same is true for LSDs. It also charges the highest fees (25% on yield earned). Coinbase’s biggest concern is regulation. It’s hard to imagine Mr. Gensler ignoring a token that promises yield, given the current intense scrutiny on Coinbase. But regulation isn’t Coinbase’s only problem. It’s set tosee more competition in the exchange lane, with Binance announcing just this week that it’s entering the LSD market.

  • Rocket Pool is the most decentralized of the major LSDs. It’s also the oldest, with roots dating back to 2016. Importantly, being a Rocketpool node operator is permissionless. With the release of its Atlas upgrade last week, node operators only need 8 ETH to join the protocol, giving them skin in the game (in addition to needing to stake RPL). The remaining 24 ETH comes from purchases of rETH, Rocket Pool’s LSD. 

  • Frax launched its LSD (sfrxETH) last November. It’s fairly centralized, but intends to shift to a model similar to Rocket Pool in the future. Frax has carved out market share with effective liquidity mining strategies, as well as by integrating into its Frax Lend product.

There are at least a half dozen smaller LSDs (Stakewise, Ankr, Stakehound, etc.) looking to carve out a niche in the growing market. It will be hard to offer something novel for vanilla LSDs, but EigenLayer and ETH restaking represent an opportunity to win market share.

EigenLayer: The next generation of ETH yield

EigenLayer was founded by Sreeram Kannan, a professor at the University of Washington and director of the UW Blockchain Lab. Over the past few months, EigenLayer has been cited by Vitalik and other core Ethereum developers as a solution to Ethereum’s thorniest problems. It also just announced a massive $50m Series A fundraising, led by Blockchain Capital.

Bridget Harris, a student at Stanford, explains the appeal of restaking well:

“Often, developers have to choose between innovating outside of Ethereum – and not being able to leverage its validator set – versus building on the EVM but having to adhere to the above constraints…These projects need actively validated services (“AVS”) in order to achieve proper validation. However, building an AVS comes with significant restraints.

EigenLayer proposes a solution to these issues by applying the security Ethereum’s validator set provides to these modules: in their words, pooled security via restaking and free-market governance.”

Rather than bootstrapping a network, EigenLayer would recruit Ethereum validators to run additional services for specific applications. The key is leveraging the ETH staked behind the validators to ensure that they perform the tasks they’re receiving awards for. To participate, validators must assign their ETH staking withdrawal address to EigenLayer. This would enable the slashing of a validator’s ETH if it doesn’t act according to the specific conditions it agreed to, as approved by EigenLayer governance.

Through this model, EigenLayer could act as a “staging network for Ethereum”, testing out new features before implementing in the core protocol. It could also align validators to implement MEV smoothing, or redistribution of MEV profits, by slashing any validator that tries to take more than its fair share. 

Ultimately, the core premise of EigenLayer is the incentive for ETH holders to seek a higher yield.

Restaking LSDs

In its whitepaper, EigenLayer explicitly states that it is not enshrining LSDs into the core protocol.. 

Still, we can see the writing on the wall. It will be more difficult to create tokenized versions of yield earned from ETH restaking. LSDs are all packaging the same underlying yield from Ethereum protocol rewards, although they have introduced additional returns from running MEV-boost. EigenLayer envisions hundreds of different yield opportunities for ETH validators to partake in. Making these fungible will certainly be a challenge.

We believe that liquid restaking derivatives (LRDs?) will take the same form as the current crop of LSDs. EigenLayer is designed to accept LSD tokens themselves, so an investor could stake stETH or cbETH within EigenLayer and then delegate to a validator that is running a service with higher rewards. This is a good way of integrating with the existing system and validator set, but wouldn’t give sufficient fungibility and liquidity to interact with DeFi. A new token that captures the additional yield is needed.

For aspiring liquid restaking derivatives (okay, tokens), the most important thing is to build around a core service that is much needed by Ethereum applications: one that is secure and can offer high rewards. After this, the focus should be on how the LSD market first formed. The simple formula (pioneered by Lido) is:

Step 1. Recruit a number of top staking companies to serve as trusted validators.

Step 2. Launch a token that captures the yield and build on-chain liquidity through Curve or Balancer (Aura also helps).

Step 3. Ensure the token is accepted as collateral on major lending platforms.

This might not seem that complicated, but the increasingly hostile regulatory environment around tokens with yield is sure to muddle the playbook.

