Why Protocols Could Benefit From Owning Their AMM Curve

19 JUN 2024 | RESEARCH | AUTHORED BY CALLEN

Token launches are pivotal events that can significantly enhance a protocol’s value and impact. These events, often accompanied by highly anticipated airdrops, can inject immense wealth into the crypto ecosystem. However, the true potential of these launches is frequently undermined by the current decentralized exchange (DEX) landscape, where the benefits of trading volume, fees, and user engagement often elude the originating protocols. By owning their Automated Market Maker (AMM) curves, protocols can more effectively capture and retain the value they create, transforming their economic model and enhancing their sustainability in the decentralized finance space.

Token Launches Are High-Value Events

Token launches are decisive moments for protocols, that if done right, result in significant value creation for its users, contributors, investors, and community. In many cases, this is characterized by a heavily speculated airdrop event that distributes native tokens to users exhibiting extensive protocol usage. Since the start of 2024, the top 5 largest airdrops alone have created roughly $6.6b USD in value to users.

The subsequent token price discovery, accompanying tokenomics, and utility shape airdrop recipients’ future expectations about the true valuation of a protocol and in turn, likely determine whether they’ll sell their airdrop allocation; this is also true for potential buyers. Such behaviour generates significant trading volume on launch day, making high-volume token launches extremely valuable for centralised and decentralised exchanges.

As indicated in the charts above, some of 2024’s largest airdrops are no exception, with the likes of Wormhole and Starknet both reaching over $1b USD in trading volume on their launch day. High volume days persist for some time post-launch-day with Ethena and Wormhole receiving more than 50% of their total trading volume in the first 14 days of trading over a 50-day period.

There is no doubt that the success of a token launch is exacerbated by the centralized exchanges they list on, their liquidity providers, and the user base they receive access to; providing a mutual benefit for both the centralized exchange and protocol. In contrast, seeding and incentivizing liquidity on DEXs to facilitate trading is a large capital cost for protocols, with no real ability to capture any of the value they created.

The DEX Value Leak

The current Decentralised Exchange (DEX) AMM landscape has largely failed to price and fairly reward the trading volume, fees, and userbase protocols bring to their platforms.

For example, Uniswap Liquidity Providers receive 100% of trading fees while protocols like Pancakeswap, Curve Finance, and Balancer also distribute a percentage of trading fees to various parts of their ecosystem – token holders, the DAO treasury, and buy-back and burn programs. Yet, nothing goes to pool or token creators.

When looking at Uniswap – DeFi’s largest DEX AMM, governance/protocol tokens (Altcoins) have historically been a major contributor to the protocol’s trading volume, accounting for 30% to 40% of all Uniswap volume in recent months. However, this number is arguably understated as Majors & Stables include LSTs, LRTs, and decentralized stablecoins, which derive value from the protocol that issues them.

Despite being the minority producer of trading volume, Altcoin pools significantly outpace Majors & Stables in fee generation. Since April 2023, Altcoin pools have accounted for 70%-80% of Uniswap’s total monthly trading fees, with October reaching as high as 87.7%. The stark difference in market share between Altcoin trading volume and fees is highly attributed to Majors & Stable pools’ commonly used 0.05% or 0.01% fee tier, as opposed to Altcoin pools’ commonly used 0.3% or 1% fee tier, with the former allowing for much higher volume at a cheaper cost.

Nonetheless, while we have seen Altcoins reach such levels of fee generation dominance previously, there has been a noticeable and sustained shift in demand in comparison to Majors & Stables since January 2023.

This is likely due to an ever-increasing Altcoin count but also the efforts of protocol teams spending countless hours and resources on cultivating their community, building their product, and driving demand for their token, in which 100% of the subsequent trading fees are captured by AMM liquidity providers, or worse, buying back and burning a token that is completely unrelated to their ecosystem.

Notably, there have been attempts by teams to recoup some value through buy/sell taxes on their token that take a fee on each buy and sell. This has worked incredibly well for some protocols like Unibot, netting their ecosystem and tokenholders $36M USD. However, one downside to this approach is that it introduces a significant amount of complexity into the token contract itself and limits a team’s ability to only capture fees on tokens they deploy and have control over.

Plugging the Hole: Owning Your AMM Curve

So where does one go if all reputable DEX AMM options leak the value they create? One option is to launch their own AMM DEX like Friendtech’s launch of BunnySwap. BunnySwap is a Uniswap V2 fork modified by the Friendtech team to facilitate the trading of their native token FRIEND.

