DEX evolution: past, present, and future
Decentralized exchanges (DEX) allow people to make swap crypto tokens.
This is possible, because liquidity providers (LP) make their tokens available on the DEX to facilitate trades.
Why would LP providers do that? Because they earn rewards for it.
DEXes charge a small trading fee for trades. This fee is yield that can be used to reward LPs. While that basic concept has remained the same, DEXes are continueing to evolve.
The purpose of this article is to:
1) See what we have learned of older DEX models
2) Identify DEXes that currently lead in tech.
3) Have a look at some new developments
1 — Uniswap and trending towards zero.
Uniswap was the first real DEX.
To decentralize the protocol, they emitted governance tokens. The more tokens you have, the more say you have about the protocol.
But governance wasn’t really (financially) useful, so most people dumped tokens as soon as they got them.
Thus “goverance tokens (with no real utility) trend towards zero”
The lessons here are that high APRs do not necessarily mean much. If the token is a shitcoin, it will likely lose value even faster as you farm them.
Protocols can emit tokens with no real purpose as a way to offer high yields and and thereby attract attention (for a short while). But the token will dump and hurt the credibility of the protocol and the team.
2 — Curve and vote escrow
Curve is revolutionary protocol that introduces several innovations.
In fact, Curve is so successful that it gave birth to the term “Curve wars”: protocols fighting to increase their relative share of the Curve governance token CRV. So what did Curve do to give CRV real utility?
CRV can be locked to recieve veCRV.
Locking tokens removes them from the circulating supply and tereby reduces sell pressure. This is beneficial for the protocol.
But no one is going to lock up their tokens if the reward does not more than make up for it.
The first benefit of veCRV is that you can get up 2.5x the farming rewards depending on how big your veCRV holdings are relative to your veCRV holding.
I don’t think of this as a boost for veCRV holding, but rather a penalty that reduces mercenary capital efficiency. If your intention was to farm and dump, you’re only farming at 40% power anyway.
A second benefit of veCRV is that it recieves 50% of all trading fees.
Instead of the LP providers recieving all the trading fees, they are now split between the LP providers and veCRV.
A third benefit of veCRV is that it allows you to vote on pools (ve = vote escrow). When you vote for a pool, you direct CRV tokens to that pool.
Thus, you farm CRV tokens with your LP. Then lock the CRV to vote for your own pool and sent more rewards to your pool.
This is important for crypto protocols. For example, stablecoin protocols like FRAX have large veCRV holdings they use to sent rewards to their FRAX LP pools. This makes it attractive for FRAX holders to provide liquidity on Curve. And deep liquidity is absolutely essential for stablecoins.
The fourth and final benefit of veCRV is that they get bribed for their votes. Protocols have found out that bribing veCRV is the most capital efficient (think best ROI) strategy to ensure high farming rewards for their liquidity providers.
So (locking) CRV has tons of utility.
But Curve still has some issues.
For one, it’s focused on the stablecoin market.
But veCRV gives you right to your relative share of all pools, regardless of how you vote. This is inefficient for the protocol, as individuals may vote for a pool they have a large share (thus boosting their farming rewards). Ideally, you want everyone to vote for the pool that is most productive, that is: that earns the most real yield as result of trading fees and/or bribes. They don’t vote for the pool that is most productive (earns most trading)
3 — UniswapV3 introduced concentrated liquidity
Before concentrated liquidity, DEXes were in liquidity wars.
The more liquidity a DEX has available for a pair, the more efficient the trades were (less slippage). This creates a flywheel were it’s difficult to beat older DEXes because they have all the liquidity and are earning all the trading fees.
But new tech can shake this up.
Imagine you can open 10 ice cream shops anywhere you want. Would you open one of them on the North Pole? You probably want to place all 10 shops in hot countries, right? You want to offer your product in places where there is demand.
In traditional LP pools, liquidity is spread out over the entire price spectrum. However, much of that price range is extremely unlikely to happen.
For example, it’s extremely unlikely that Bitcoin ($28.000 currently), will trade at $28 or at $28.000.000 anytime. It would be much more efficient, is your liquidity instead would be concentrated in a much more narrow range where trades are likely to happen. And that is exactly what concentrated liquidity does.