Odds & Ends

  • WBTC supply on Ethereum has declined by over 50% Link

  • Delphi Labs proposes BORG, a new framework for cryptolaw entities Link

  • Gearbox releases v3 Link

  • a16z launched Magi, an rust client for the Optimism rollup stack Link

  • Bancor launches new DEX Carbon Link

  • ETH Tokyo winners Link

  • Ameen announces Hai, a multi-collateral RAI fork on Optimism Link

  • 0x reveals new suite of integrated APIs Link

Thoughts & Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in NYC, great to be back but wish the weather was more spring.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. All content is for informational purposes and is not intended as investment advice.

US Treasury goes after DeFi and top MEV bots lose $25m

https://doseofdefi.substack.com/p/us-treasury-goes-after-defi-and-top

Tweet of the week: DeFi is misunderstood

Regulators have always been playing catchup when it comes to crypto, and after a string of (coordinated) regulatory actions against a wide swath of crypto actors, it seems that the US Treasury is now setting its sights on “DeFi”. The tweet from crypto Twitter maestro, Neeraj sums up a piece written by his colleague Peter Van Valkenburgh. We’ll defer the constitutional questions to CoinCenter, but it is clear from the Treasury’s assessment that it is misconstruing what DeFi actually is vs. those that purportedly use it as a marketing tool.

Regulators target entities that serve as intermediaries to financial activity. It’s easy to target Coinbase or Kraken because it’s a registered company in the US. But what about Uniswap? Regardless of whether regulators legally can or should target it, the simple fact is they can’t. Even if they put Hayden in jail and got all UNI token holders to go along, they simply can’t change the immutable smart contract on Ethereum.

This is not to say they won’t try! For DeFi protocols that rely significantly on governance (all the lending protocols), they can target the token holders themselves and could muster through regulation by commandeering enough governance power.

There is also the very remote possibility that Uniswap could get the Tornado Cash treatment. Tornado Cash is also a set of immutable smart contract on Ethereum that regulators were unable to take down directly, but they achieved the same end by forcing RPC providers and validators to refuse to broadcast or confirm blocks that have transactions that interact with the Tornado Cash smart contracts.

But Tornado Cash reportedly facilitated payments to North Korea. What has Uniswap done?

Chart of the week: Exploiting the arbitragers

A chart that attempts to breakdown how a malicious actor stole $20m from the most profitable MEV bots through an exploit of the Ultra Sound Money Relay because of a vulnerability in mev-boost-relay, the Flashbots-built client MEV searchers and relayers. Bert Miller of Flashbots has a full post-mortem and step-by-step account of how the exploit ocurred. In short, the attacker exploited mev-boost’s commit and reveal scheme by convincing the relay to reveal the contents of a block because, the relay only requires a signed block header but does not check if the block is invalid. Typically, since the block is invalid it would never get confirmed by the beacon chain.

But in this instance, the attacker looked at the contents of the block being proposed and then used this information to propose their own block where it exploited the MEV bots that had submitted transactions in the original bundle.

This was a shock to the MEV community, which typically does the exploiting. MEV godfather (and Flashbots cofounder) Phil Daian said the exploit “demonstrates the true power of having in-protocol [Proposal Builder Separation] + [Single Slot Finality] one day, while also showing that there’s some work to do to get there :)”

OtterSec has a great Twitter thread, as does MEV OG – and mev-boost skeptic – Pmcgoohan.

Odds & Ends

  • Euler exploiter returns $177m in stolen funds Link

  • Sushi Head Chef releases statement on SEC subpoena Link

  • DeFi Saver launches DCA and limit orders on Ethereum Link

  • CoW Swap launches RPC endpoint to protect against MEV Link

  • OpenEden launches regulated on-chain vault managing US Treasuries Link

  • GFX Labs launches Google Sheets add-on to query on-chain data Link

Thoughts & Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in Texas, but my heart is in Nashville with the Tennessee Three.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. All content is for informational purposes and is not intended as investment advice.

Damage control: DeFi lenders and the USDC depeg

https://doseofdefi.substack.com/p/damage-control-defi-lenders-and-the

It seems like every few months, there’s a black swan event in crypto. In just the last three years, there’s been Black Thursday at the start of Covid, DeFi summer 2020, the 2021 bull market, Luna/3AC, and then the FTX collapse. The failure of SVB and the burgeoning banking crisis that’s unfolded over the last two weeks is the latest unprecedented incident.

