Single-Sided Liquidity Provisioning (SSLP) Layer: DEX-agnostic - Testing Complete
A few weeks ago, the AllianceBlock team released their brand new take on an automated market maker, AllianceBlock DEX, on the Testnets of two major blockchain networks — Energy Web Chain and Polygon. You can access the DEX here, find out more about the bug bounty here and read our top-downloaded research paper on SSRN. We’re confident our take on a decentralized exchange can help DeFi grow with a number of industry-first features that aim to push the DEX model forward.
One of those features is the upcoming, first-of-its-kind, single-sided liquidity provisioning (SSLP) layer that will open new ways for users to add liquidity to their favorite platforms while increasing the utility of ALBT. The layer will be chain-agnostic and enable DEX users to provide liquidity with a single asset, instead of two or more as is the current industry standard. Today, we wanted to give you a breakdown of our proposed SSLP layer and an update on the state of its development.
Most DEX Models only enable liquidity providers with two (or more) tokens
Decentralized Exchanges (DEXes) have been among the main innovations of the DeFi space. DEXes allow traders to swap digital assets without any central third parties directly on the blockchain. At the same time, they make possible the earning of trading fees by anyone contributing to liquidity pools at the core of the Automated Market Makers (AMMs) within the smart contracts. AMMs usually determine simple mathematical relationships between the pools of digital assets kept within their custody. During a trade, an inflow of assets changes some pools which, thanks to the AMM constraint, automatically determines the required outflow of assets to keep the mathematical relationship between the pools satisfied. Among such market makers, the most common model is the constant product market maker which has been extensively forked by various protocols on Ethereum first but also followed by other blockchain protocols.
DEXes built upon such models require Liquidity Providers (LPs) to simultaneously supply two digital assets with the same ratio. Geometric market makers offer the possibility of binding more than two assets together but the constraint on LPs remains the same. They should provide at least two or more assets with a determined ratio at the time of entering the DEX.
These constraints can constitute an important hurdle for many LPs. Indeed, the determined ratio imposed by the DEX does not necessarily fit the holding nor the risk appetite of the liquidity providers. For instance, in order to join the pools ETH/USDT of a particular DEX, not every LP will have the two tokens in equal amounts. Even worse, a LP might want more exposure to ETH than USDT or vice versa. However, the current DEX ratio requirements will bring this LP to modify their holdings to fulfill this constraint; the LP might sell part of their ETH holding to recover some USDT in order to satisfy the DEX constraint whereas their natural appetite was to be fully long ETH. Such situations are clearly aspects that might stop many from becoming active LPs. Hence, they also constitute an opportunity cost as they miss the earning of trading fees or yields on their assets.
A small number of market maker protocols offer LPs the possibility to provide only one asset to their smart contracts. Among them, some rely on their tokenomics; an elastic supply of tokens that are minted to match the provided asset. They usually use the same principle of newly minted tokens to reduce part of the risk of LPs which comes with earning the trading fees; that is commonly known as Impermanent Loss (IL). While appealing, elastic tokens can suffer during stressed market scenarios and the protocol could bear the risk to fall into hyperinflation. Other protocols change the market maker model by replacing the mathematical relationship between the asset pools by external oracles for determining the price of assets. These approaches also give the LPs the possibility of providing their assets with any ratio. However, they suffer from other weaknesses; prices coming from external oracles have their own issues. Moreover, LPs can bear strong inventory risk when the market moves drastically countering the benefits of earning fees.
The SSLP Layer will be extendable to most current DEXes and increase the utility of ALBT
AllianceBlock approaches this problem by first relying fully on the usual automated market makers models, therefore, avoiding the need for oracles. Playing with tokenomics to tackle the single-sided liquidity issue, while in principle possible, has also been discarded to keep the supply of ALBT completely stable. The approach chosen by AllianceBlock is a mathematical layer that will be DEX-agnostic and able to deploy on top of all existing main AMM protocols including the recently developed AllianceBlock Decentralized Exchange. The layer will be designed to increase the utility of ALBT, by charging fees to run the protocol in the pool’s native currency and swapping it to ALBT in a shared pool, similar to our approach with the AllianceBlock Bridge.
