In The Weeds #9
Why we're paying attention to Cron Finance's TWAMM, Voltz V2, and Liquity
Welcome to Decentral Park’s new research sub-newsletter: In The Weeds.
This weekly instalment will focus solely on key technical developments and themes within Web3, keeping you ahead of the game on upcoming trends.
Let’s get stuck into this week’s key highlights.
1: Cron Finance TWAMM
What is it? While Ethereum has been evolving rapidly over the past 12 months, issues remain with its onchain trade execution algorithms, which are currently limited due to factors such as contract space, gas costs, and algorithmic complexity.
The popular trade execution algorithm used today is called AMM (Automated Market Maker), which runs onchain and follows a simple mathematical formula (X*Y=K). However, large swaps cannot be executed onchain in the AMM model due to slippage and MEV attack-related diminishing returns. Aggregators like CowSwap have developed complex onchain and offchain services to improve execution, but this breaks protocol composability and adds additional trust required within the offchain component.
Cron Finance is building advanced fully on-chain trade execution algorithms and aims to provide a solution to the limitations of onchain trade execution algorithms. Building upon research released by Dan Robinson, Dave White and Hayden Adams in 2021, Cron Finance has released Cron V1: TWAMM.
Built upon the Balancer protocol, this first product iteration from Cron is an implementation of a fully onchain Time-Weighted Average Market Maker. The purpose of this is to smoothly execute large swaps with minimal slippage and MEV attack resistance.
The TWAMM algorithm solves the issues associated with large AMM swaps by breaking orders into countless tiny virtual orders that execute smoothly over time. It uses a mathematical relationship with its AMM and spreads the gas cost across virtual orders. Since it operates between blocks, it is less vulnerable to sandwich attacks.
The result of TWAMM: traders can make multi-million dollar swaps efficiently, in a permissionless manner, and transparently. This is achieved without the need to rely on third-party custody, counterparty risk or offchain dependencies.
Why is it important? TWAMM completely shifts large order execution considerations from favouring off-chain solutions to now having potentially superior onchain solutions.
For example, OTC trading uses advanced algorithms and order splitting to get the best fill given they are not constrained by gas costs. In contrast, DeFi's current solution involves aggregators or manually splitting orders, which comes with drawbacks associated with gas fees, MEV attacks, and human error. TWAMM executes suborders virtually and only writes them to the chain when a new interaction with the underlying AMM occurs, allowing traders to pay gas costs only for starting, cancelling, or withdrawing order proceeds, thus making the onchain alternative to OTC trading far more efficient.
Ultimately, TWAMM adds functionality to the onchain trading experience that was previously unavailable, enhancing the DeFi arsenal. This encourages migration away from centralised or non-trustless solutions, towards a strengthened DeFi proposition.
Where does it go from here? Cron Finance has indicated that this implementation is merely V1 and that subsequent iterations will build upon the current features of TWAMM. Publicly stated features that will be layered on in future iterations include privacy and limit orders.
While limit orders have been available on platforms such as 1inch for a while within the DeFi ecosystem, private TWAMMs are an innovation proposition. Privacy is an inherent feature of OTC desks, given trades are not published onchain, although, within the V1 iteration of TWAMM, trades are not executed privately. Given large trade executors are generally averse to broadcasting trades, privacy will act to materially enhance the attractiveness of TWAMM in its efforts to surpass OTC offerings.
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2: Voltz V2
What is it? A non-custodial AMM for interest rate swaps. While the introduction of DEXs within DeFi was pivotal to crypto asset adoption, it inadvertently created liquidity fragmentation for particular users, such as market makers and trades. This fragmentation comes from the need to post multiple margin positions across various exchanges, even when these positions are offsetting. Of course, this issue isn’t exclusive to DeFi, the same can be seen in TradFi where various regulatory requirements have led to similar liquidity fragmentation issues.
Voltz V2 acts to solve this issue, by creating a generalisable margin account that can be used to support derivative positions across various instruments and decentralised exchanges. Essentially, it acts as a non-custodial clearinghouse for any derivative instrument, removing liquidity fragmentation for market makers and traders.
Not only does this result in the unification of previously fragmented liquidity, but Voltz V2 allows for the cross-margining of different collateral assets, positions of the same instrument, and positions of different instrument types. This materially improves the existing flexibility offered to traders and market makers.
Voltz V2 builds upon Voltz V1, so traders and market makers still benefit from the features of atomic execution, clearing and settlement of any derivative instrument.
So, how on earth does this work under the hood? The innovative design leverages a generalizable structure enabled by an onchain risk matrix that can assess the risk of any asset or combination of assets. The matrix uses a covariance matrix estimated from historical market data and is converted into a risk matrix with shocked volatilities on-diagonal and correlations off-diagonal. To understand how this maths works in more detail, I’d recommend having a read through the Voltz V2 whitepaper.