Soon after the FDIC announced it had taken over SVB on Friday March 11, USDC – the most trusted stablecoin – began drifting from its peg. It then plunged when Circle revealed it had $3.3bn of cash locked up at SVB, and then dropped further when they halted redemptions before bottoming out at $0.87. As the weekend went on and with markets closed, USDC’s on-chain price became a proxy recovery rate for SVB depositors, trading sideways below its $1.00 peg. This carried on until the FDIC announced on Sunday evening that all SVB deposits would be accessible at Monday’s market open.

As the chart above from Coin Metrics shows, USDC wasn’t the only stablecoin on the move. Dai (aka “wrapped USDC”) mirrored USDC’s price, while USDT traded at $1.01+, as investors were willing to pay a premium for stability. 

DEX volume soared on-chain, posting an all-time daily high of $25bn (Uniswap ended at $12bn, while Curve had $8bn). MEV-Boost also posted an all-time high. For a DEX, a depeg – or any volatility – is a good thing; there’s no strain on the system and fees skyrocket. This is not true for DeFi lending, where a depeg could destroy a protocol if risk and volatility are not properly governed.

Lending in volatility

Each of the major lending protocols (Maker, Aave, and Compound) responded quickly with emergency governance actions, and are now discussing long-term changes to insulate their protocols from failure in the event of another depeg. The impact of these changes will hinge on whether they heed the key lessons from this latest incident (more on that later). First, here’s how the Big Three fared:

Maker

  • Where they were: Prior to the USDC depegging, Maker held $2.4bn of USDC (5% of USDC’s circulating supply). Almost all of this sits in Maker’s Peg Stability Module (PSM), which enables 1:1 exchange between Dai and USDC.

  • During the depeg: As investors sold USDC (typically for USDT) and pushed down the price, many USDC holders deposited their USDC in the PSM, minted Dai, and then sold the Dai. This meant that Dai’s price slightly lagged USDC’s price, because the PSM enabled the same sell pressure on Dai by allowing 1:1 minting. This resulted in $2bn of additional USDC inflows, which Maker is now stuck with. MakerDAO governance went into emergency mode, adding a 1% fee to the PSM (plugging the hole), reducing the debt limits on all USDC-based collateral, and increasing the debt limit on USDP (which didn’t suffer depegging issues). It also updated protocol parameters to allow debt ceiling adjustments to bypass the Governance Service Module (GSM) Delay.

  • Going forward: Dai is now more backed by USDC than it was prior to the depeg. No one in the Maker community is particularly happy about this, but in typical DAO fashion, they still can’t agree on a plan to wean themselves off of USDC. Increasingly, it looks like Maker will follow in the direction of its founder, Rune Christensen. He also prefers the most extreme option: decoupling Dai from the US dollar to become an independent stable currency. 

    It’s hard to square this vision with the reality of the here and now. There’s almost $6bn of Dai in circulation that desperately wants to be pegged to the dollar. Rune’s ideas don’t seem to acknowledge that Dai is a product that already has market adoption. And right now, it still needs to operate within the confines of its self-imposed USDC straightjacket.

Compound

  • Where they were: Compound is in the midst of transitioning to v3, while also trying to go multi-chain and claw back some market share from Aave. USDC was hardcoded at $1.00 in its v2 contracts, and Compound exclusively uses it as the borrowing asset in v3.

  • During the depeg: The Compound v2 Pause Guardian (a multisig) halted USDC supply transactions, while continuing to allow all borrowing. It did not pause Dai supply transactions even though it mirrored USDC’s fall, likely because the protocol adapted to its price decline because it was not hardcoded. 

    Notably, Gauntlet recommended pausing borrowing for all assets, a much more aggressive step that was not implemented. Their concern focused on Compound users who were recursively borrowing – simultaneously supplying a stablecoin while also borrowing a stablecoin. Given the high loan-to-value ratio (LTV) of stablecoins and their price correlations, traders are able to make a levered bet while also farming COMP. The biggest risk of this activity during the depeg came from an address that supplied 20.7m USDC and borrowed 17.1m USDT.

    Presumably, this was a leveraged bet to short USDT. That was not the correct bet following the USDC depegging, but with the price hardcoded at $1.00, this position was safe. 

  • Going forward: All eyes are on v3 and Compound’s expansion to other chains, with Arbitrum and Optimism up first. Compound did not take any risk mitigation measures on v3 during the depegging event, because “Compound v3 features an upgraded risk engine”. On v3, only USDC is borrowable, so there was no risk of bad debt accruing because USDC is not used as collateral. 