As a result, concentrated liquidity is MUCH more efficient. With much less liquidity, you can provide the same or even better trades (less slippage for traders).
Better trades attracts more trade volume and consequently higher trading fees.
However, concentrated liquidity is not all upside.
When prizes move outside the range where you liquidity is concentrated, you no longer earn trading fees. In addition, while farming yields are magnified, so is impermanent loss.
You REALLY have to know what you’re doing, or you’ll REK yourself. Indeed, there is a research paper that shows that the majority of LPs would have been better off if they had just HODLed instead of providing concentrated liquidity.
4 — Andre Conje introduced ve(3,3) tokenomics
Decentralized finance legend Andre Cronje came up with the concept of ve(3,3) tokenomics.
A main element is that ALL trading fees go to token lockers and that you only recieve your relative portion of the trading fees of the pools you vote for.
In short, this just aligns incentives a lot better than on the older Curve ve-model. People vote for productive pools (high bribes and/or trading fees), and those pools get rewarded with more token emissions.
Another innovation included infrastructure for bribes of both stable and volatile pools.
The combination of these things has resulted in that the main source of (real) yield on many ve(3,3) DEXes is the bribes, not the trading fees.
The ideal behavior is that LP provide liquidity, lock the token (which is attractive due to its many benefits), and use bribes to increase their LP positions to complete the flywheel.
5 — Thena has just combined concentrated liquidity with ve(3,3) tokenomics
ve(3,3) DEXes have been doing quite well. They have 2 sources of real yield:
- trading fees
- bribes
Most of them are doing quite well on bribes. But the trading fees earned has remained fairly low for most. The reason is that they have to compete with older DEXes that tend to have more liquidity.
But as of April 2023, Uniswap’s concentrated liquidity license is expired. Other DEXes are now free to incorporate concentrated liquidity.
This shakes things up, because you have to implement it to stay competitive. And shake ups are good for newer DEXes. Older DEXes have tons of legacy liquidity. Liquidity that is deposited a long time ago, but the owners don’t check in on it.
Migration to newer liquidity pools means that legacy liquidity stays behind. In addition, the whole shake up causes people to have a look if there are not alternative farming opportunities.
But the real oppertunity lies in who best implements concentrated liquidity.
What if concentrated liquidity could be:
1) simplfied and optimized by auto-management
2) plugged in with ve(3,3) tokenomics
This is exactly what Thena’s FUSION does.
Thena is the first ve(3,3) that has implemented concentrated liquidity.
Thena has partnered with Gamma Strategies, who provide management solutions for concentrated liquidity. In short, your liquidity positions will automatically be adjusted so you always stay in range, earn fees, and minimize impermanent loss.
Thena has also partnered with Algebra, which allows the ve(3,3) tokenomics to be integrated with concentrated liquidity.
The end result has no clear weaknesses:
- concentrated liqiduity allows much higer liquidity efficiency
- auto-management so not a 24/7 job to adjust your position
- auto-management to that rebalances to minimize impairment loss
- integration with ve(3,3) tokenomics
It will be interesting to see how succesfull Thena will be in the coming weeks and months.
Other DEXes need to implement concentrated liquidty to remain competitive.
Multiple ve(3,3) DEXes have already indicated they are moving towards concentrated liquidity. It will be interesting to see how fast they can execute, and if they come up with alternative solutions or new innovations.
6 — Maturity-adjusted position?
The ByteMasons have recently released Reliquiry, which allows flexibility in token emissions. This opens tons of options that protocols are now starting to experiment with.
Beethoven X has moved to a maturity-adjusted model for their BEETS token. The longer you stake BEETS, the more voting power you get. The idea here is to incentivize people to stay long-term, but not require them to lock (which many people refuse to do). This may attract more people to actually stake their token and thus more effectively reduce the circulating supply.
Chronos is doing something similar for their LP position. LP farmers get higher farming rewards the older their position is (and max rewards after 6 weeks).
This is interesting in combination with the ve(3,3) tokenomics. Protocols will bribe pools, resulting in high farming yields. This will attract liquidity to the pools. But the maturity-adjusted farming system rewards LP holders to stay in a pool. With LP holders less likely to jump around to whatever the highest farming pool of the week, it may become more attractive for protocols to bribe aggressively because the liquidity it attracts is more sticky.
