AllianceBlock Announces Launch of AllianceDEX, A New Market Maker
New automated market maker (AMM) product announced as part of AllianceBlock’s digital exchange offering
The AllianceBlock team is delighted to announce the on-going development of its decentralized exchange, AllianceDEX, as part of our continuous effort to build a decentralized capital market. Unveiled at the blockchain industry’s flagship event, Consensus 2021, the new DEX will have its own take on an automated market maker (AMM) — an algorithmic agent that provides liquidity in electronic markets — called AllianceDEX. It aims to minimize impermanent loss in both uptrend and downtrend markets with its new methodology. In this article, we will take a look at the market conditions surrounding decentralized exchanges, and what sets our DEX apart from those currently operating in the market.
With the recent rise of Decentralized Finance (DeFi), we have seen the emergence of a variety of blockchain-powered applications aimed at creating decentralized alternatives to traditional financial services. DeFi brings a myriad of benefits such as greater transparency, decentralization, enhanced security, and peer-to-peer global transactions among others. The market cap of DeFi rose from $1 billion USD in May 2020, to a stunning $80 billion USD in May 2021. One of the most influential catalysts that has spurred this growth has been the adoption of the Ethereum blockchain and its smart-contract functionalities.
Innovation in the DeFi space has particularly thrived over the past year. However, one area that has received significant attention has been the decentralization of asset exchanges (DEX), which provide a specific form of liquidity mining. Through decentralized exchanges, liquidity providers (LPs) generate revenues by providing their funds to the DEX of their choice, inherently replacing the need for third party market makers. These exchanges are powered via protocols acting as Automatic Market Makers (AMM). AMMs are algorithmic agents that provide liquidity in electronic markets, and they rely on algorithms to price assets. Over time, trading fees are accumulated and LPs can see substantial return on their capital.
The most elegant, highly regarded, and simple model of DEX is the one used by Uniswap, which is now also used by many other large players in the industry. In Uniswap’s case, the corresponding model is the constant product market maker. Balancer Lab has also made a highly effective form of DEX which enables the trading of multiple assets as opposed to Uniswap, which only provides for the handling of two assets at any given time. As usual, alongside every reward is a risk. Here, the risk is commonly called ‘impermanent loss’ (IL) and it is one of the main issues faced by AMMs today.
When a LP joins a DEX, the LP makes the choice to put funds at play within the DEX instead of keeping them static in their portfolio. On the DEX, the LP gradually accumulates trading fees. In exchange, at any time when the LP withdraws their funds, the number of tokens recovered can be substantially different from the invested capital at the beginning due to the dynamics of the DEX and the volatility of the traded base versus quote cryptoasset. The IL is the risk associated with the difference between the value of funds at the time of withdrawal versus the fund had the LP not invested his assets in the DEX. The term “impermanent” is employed since, without withdrawal, there is a chance to recover this loss if the spot reverts to its initial value; it can be compared mark-to-market in a traditional portfolio. An intuitive view of the phenomenon shows that when the market moves heavily, a LP can recover more of the cheaper tokens and less of the valuable tokens than when the LP entered the DEX.
This risk therefore remains a main concern for LPs and an area of innovation among various participants in the DEX industry. Uniswap and similar market models embed an impermanent loss profile which can strongly and negatively impact the returns of the LPs. When Balancer is used for two assets, by modifying the weights associated with each token, one can improve the IL profile on one side of the spot move but not both. The below figure shows the IL in % for Uniswap and two Balancer configurations without the returns from trading fees. The weights of the two Balancers were chosen to improve the IL on the downside. The x-axis represents returns as the ratio of spot of the invested pair at the time of withdrawal divided by the spot at inception (on a log scale).
In the extreme cases where spot is decreased by a factor of 100, Uniswap can lead to a large IL of -80% whereas for example Balancer improves the IL to -63% for a weight of 0.3. On the other hand though, if the spot increases by a factor 100, all three systems lead to a large IL of at least -80%. Naturally, trading fees returns will help to counterbalance this effect.
To counter this negative effect for LPs, other solutions have been proposed by Bancor, Uniswap V3, and Dodo. Bancor provides a system of insurance pools as well as a protection of IL, paid-out with their own protocol’s token with elastic supply if LPs accept to stake for a determined period. It is an efficient solution in most market regimes; however, this methodology could present a systemic risk under a stressed market scenario. Uniswap V3 on their side, improved the capital efficiency by concentrating the liquidity in user specific ranges. This creates a trade-off between capital efficiency and impermanent loss, as LPs can earn more trading fees but at the expense of suffering from IL. Quite different from the above solutions, Dodo DEX uses a proactive market maker model based on an external price Oracle. One of the main advantages of Dodo is to allow single sided liquidity provisioning by construction. Although the risk of IL is effectively reduced, LPs bear inventory risks that have similar disadvantages to IL particularly in highly volatile market conditions.
Alliance DEX — A New Mathematical Framework
Our DEX works directly on the intrinsic mechanism of the automatic market maker with a new approach to reduce the impermanent loss. This new methodology, allows AllianceDEX to minimize the risk of IL compared to standard DEXs and the volatility of each LP’s profit-and-loss when entering the DEX. In the below, the LP returns will be composed of both the cumulative reward from trading fees as well as the negative impact from impermanent loss. This allows the return, denominated “IL” in the below graph for simplicity, to be sometimes positive thanks to the impact of trading fees on the LP’s holdings.
The below figure illustrates this DEX more effectively. It displays a back-test of the pair ALBT-WETH, including returns from cumulative trading fees from time 0 onwards, over a time-interval starting on the 11th of November 2020 and ending on the 25th of May 2021:
In the above example, when the spot reached its maximum, the returns of the LPs between AllianceDEX and Uniswap V2 reached a difference of more than 20%. However, the IL is reduced at the end of this time-interval for both DEXs since the spot reverted to its original value. A liquidity provider deciding to exit after three months (around the 0.2 mark on the X-axis) in the above example would have incurred a loss on Uniswap V2 and a gain on the AllianceDEX compared to a buy-and-hold strategy.
The returns (which combine the cumulative rewards from trading fees as well as the IL) obtained with AllianceDEX are positive and above those garnered by using Uniswap, which also shows negative results. The IL improvement of AllianceDEX is independent from the direction of spot movement. We strongly believe that this methodology can bring substantial benefits for LPs and large advantages for the actors within the industry.
At AllianceBlock, we are fully committed to ensuring the DeFi ecosystem is as liquid, innovative, and high functioning as it can be, and this DEX is a notable step along the path towards achieving that goal.
The AllianceDEX is the latest in a string of high-profile product announcements for the company and follows the release of the AllianceBridge and the launch of the Liquidity Mining as a Service (LMaaS). Additionally, AllianceBlock also made waves when they announced a collaboration with industry leader Hedera Hashgraph, the most used enterprise-grade public network for the decentralized economy.
About AllianceBlock
AllianceBlock is building the first globally compliant decentralized capital market. The AllianceBlock Protocol is a decentralized, blockchain-agnostic layer 2 that automates the process of converting any digital or crypto asset into a bankable product.
Incubated by three of Europe’s most prestigious incubators: Station F, L39, and Kickstart Innovation in Zurich, and led by a heavily experienced team of ex-JP Morgan, Barclays, BNP Paribas, Goldman Sachs bankers, and quants, AllianceBlock is on the path to disrupt the traditional markets with its state-of-the-art and globally compliant decentralized capital market.
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