Aave

  • Where they were: Aave has always been the most aggressive lending player, whether it be via marketing, adding new assets, or expanding to new chains. It released its v3 six months before Compound, and was further along in the deployment process; v3 was running live on Avalanche, Arbitrum, Optimism, Polygon, and Mainnet. While not yet implemented on all chains, v3 also features E-Mode (efficiency mode), which enables higher borrowing power for assets with correlated prices.

  • During the depeg: USDC was not hardcoded to $1.00, so the protocol’s oracle instantly registered the declining price of the more-than 1 billion USDC deposited into Aave. On v2, with a LTV ratio of 85%, the protocol would only take on losses if USDC dipped under $0.85 and failed to stabilize. So while the Aave war room debated whether to pause v2 on Ethereum (the largest market), it ultimately did not and USDC’s peg eventually recovered. 

    Outside of Ethereum, there were issues: Aave incurred bad debt and had to take emergency action. This was for two reasons. First, there was less USDC liquidity on smaller chains, with most of it bridged USDC (as opposed to native). Second, Aave v3 on these smaller chains had E-Mode enabled. This allows borrowing of up to 97% of stablecoin collateral and has a liquidation threshold at 97.5%, so there’s a very tight band for healthy liquidations.

    As the price of USDC dropped, many recursive stablecoin borrowers should have been liquidated (when USDC hit $0.97), but most were not – USDC liquidity was crumbling so it wasn’t appealing to liquidate (especially with a low liquidation penalty). As the price of USDC continued to drop, the protocol missed the window for healthy liquidations (where the value liquidated and returned to the protocol exceeds the outstanding debt that is paid off). Avalanche was hit worst worst, incurring almost $300k of bad debt. This prompted the Aave Guardian to freeze the USDC, USDT, Dai, Frax, and Mai markets on Aave v3 Avalanche.

  • Going forward: The Avalanche markets were unfrozen earlier this week, with plans for the supply caps to be drastically reduced. And now, Aave governance is discussing what adjustments to make to E-Mode, which is leading to a frank discussion on what exactly is the target use case for E-Mode. The main problem during the depeg was that some of the assets in E-Mode depegged together (USDC/Dai) while others did not (USDT). E-Mode leaves a protocol susceptible to a depegging incident, which is by nature hard to predict. Aave has yet to pass any changes to E-Mode, but the current community consensus seems to be to reduce the LTV ratio for stablecoins in E-Mode to insulate the protocol against the risk of a depeg. Any adjustment to E-Mode parameters will lead to significant liquidations if positions are not unwound before the change is put into effect.

Three takeaways for DeFi lending 

First, recursive borrowing may not be worth the heightened risk. Borrowing and supplying the same stablecoin is not risky to the protocol – although we do question its utility to the protocol; the bigger risk to protocol solvency is from users that simultaneously supply one stablecoin and borrow another. Recursive borrowing is profitable for the user because of protocol or chain rewards, and protocols like it because it can juice its revenue (E-Mode on Avalanche yielded almost $2.5m last year). Is the revenue and user growth enough to justify the added risk? A possible future influence on the answer may be the emergence of the ETH liquid staking derivatives (LSD), which will completely upend the lending market. Having a system (like E-Mode) that could efficiently manage multiple LSDs as collateral could be very appealing to borrowers.

Second, USDC may become more entrenched into lending protocols. It’s complex to manage multiple stablecoins in a shared lending pool. As more lending moves into isolated pools, those will likely come with a single borrowable asset (like Compound v3). You could have a ETH-USDC, ETH-Dai, ETH-USDT pool, but protocols may drift towards a preferred stablecoin as not to siphon liquidity. Aave’s E-Mode would have less insolvency risk if it only included USDC-backed stablecoins (like Dai and Frax). 

Third, a governance system and community that can respond in real time is crucial to ensuring adequate risk management. DeFi OGs will recall the confusion and panic in Maker governance in the months following Black Thursday in 2020, when Dai consistently traded above its $1.00 peg. Those DeFi days are over. Unlike in 2020, there was a swift response and active discussion amongst a wide range of stakeholders at Maker, Compound, and Aave following the depeg. Some may think that DeFi must prioritize governance minimization, but for a lending protocol governance is an unavoidable reality, given the need to balance capital efficiency and protocol solvency. 