By launching their own Uniswap V2 fork, they were able to implement 2 important changes:

1. 1.5% Trading Fee: That accrues to Liquidity Providers in the FRIEND-WETH pool.

2. 1.5% Protocol Fee: That accrues to an address owned by the FriendTech team.

The former is not possible on Uniswap V2 due to a fixed 0.3% on all liquidity pools and similarly, the latter is fixed at 0.05% with all protocol fees accruing to the Uniswap DAO’s treasury.

With these changes in place, BunnySwap allowed the FriendTech team to capture $8.26M USD worth of WETH from protocol fees in 35 days since the launch of FRIEND. Evidently, like most other airdrops there was significant trading volume in the first 2 weeks, with FRIEND’s launch day alone reaching $89M in trading volume, netting the FriendTech Team $1.7M in protocol fees.

However, FriendTech isn’t the only project successfully incorporating its own AMM DEX to recoup some of the value it created. For example, Katana DEX has been capturing a 0.05% protocol fee on all swaps since 2021 on the Ronin Chain which accrues back to the Ronin Treasury.

The Ronin Chain was born out of the necessity to advance blockchain gaming through its specialized gaming-centric EVM architecture. As the entire Axie Infinity economy was ported over to the Ronin Chain due to high Ethereum gas fees, the Katana DEX was created to facilitate the exchange of Axie Infinity’s in-game assets (AXS & SLP) but now serves as the main DEX for all gaming ecosystems on the Ronin Chain.

Since its launch in November 2021, Katana DEX has facilitated over $10b USD in trading volume and generated $5M USD in protocol fees for the Ronin Treasury. When looking solely at AXS and SLP token pairs, Katana DEX now accounts for roughly 97% of all trading volume across DEXs highlighting how effective a closed ecosystem can be in retaining value. However, despite this success, and largely prior to the launch of Katana DEX, AXS and SLP liquidity pools generated $3.8b in trading volume across other major DEXs resulting in an estimated loss of $1.9M USD in protocol fees.

Trade-Offs & Challenges

Owning your own AMM DEX might seem like a profitable endeavour but it certainly comes with some important considerations, challenges, and trade offs. In the examples above, both FriendTech and Ronin Chain/Katana DEX cultivated strong ecosystems with tight constraints around the flow of value; allowing for its capture. The former placed restrictions on FRIEND transferability and provided the only UI for users to buy/sell their tokens, while the latter heavily incentivized the migration of AXS and SLP to its own purpose-built chain that is now the only place such assets can be minted and cheaply traded. So having tight controls over the value you create in your ecosystem is important to how successful you will be at capturing it given the permissionless nature of DeFi; anyone can take your token and deploy their own liquidity pool on another DEX.

Building out your own AMM DEX also comes with additional audit costs, time, and technical resources, and requires your users and liquidity providers to take on increased risk depending on the extent of code changes from popular deployments like Uniswap V2. The safety and security that Uniswap deployments provide to protocols and liquidity providers is largely attributable to its success.

Lastly, you lose a lot of the liquidity network effects that come with launching your token on popular AMM DEXs. For example, by only having a TOKEN-WETH pool, you are forcing all prospective buyers to acquire WETH before they can purchase your token, not to mention the lack of token visibility across DEX aggregators who have yet to integrate your product.

Luckily the future of the DEX AMM landscape is changing with Balancer announcing their V3 product along with Uniswap V4 which will allow for liquidity pools to be highly customisable. Specifically, Uniswap V4’s hook architecture will allow pool creators to add additional swap fees, acting as a form of protocol fees. This will allow protocols to capture some of the value they create while benefiting from Uniswap’s security and liquidity network effects. Yet, they will still be exposed to the underlying protocol fee.

Conclusion

The current Decentralised Exchange (DEX) landscape fails to appropriately reward protocols for the value they bring to their platform. By owning their AMM curves, protocols can mitigate the value leakage that occurs when relying on third-party DEXs. The examples of FriendTech’s BunnySwap and the Ronin Chain’s Katana DEX illustrate how protocols can successfully retain more value by implementing their own AMM solutions. While there are trade-offs and challenges, such as the need for additional resources and potential security risks, the potential benefits in value retention and ecosystem control make this a compelling strategy. As the DeFi space continues to evolve, protocols may increasingly look towards owning their AMM curves as a means to ensure their long-term sustainability and success.

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