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Uniswap Deep Dive (Part 2)

Continuing with our Uniswap deep dive from yesterday, today we remove the rose tints, and take a look at situations where Uniswap’s unique Constant Product Market Maker pricing model can act against the platform’s liquidity providers in a rapidly increasing or decreasing market. This is not in anyway discounting Uniswap’s massive potential.  However, it is important to note that Uniswap’s rapid growth within a short period of time has seen it become the biggest market for liquidity in the MKR/ETH and DAI/ETH trading pairs. One reason could be that there really has not been a liquid market for either DAI or MKR on a centralized exchange. According to Onchainfx’s recently added “Real10 Trading Volume” metric, which captures real trading volume on legitimate centralized exchanges that do not inflate trading volumes, MKR has the second lowest turnover (Trading Volume/MarketCap) after Grin.

This was therefore a market opportunity that was there for the taking and Uniswap users capitalized on this by creating a market for MKR/ETH and DAI/ETH, which quickly attracted users as there never existed a liquid MKR/ETH market before. It would be interesting to see if users defect to a reliable centralized exchange like Binance once it lists a MKR/ETH pair, especially given that there is absolutely zero control over prices on Uniswap.Another downside is that a trade starts becoming exponentially more expensive (more price slippage) as the trade size relative to the liquidity pool keeps increasing. So, Uniswap is an ideal place to trade small orders if you don’t want to incur too much price slippage. Whales and large-ticket hedge funds and arbitrageurs are not likely to come into the DEX fold because of Uniswap.

Another important thing to keep in mind is that liquidity providers on Uniswap are better off in a range-bound market than in a persistently increasing/decreasing market. As we mentioned yesterday, while this encourages anyone to be a liquidity provider, everyone providing liquidity is effectively shorting volatility; the relative loss vs HODLing increases almost parabolically as the price moves further away from the base price in either direction, the base price being the price at which a user has contributed liquidity into the pool, as seen in the figure below.

Therefore, in a directional market, trading volumes need to increase rapidly and become large enough so that the liquidity providers are adequately compensated for the loss in value of their liquidity pool. This could lead to a downward spiral, if the trading volumes don’t keep pace with the price increase as liquidity providers will start pulling out to limit their losses. It will likely be a ‘double whammy’ at such a time and could lead to disastrous outcomes for users if liquidity keeps shrinking at a time when users are competing to sell on Uniswap. This ‘negative optionality’ is bidirectional, and can hit the market in the case of a rapid slump or a rapid spike in the prices of something like ETH.

In conclusion, Uniswap is another fresh take on addressing the vexing problem of liquidity that others like 0x are trying to solve with approaches such as hummingbot and the 0x mesh. It is also in a great position to participate in the emerging ‘trifecta-trade’ that involves ETH, MKR and DAI, as detailed in this post by Cyrus Younessi. Uniswap has the potential to become a key player in the emerging DeFi stack, and will likely continue to attract a fair bit of attention over the next few months. It will be interesting to see how it passes real-world ‘stress tests’ as turbulence returns to the crypto markets.

Meanwhile in Crypto Wonderland….

“KuCoin Enables Crypto Purchases Through Credit Card” Singapore-based crypto exchange KuCoin has partnered with Israel-based payment processing company Simplex to let its users purchase crypto via credit card. The exchange has already added the service to its assets page, the announcement reports. Now users can purchase Bitcoin (BTC), Ethereum (ETH), Ripple (XRP), Bitcoin Cash ABC (BCHABC) and Litecoin (LTC) for both dollars and euros. The service is reportedly available in more than 100 countries. As the release notes, Simplex — which also has offices in the United Kingdom, U.S. and Lithuania — has already provided its “fraud-free” payment processing services to other companies, such as Shapeshift, the Litecoin Foundation, Xapo and Changelly.

“Tokenizing Palladium” Russian billionaire Vladimir Potanin wants to launch cryptocurrency tokens pegged to the precious metal palladium. Potanin also wants to establish a regulatory framework for digital platforms in order to promote crypto use in Russia. Potanin — whose net worth tops $18 billion — is the richest man in Russia and the CEO of Norilsk Nickel, a nickel and palladium-mining company. The Russian oligarch wants to launch several digital platforms, including one that will use cryptocurrency tokens for trading palladium.

“Swiss ICO Violated Regulations” Switzerland’s finance watchdog has found that the cryptocurrency mining firm Envion AG, which raised millions through an initial coin offering (ICO), held the sale illegally and “seriously violated” laws. Announcing the news on Wednesday, the country’s Financial Market Supervisory Authority (FINMA) said that Envion unlawfully received public deposits worth over 90 million francs ($90.33 million) from at least 37,000 investors through its token offering early in 2018. FINMA began investigating Envion in July 2018 for potentially breaking financial market rules. In Wednesday’s statement, the regulator concluded that Envion carried out the offering without the necessary banking license in place.

“Ledger and Legacy Trust Together Launch a New Custody Product”To accelerate the flow of institutional capital into digital assets, Ledger and Legacy Trust forged a partnership to form Ledger Vault. The new product is a multi-authorization wallet management tool for digital assets that offers both hardware and software security benefits. It will allow cryptocurrency exchanges, OTC (over the counter) desks and investment funds to appoint an independent qualified custodian, as well as tailor the rules to transaction authorization individually for all accounts, according to the announcement. The custodian will be able to make transactions without the need for multi-signature participants to be physically together, speeding up the usually slower process.

Crypto Twitter Pick

What We’re Reading / Listening To

The Year of the DAO Comeback by Steven McKie
A Billionaire on Why Crypto featuring Mike Novogratz

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