It was not a flawless weekend for DeFi, but the quickness of the governance response underscores how far off-chain coordination in DeFi has come.

Special thanks to Nick Cannon, Luigy Lemon and Ross Galloway for inspiration and feedback on this post.

Odds & Ends

  • mevnomics.wtf Link

  • Coinbase to add Uniswap and Aave to L2 Base Link

  • Data and analysis on DEX volume over past 7 days Link

  • The Espresso Sequencer aims to decentralize rollup sequencers Link

  • Lido to allow ETH withdrawals “in mid May” Link

  • Idex v4 to launch on May 22 Link

  • ARB airdrop Dune dashboard from Blockworks Link

Odds & Ends

That’s it! Feedback appreciated. Just hit reply. Written in Nashville, where spring has sprung! I’ll be in Austin the week after next. Reach out if you’re around.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. Caney Fork, which owns Dose of DeFi, is a contributor to DXdao and benefits financially from it and its products’ success. All content is for informational purposes and is not intended as investment advice.

How a bank run in DeFi would work and how DEX volume fared after FTX collapse

https://doseofdefi.substack.com/p/how-a-bank-run-in-defi-would-work

Tweet of the week: How DeFi deposit rates work

Of course the bank runs at Silvergate and Silicon Valley Bank are all anyone can talk about this week. Crypto folks should be familiar with this situation after experiencing FTX, BlockFi, Genesis and the rest of 2022, but once again we are drawn to the stark differences between how the same financial panic would play out in DeFi. In the above tweet (h/t Hart Lambur), Superfluid founder Francesco Renzi highlights how depositors would have more incentive to stay when others withdrew their funds because interest rates adjust automatically.

We’d add one more: transparent collateral. There wouldn’t be whispers of how a bank didn’t react quick enough to changing rates and the losses that may have ocurred. It would be on-chain for everyone to verify.

Perhaps it’s because we’re obsessed die-hards, but just as after the FTX collapse, it’s just more reason to double-down on DeFi.

Chart of the week: FTX’s fall is Uniswap’s gain

via CoinMetrics’ “State of the Network”

The first chart in a deep dive into the state of DEX trading activity in the months following FTX’s collapse from Tanay Ved & Kyle Waters in CoinMetrics’ latest State of the Network. The chart above lays out the market share amongst Uniswap and major CEXs – with the notable exception of Binance, which commands an 80% marketshare in the spot market. While Kraken and Coinbase took a good chunk of flow from FTX, Uniswap’s market share has also steadily increased. Barely touching 20% prior to FTX fall versus now consistently above and closer to 30-35%. Uniswap is happy to be on par with these CEXs but it has its sights set on Binance.

It will need to focus on growing volume outside of Ethereum mainnet if it hopes to take on Binance. Around 80% of Uniswap v3 volume comes from Ethereum mainnet, versus ~11% on Arbitrum, 6% on Polygon and 3% on Optimism. With the addition of Base from Coinbase (a fork of Optimism) and other zkEVMs on the horizon, there is more room to grow. And, of course, Uniswap Governance voted last week to launch on BNB chain itself.

Check out the full CoinMetrics post to better understand DEX volume the last few months. There was also a great piece on Messari Pro yesterday looking at DEX users.

Odds & Ends

  • Alpha Homora offers $32m in ‘seized’ assets to Iron Bank to pay down debt Link

  • Timeboost: A new transaction ordering policy for Arbitrum Link

  • Frax co-founder makes a case for stablecoin maximalism at ETH Denver Link

  • Blockchain Association announces principles for stablecoin legislation Link

  • Rune, MakerDAO founder, proposes rebranding DAI stablecoin Link

  • Rocket Pool to launch 8 ETH “mini” pools Link

  • WSJ: Stablecoins like USDC are commodities, says CFTC chair Link

Odds & Ends

That’s it! Feedback appreciated. Just hit reply. Written in Nashville, where the anticipation for spring is building.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. Caney Fork, which owns Dose of DeFi, is a contributor to DXdao and benefits financially from it and its products’ success. All content is for informational purposes and is not intended as investment advice.