Why is it important? In DeFi, liquidity is king. This is true across almost all sub-sectors, ranging from LSTs to lending and has been proven with the rise and now dominance of stableswap DEX’s such as Curve, and DeFi legos built upon them such as Convex. By allowing for generalisable margin accounts, Voltz V2 helps to further the capital efficiency within DeFi, and unlock previously fragmented liquidity. This capital can then be fed back into the DeFi ecosystem to increase the overall size of the liquidity pie.
Given the benefits of a non-custodial, onchain clearinghouse, Voltz V2 has the potential long-term to act as a clearinghouse for a material portion of the $1,000t+ in derivative trading volume.
Where does it go from here? Voltz V2 is expected to launch in a phased approach throughout 2023. The initial phase will be an MVP stage built within the Voltz V1 AMM, acting as the first exchange operating on top of the generalisable margin engine.
As TradFi continues to lean toward onchain experimentation, the ultimate adoption of ‘crypto rails’ to underpin the traditional finance ecosystem edges closer. While still a way off, Voltz is leading the clearinghouse technology race, and if it maintains this dominant position, will be set up to become an important piece of the global financial system.
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3: Liquity and LUSD
What is it? Decentralised stablecoins follow many different designs, ranging from MakerDAOs over-collateralised DAI to Frax’s partially backed by collateral and partially stabilised algorithmically stablecoin FRAX. Each of these designs has its vulnerabilities from a decentralisation standpoint, such as reliance on centralised collateral. Decentralisation is a spectrum, and no one stablecoin can truly be considered entirely decentralised.
In our opinion, however, no stablecoin is more decentralised than that of Liquity’s LUSD. Liquity is a decentralised borrowing platform in which users can borrow LUSD, an over-collateralised dollar-pegged stablecoin in exchange for depositing ETH as collateral, interest-free.
The mechanism itself is simple, Liquidity deployed immutable smart contracts that have not been changed since deployment, nor are they able to be changed. That’s right… no governance is required because there’s nothing to vote on! Liquity’s monetary policy is set in stone.
Users simply deposit ETH to the protocol and can withdraw LUSD with a collateral-to-debt ratio standardised at a minimum of 110%, this is low relative to comparative lending on-chain protocols, made possible by Liquity’s instantaneous liquidation mechanism. For comparison, Aave, Compound and Maker require a minimum of 150% collateral-to-debt ratio.
The Liquity protocol itself can be accessed via a network of third-party front ends, in the same way that MakerDAO operates. This acts to further decentralise the protocol. The protocol itself is simply the smart contracts, and its front-end is uncensorable since it doesn’t have one. The most popular front-ends are DeFiSaver, Instadapp and Liquity.App.
LUSD can be redeemed at any time for $1 worth of ETH, meaning that the LUSD peg is maintained by arbitrage opportunities that account for minting and redemption fees. The only varying fee within the protocol is the borrowing fee, which is determined by the current base rate, an algorithmically-governed rate based on the volume of redemptions.
Why is it important? Regulatory pressure continues to rise for stablecoin providers, including centralised offerings such as Circle and Tether, as well as decentralised options.
The latest draft US stablecoin bill acted to further this pressure, with the proposal to make it illegal to offer unlicensed stablecoins in the US, with a maximum fine of $1M and of 5 years in prison. Their definition of "stablecoin" is very broad and includes FRAX and LUSD, as long as they are designed to be redeemable for a relatively fixed amount of "monetary value", including all fiat currencies.
During the recent regulatory pressure placed on BUSD, many holders opted to swap out of the Binance-based asset, and pivot to the most decentralised stablecoin in the space, LUSD. As a result, TVL within Liquity increased 62.3% from $172M to $280M. This is practical evidence that Liquity could accumulate TVL from centralised stablecoin providers as regulatory pressure increases from regulatory bodies.
Beyond this, the fact that only ETH can be used as collateral within the Liquity protocol makes the protocol more robust in comparison to alternatives that accept highly speculative assets as collateral, such as MakerDAO and Aave. When combining this with the fact that Liquity’s smart contracts are audited, immutable and most importantly simple, the protocol is considered a market leader in terms of decentralisation and reliability.
Where does it go from here? Liquity and its smart contracts will never evolve, so the product, alongside LUSD can only truly change in terms of utilisation and TVL. As mentioned, due to its relative decentralisation, and immutability, LUSD gains market share upon regulatory clampdown for centralised stablecoins. This is expected to continue should further regulatory pressure and/or action be taken.
Liquity is expected to be the final protocol pursued by regulatory bodies, if at all, given the decentralised nature relative to its peers. Protocols such as MakerDAO and Frax are deemed easier for regulatory bodies to pursue.
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