But the tech allows much more new concepts to be explored.
For example, what would happen if the rewards schedule was a bell curve? This means that early on, your maturity boost increases, great! But once you’re over the peak, your boost starts to go down.
Your position is now “too mature: for the max boost. So how do you fix this? Withdrawing everything and depositing again starts you over at zero boost, so that’s not an option.
But if you provide some additional liquidity, your new position will be a combination of “too mature” and “completely new”. By depositing the the right relative amount of “completely new” liquidity, you can shift your position back to the max boost. So this curve could be a way to incentivize people to DCA more into their position.
7 — Not all innovation is good
Ofcourse, not all new tech will work out.
Olympus DAO was one of the hottest DEFI protocols who innovated bonds and had rebases with >100.000% APR…..and it all sounded great.
Satin Exchange had potentially promising ideas to improve the ve(3,3) model, but completely failed. It seems the main problem here was that the underlying tech was broken, not the ideas itself. But it highlights that protocols feel like they need to innovate to compete in the market, which may come at the expense of first making sure you have the basics soundly working for you jump into innovation.
8 — Lets try to pick a winner
In the first 3–4 months of this year, ve(3,3) DEXes have become the new standard. Every chain now has one or more ve(3,3) DEXes. It seems unlikely that other DEX models can compete, simply because they don’t have the bribe infrastructure and related optimized tokenomics.
Now ve(3,3) DEX launch season is over, I expect that winners and losers will start to grow apart. Many people have jumped from one ve(3,3) DEX to the next, to be early on all of them. Now that launch season is over, I expect capital to flow to the actual best DEXes.
I feel that straight forks are in trouble. Because ve(3,3) DEXes were doing well, any fork was attracting liquidity. But farmers now have the option to pick and choose. So now it’s important that the teams show what they can actually build and/or have good business development skills.
I’m going to highlight Thena as the horse I’m betting on most. Here’s why:
1) one of the first ve(3,3) DEXes (team is fast)
2) first and still ve(3,3) on BSC (little competition)
3) by far best UI (team can build, allows easier entry)
4) first and still only ve(3,3) DEX with concentrated liquidity (team can build/is fast)
5) the team is advising several other ve(3,3) DEXes. In fact, one other DEX is even friendly forking THENA. (Team is seem as THE authorities on ve(3,3)
6) innovators of NFT bootstrap model
7) no private sale that will dump
In short, the team can build and execute. I believe they will stay ahead of the competition with faster innovations and/or better innovations.
Ofcourse, you should also have realistic look at risks. The main risk for Thena is that it’s on the BSC chain. The BSC chain is relatively centralized and obviously connected to Binance. Personally I don’t think this is a big risk. There has been Binance FUD every single month for the last couple of years (bankruns, lawsuits etc). Binance is also MASSIVELY burning their BNB holdings every 3 months, improving centralization. Even if something bad happens to Binance, I don’t think this will have massive effects on the BNB chain. I think the risk:reward of Binance being involved in the chain is clearly a good trade off. But you might judge differently.
Ofcourse, the strengths and risks of a protocol can change in a heartbeat. Don’t blindly marry to a protocol. I have all my Thena tokens as liveTHE, which is a liquid wrapper. This provides the benefits of locking THE, but you remain liquid (ofcourse some small fees are involved). This allows me to benefit from my THENA conviction, but I could exit whenever I want. (liveTHE is build by the another project from the Thena team…they can build)
9— CONCLUSIONS
- ve(3,3) DEXes are the new standard and will continue to gain market share
- ve(3,3) DEX winners and losers will start to separate from now on
- Winners will be determined based on new tech and/or their business development (number of partners)
- DEXes need to hurry up and integrate concentrated liquidity to remain competitive
- Keep an eye on for new tech. Development never sleeps. But not all innovation will be winners.
- Analyze WHY you think a DEX will be a winner or loser. Discuss in various discord and Twitter to gain perspectives.
If you liked this article, please like, share and comment on my Twitter thread here. I’d love to hear what your favourite DEX is and why.
-Remember The Name