Stablecoins part 2: Can on-chain stablecoins break through a fiat-dominated market

https://doseofdefi.substack.com/p/stablecoins-part-2-can-on-chain-stablecoins

Last month, we looked at the largest (fiat-backed) players in the stablecoin market and the hazy regulatory scrutiny they’re trying to navigate. It’s becoming increasingly clear that these issuers are at the relative mercy of US regulators. Indeed, just shortly after our post, the third-largest stablecoin (BUSD) received a possible death sentence from the SEC and NYDFS because of unbacked BUSD on the BNB Chain. This month, we explore a different class of stablecoins; ones that are much smaller and somewhat less stable. Yet crucially, because they’re trying to operate on-chain and outside of the TradFi infrastructure and regulatory constraints that fiat-backed stablecoins face, they have the most potential to unlock new credit innovations and efficiencies. 

It’s no surprise that money creation was one of the first financial experiments on blockchains. Tokens on a blockchain that represent a US dollar are in theory useful for payments, but the market for this never really took off. Instead, the first real use case for such tokens was the same thing that underpins most crypto headlines: speculation.

Traders looking to increase their crypto exposure through leverage powered the first synthetic dollar-pegged stablecoin (Dai), with over-collateralized on-chain loans backing it through a complex system of smart contracts and oracles. Since then, there have been many attempts to create more efficient designs, with less and less collateral backing.

This was taken to its logical extreme with algorithmic stablecoins like Terra, or (who remembers?) Empty Set Dollar and the associated series of zero-collateral death spirals in January 2021. These failures turned many sour on innovative stablecoin designs, but the ability to print money is so enticing that new ventures are always going to emerge. And with many of the latest innovations coming from DeFi veterans, there should be stronger conviction regarding their future success. Yet will any of them be able to challenge the large fiat-backed stablecoins? To attempt an answer to this hypothetical question, let’s take a look at the most prominent players on this side of the market.     

MakerDAO: Flying too close to the sun

The OG decentralized stablecoin spent from 2020 through most of 2022 centralizing its reliance on USDC, some now dubbing it “wrapped USDC”. It spent that time soul searching with its founder Rune Christenson penning its Endgame Plan, which aims to move MakerDAO away from its reliance on the US dollar and into an truly independent and stable store of value.

The Endgame Plan was poorly received. The underlying conundrum MakerDAO finds itself in is one that every creator of a new, innovative stablecoin will eventually run into: how to scale and grow supply relying exclusively on on-chain assets and enforcement mechanisms. MakerDAO grew and grew in 2021 and 2022, but that growth came at a cost: it’s now nearly 60% backed by fiat stablecoins.

data via Daistats.com

This highlights an inconvenient truth: there is more demand for stablecoins on-chain than there is on-chain collateral to back it. For now, at least. But since Rune talks about Maker on a century-long timeline, it would be wise to slow Dai’s ascent to match with the current asset base of blockchains. 

Looking ahead, while MakerDAO is pushing forward with strategic initiatives like raising the Dai Savings Rate (DSR) to 1% and forking Aave v3’s front-end (Spark Protocol) to strengthen its position, it seems to have become a victim of its own success. It’s simultaneously in both decentralization and growth mode: the latest example being allowing Dai to be minted with MKR collateral. It is going all-in on regulatory arbitrage, but also betting big on real world assets (RWAs) that are very easy to regulate.

Aave’s GHO: It’s all about the network

MakerDAO has long been focused on getting Dai into the upper echelons of liquid stablecoins, but it increasingly looks like it will have to defend turf against fellow DeFi OGs Aave and Curve, which have imminent plans to launch stablecoins of their own.

The rumors surrounding secondary lending platforms like Aave and their plans to launch stablecoins have been around for some time. These lending protocols already have the key piece of infrastructure needed to launch a stablecoin: the ability to quickly liquidate an underwater position. Lending protocols want their own stablecoins for the same reason that centralized exchanges have their own preferred stablecoin: to create lock-ins to their ecosystem.

Aave’s GHO stablecoin is quickly approaching launch, deploying on test net two weeks ago. It doesn’t offer anything new in terms of design; its success will hinge on the ability to capitalize on Aave’s network effects. Aave has already out-competed Compound in this sense, by deploying to more networks and listing more assets. Attracting more on-chain borrowing demand is a tall task, but Aave has been leading the way in DeFi on this front for several years. Much like a bank with wide distribution, Aave will try and leverage its existing lending footprint to upsell to GHO. How it deals with peg enforcement and manages its reliance on fiat-backed stablecoins is another issue altogether.