The participant providing liquidity to the DEX of their choice will be able to provide assets in the ratio of their choice. Coming back to our example above, a LP will be able to provide for instance only ETH to the pool ETH/USDT within the DEX of their choice. Such a LP, will have their investment reference defined by the asset they provided; in this case 100% ETH. Should they have provided only USDT, the investment reference would become 100% USDT. The investment reference is used for the calculation of the IL. A LP choosing USDT versus a LP choosing ETH have different risk appetites and therefore it is natural to refer to their original investment reference to calculate their returns.
The AllianceBlock SSLP layer will perform several tasks. First, it handles the matching of provided liquidity with other LPs funds in an optimal way to make the whole process fluid and seamless. Moreover, the SSLP layer will perform specific computations at withdrawal times; this is to ensure that each LP has a similar theoretical return, with respect to their investment reference, than the one LPs experience if providing liquidities to the underlying DEX.
With such a system, every LP can have their own choice of assets independently from the requirement of the underlying DEX. Therefore, they can build their own investment reference rather than the one imposed by the DEX mixing two or more assets. AllianceBlock’s SSLP Layer will guarantee LPs can avoid inventory risk, should the token they provided significantly change in value. The layer also guarantees that the LPs’ impermanent loss (IL) is similar to the one they would have experienced with a standard liquidity provisioning within the underlying DEX used.
In the below examples, we display the liquidity providers’ returns, which include the impact of trading fees and is denominated ‘IL’ for simplicity.
Firstly, we display that measure, for a single simulated asset scenario and for a single LP who entered the DEX with token A holdings and reference investment asset. The IL is displayed for each time within the scenario path and plotted on a logarithmic spot return scale.
We notice that thanks to trading fees, the return of the LP can rise. However the fee increase is counterbalanced when the spot deviates from the entry-level on the wings where the return can drop. This is similar to the impermanent loss effect and earnings from trading fees one would experience on a dual-sided liquidity provisioning within a DEX. Although here, the return is fully based on SSLP.
Secondly, we display a similar graph but where a large amount of LPs and market scenarios have been added together. This is done for both Uniswap and the AllianceBlock DEX (with a weight of 0.9) denominated sync-AMM within the graph.
In both Figure 2 and Figure 3. We recognize the impermanent loss overall shape that LPs can experience on both Uniswap and AllianceBlock DEX (with a weight of 0.9) when providing both assets to the DEX. We also notice that with the AllianceBlock DEX as the underlying platform, the average return over all paths is better than with the current industry standard.
Off-chain testing complete, smart contract development starts in January
The model presented interesting and difficult challenges to tackle and as of today, the SSLP layer is complete in terms of initial research and proof-of-concept. The off-chain stress- and back-testing has also been completed and we are ready to start the development of smart contracts in January. After the development of smart contracts is complete, the next step would be to have the layer generalized in order for it to be extendable to multiple DEXes and pools.
We’re confident our SSLP layer is going to introduce a new dimension to the current DEX market and invite new ways of providing liquidity not only in our own DEX, but across all DeFi. Single-sided liquidity provision is a new area of DeFi technology and we need to make sure proper attention and time is given to the development of the layer before we can offer it to our partners and collaborators.
In the meantime, you can read about our recently released Testnet DEX here, find out about the bug bounty here and test it yourself here.
About AllianceBlock
AllianceBlock is bridging the gap between decentralized and traditional finance by remedying issues in both spheres and linking them more closely together. They see the future of finance as an integrated system in which the best of both worlds can work together to increase capital flows and technological innovation.
They are building this future by bridging traditional finance with compliant, data-driven access to new decentralized markets, DeFi projects and ecosystem-scaling tools such as funding and interoperability. As such, they are building a next-generation financial infrastructure that aims to provide regulated financial entities worldwide with the tools they need to access the DeFi space seamlessly.
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