VE(3,3) DEXs as efficient liquidity providers
A case for oTokens, CL, and ALMs
Introduction
Ve(3,3) style decentralized exchanges (DEXs) are an established player in the ever growing and diversifying DeFi landscape. While their innovative character is widely appreciated, they still have to demonstrate that they can stand the test of time and be sustainable. While initially introduced as the ‘flywheel of liquidity’, a series of unsuccessful attempts resulted in them being labeled as ‘deathspirals’.
In this article we will analyze some of the reasons for this and also argue that there are promising developments that carry the potential to reverse the momentum back to the initial hope: the flywheel.
Throughout the text we assume that the reader is familiar with the core concept of ve(3,3)s.
The role of liquidity
The heart and soul of any DEX is its liquidity which allows it to exercise the core functionality: the swaps. The number that is usually used as a benchmark for this is the total value locked (TVL). This can be a misleading number for two reasons:
- A DEX, roughly speaking, has two types of liquidity pools (LPs). There are core pools that produce the bulk of fees. In the case of retro.finance those would be weth/matic and there are the majority of pools that produce relatively little fees. TVL does not distinguish between those. Often, the relative emission on these is not in the best interest of the protocol and with that of the voters. For more details read Infobox 1: Fees vs Bribes.
- Not all liquidity is equal. It turns out that the concept of concentrated liquidity (CL) introduced by Uniswap v3 has changed the game completely. While previously, providing liquidity with Uniswap v2 constant market maker LPs was convenient and also more easy to digest, it also comes with a main disadvantage: it does not put the liquidity where it is needed. Instead, it smears it out over a large price range making most of it inefficient. For more details read Infobox 2: Concentrated Liquidity.
There are thus two main things which have to come together to make a ve(3,3) DEX highly efficient. It has to make sure that emissions are directed towards the most important pools in terms of fee generation as well as making sure that the liquidity in said pools is put to optimal use. In the rest of the article we will detail how retro.finance attacks this and what type of (promising) results this brings.
Directing emissions
As mentioned before, from the point of view of protocol health and therefore in the best interest of the users of the platform, it is important to have the emissions directed to the most important pools. Usually, those pools do not receive incentives in forms of bribes but they have to self-sustain from their fees. So how can one get this flywheel starting? One strategy to use would be to use protocol voting power to direct emissions to those gauges until enough TVL builds up generating fees that make it self-sustaining. For a short time, this can be a viable strategy but it is not desirable and sustainable as a long term solution. A more systematic approach is to use independent revenue to bribe those important bluechip pools. This is where the concept of oTokenomics comes in.
OTokenomics
The key to attracting liquidity providers on ve(3,3) DEXs are the emissions. Traditionally, those emissions were made in tradeable tokens that could be held, sold, or locked. The concept of oTokens has the following twist: it emits an options token. This token can again be held or locked. Or, one can buy the platform token against a discount and then sell or hold (locking makes no sense since redemption into veToken is free of fees). The corresponding fees can be used to autobribe the most important gauges of the platform. The way this works is via a buyback of the platform token. This is then used in a locked form as bveToken, and consequently used as bribe. Not only does this direct the emissions to the most important pools, it also stabilizes the price of the token and with that the emissions. To summarize, oTokenomics achieves two things: it stabilizes the price and it directs emissions to bluechip pools of the platform. Both of these measures contribute enormously to the health of the protocol.
Concentrating Liquidity
While introduced in 2021 by Uniswap v3, the concept of concentrated liquidity is still somewhat mysterious to the casual user. In the standard implementation, the user has to worry about price ranges, ticks, being in range or out of range, massive impermanent loss, and many other things. All of this can make this seem terrifying and consequently unattractive. However, as argued above, concentrated liquidity is necessary for providing useful TVL. The solution to this are active liquidity managers (ALMs) that take care of all that headache for the user and make sure they are in-range as well as minimize impermanent loss. There are a variety of different strategies for this and retro.finance decided to implement a large number of those managers: Gamma, Ichi, and DEFI EDGE. Having said that, manual positions are still possible. The way to incentivize an efficient liquidity provision by both manual positions as well as ALMs is through the Merkl distribution system. This system is geared in a way that it distributes rewards according to their usefulness to the swapping activity. In that way retro.finance manages to have very efficient CL TVL, not only in their core bluechips pools but all over the platform.
Let’s talk numbers
Disclaimer: It is not straightforward to compare different chains in a fair manner. Different chains have different relative traffic depending on the day. Changing the date would change the relative numbers. Therefore, one should only compare DEXs within the same chain.
After all this talk, let us have a look at numbers to see how efficient the aforementioned measures are. We are now going to show that there are currently at least three ve(3,3) style DEXs that show very promising numbers. We choose retro.finance, thena.fi, and ramses.exchange as reference points (two of them, retro and ramses, have oTokens).
There are a number of quantities that one can use to characterize the efficiency of TVL. We will make a very simplistic choice here. We refer the reader to two upcoming articles that make a much more in depth analysis of the issues discussed here and also take into account the specifics of the different chains.
The first thing to discuss is how the oTokenomics is successful at directing TVL into the desired LPs. This is shown in the below table, and compared to other platforms.
The second thing to discuss is the way the TVL of the platform is effective in generating fees. We have compared ve(3,3) style DEXs that offer CL and ALM to competitors on the respective chains. The results are shown in the Table below. We observe that this type of DEX sports impressive numbers when we consider volume/TVL as well as fee/TVL, often better than the dominant DEX on the respective chain.
Conclusion
The purpose of this article was to glimpse at the competitiveness of ve(3,3) style DEXs in the landscape of DEXs.
We pointed out the importance of efficient TVL and identified two key measures that help to achieve that in a ve(3,3) setting. The first one is directing emissions into LPs that generate a lot of fees. We discussed how oTokenomics is ideal for this and plays a massive part in this, but also other sources of revenue can be and are used. The second one is to make sure that those LPs then indeed produce fees. This is ensured by a competitive management of CL positions that only rewards useful positions.
We would also like to make the reader aware that there are two parallel articles that discuss the points made here in much more detail. The respective links can be found below.
- https://medium.com/@c2ba/retro-dex-capital-efficiency-mechanics-analysis-and-comparison-6ddf72b0a93e
- Article 2
Coauthored by Dr. Simplex