crvUSD and Gyroscope: Innovating core design

In developing its stablecoin-launch plans, Curve’s stable swap pools have been critical in unlocking liquidity by pairing them with other stablecoins. Like Aave, Curve will soon launch a stablecoin (crvUSD) to enhance its ecosystem. But unlike Aave, crvUSD will be based on a new, innovative design where liquidations are replaced with a special purpose AMM. One way to make collateral more efficient is by earning fees off of it through liquidity provisioning, and indeed crvUSD will be backed by collateral that is also market making on ETH and USD. 

crvUSD’s whitepaper is heavy on the math and on the hand-waving, but it does showcase a new stablecoin design that could prove a breakthrough in efficiency and in attracting new on-chain borrowing demand. The question of whether this design works out for Curve should be answered imminently; crvUSD cleared an important governance milestone last week, and could be live in the next few weeks.

Gyroscope is another new stablecoin soon to launch on Ethereum with an innovative design. It aims to limit reliance on single oracle feeds for prices by meta-aggregating and indexing them. It also introduces an updated version of Maker’s Peg Stability Module that would attempt to prevent the Gyroscope stablecoin (GYD) from getting co-opted by a centralized stablecoin in its search for peg stability (what happened to Maker). Gyroscope is live on Polygon and preparing for a mainnet launch. 

Frax: A one-stop shop for DeFi

Perhaps no DeFi project has had a better past year than Frax. After successfully bootstrapping itself in 2021 through some ponzi-nomics, it built on key partnerships to integrate Frax around DeFi. 

Frax is developing more than just a stablecoin, but rather an ecosystem of different financial products and services. Most recently, it launched one of the most successful ETH liquid staking derivatives ever (LSD). Frax has the same issue as MakerDAO in terms of dependence on the centralized USDC for backing, but its smaller size means it will be easier to wean itself off. We’re optimistic about Frax because the success of any stablecoin will ultimately come down to having a huge swath of users looking to take on debt in that stablecoin, and Frax has demonstrated its ability to grow market share in more than one product vertical.

Frax started as a partially-backed algorithmic stablecoin, but is now moving to be fully-backed, with a signal vote passing this week. This will inspire more confidence in Frax but also means it will be harder to scale as it runs into a similar set of problems as Maker and Dai.

LUSD & RAI: Resisting the centralized-collateral temptation 

Many DeFi die-hards and ETH maximalists long for single-collateral Dai, which was previously backed entirely by ETH – the purest asset known to humanity. Liquity’s LUSD and Reflexer’s Rai are the only ETH-only stablecoins still standing. We covered Rai’s attempt to become a non-USD stablecoin in the summer of 2021. Ultimately, it failed to generate enough demand for its stablecoin and its “un-governance” design prevented any changes to the core protocol. Ameem Solemani, one of Rai’s co-founders has done a mea culpa, explaining that ETH is not great collateral in a world of liquid staking derivatives (LSD), which have the same fungibility but come with built-in yield. Staked ETH may soon become the most popular collateral on Ethereum. 

That may be a problem for Liquity’s LUSD, which is backed entirely by ETH and boasts a low collateralization ratio (110%) as well as a no-interest-rate structure and an avenue for LUSD holders to earn yield through liquidations. It has stayed stubbornly above $1.00 for the last six months, but is finally inching its way down, in part due to chicken bonds. While some now tout the ETH-only collateral, will Liquity stay competitive if borrowers prefer ETH with a yield a la LSDs?

It’s important to remember the difference in size. Liquity’s is currently $600m, Rai maxed out at $100m. Frax is at $1bn and Dai at $5bn. All of these combined still only represent 15% of the size of USDC, and even less of a proportion of USDT. While printing your own money on-chain will forever be enticing and profitable for an ecosystem building lending products, fiat-backed stablecoins remain the only way to meet the insatiable demand for dollars on the blockchain.

Odds & Ends

  • MakerDAO raises debt limits on ETH LSDs Link

  • Coinbase launches Base, a rollup fork of Optimism Link

  • zeromev.org shows MEV extraction block-by-block Link

  • Flashbots announce MEV share to return some MEV to users Link

Thoughts & Prognostications

That’s it! Feedback appreciated. Just hit reply. Written in Nashville, but headed to Denver on Wednesday. Reach out if you’re around.

Dose of DeFi is written by Chris Powers, with help from Denis Suslov and Financial Content Lab. Caney Fork, which owns Dose of DeFi, is a contributor to DXdao and benefits financially from it and its products’ success. All content is for informational purposes and is not intended as investment advice.