Possum Nexus, the key to positive sum scalability
Summary:
- The Nexus is a novel DEX / AMM which innovates on proven concepts
- It solves the problem of pair selection for LPs
- The Nexus unlocks unlimited scaling of the PSM ecosystem
Overview
The financial sector knows many products and instruments, be it derivatives, ETFs, bonds, stocks or otherwise. However, the fundamental purpose of a functional financial system is simple: to transport value & risks across space and time.
The main financial primitives to achieve this purpose are credit markets (lending & borrowing) and asset exchanges. Other financial instruments and products are somehow derived from these primitives or often a combination of the two.
Unsurprisingly, a similar dynamic can be observed in DeFi. According to defillama.com, the biggest DeFi categories by TVL are 1. Lending and 2. DEXes, if the list is cleared from infrastructure verticals such as Liquid Staking & Bridges.
The Possum Nexus is our foray into the second largest and arguably most important DeFi vertical: Decentralized Exchanges (DEXes).
Speedrunning the history of DEX evolution
To better understand where the Possum Nexus finds its place in the DeFi universe, we’ll do a quick summary of relevant DEX innovations over the past few years.
Albeit not being the first DEX, Uniswap V1 has laid the groundwork for DEX design in 2018. The now famous implementation of the constant product market making strategy x * y = k, was groundbreaking for crypto at the time and an important catalyst for DeFi Summer in 2020.
The power of easy composability and the intuitive understanding of the pricing curve led to widespread adoption of DEXes, mainly Uniswap and its early imitators like Sushiswap.
Fast forward, innovations in the DEX space mostly focused on increasing capital efficiency, inevitably leading to trade-offs in composability and increasing complexity. This trend continues with the upcoming Uniswap V4 design, whose complexity will likely give the final push to regular users to use third party applications and centralized access points when interacting with the protocol.
Interestingly, even after all these years of DEX innovation, the constant product pricing curve still underpins most DEXes. For example, Uniswap V3 uses the same pricing curve with the innovation that Liquidity Providers (LPs) can choose the price range in which the capital is used for market making.
DEXes and automated market makers (AMMs) are the most essential part of DeFi as we know it today, because not only do they facilitate regular asset swaps, but they also serve as the backstop for liquidations occurring in on-chain lending markets. Due to their size, on-chain liquidity even serves as the backstop for large, centralized order book exchanges (CEXes).
The importance of DEXes for DeFi and crypto as a whole can hardly be overstated.
However, developments in DEX & AMM design become more and more complex, making it improbable that regular users comprehend and validate the protocol’s functionality. Creating a second-class user base is dangerous for individuals and DeFi as a whole because it makes regular users dependent on third parties. This is the antithesis of decentralized, permissionless and widespread access to financial markets which was the purpose of DeFi all along.
Pair selection, a tenacious challenge for LPs
If you ever delved into market making, i.e. becoming an LP, you will know the challenges of deciding what pool to join. Let’s say you hold ETH and want to improve your risk adjusted returns by pairing it with another asset. Which asset would that be, a stable coin? If so, which stable coin? After all, they have very different risk profiles depending on their origin, i.e. centralized versus decentralized stable coins and within those groups there are large differences as well.
Or would you rather pair ETH with some other project token, perhaps a DeFi play, a memecoin or a gaming token? How would you rate the risk of that particular project, the risk of inflation if supply is uncapped, the impermanent loss potential and its correlation to ETH which greatly affects your earning potential?
There is a serious amount of variables to be evaluated, even for full-range LPs, not even mentioning the additional complexities of CLMM positions.
Professional market makers with sufficient capitalisation can of course diversify their activities among a wide selection of tokens, however, for regular investors, this situation is often overwhelming and impractical.
How the Nexus solves pair selection
Our solution to the pair selection challenge is to establish PSM as a “basket token”, effectively representing the movements of a broad crypto investment portfolio. Combined with the fixed supply nature of PSM, it becomes an ideal choice as a routing / pairing token because it offers reliability, predictability and opportunity cost indifference since it moves systematically with the market.
Building the Nexus
When designing systems, we always follow our guiding principles: simplicity, security, independence, reliability, incentive alignment and creating network effects for the Possum ecosystem.
One does not need to reinvent the wheel when certain principles have proven themselves over a lengthy period, such as the pricing curve given by the constant product formula. It continues to be the most efficient pricing curve when no assumption about possible asset prices can be made, which is generally true for volatile crypto assets.
The Nexus is a full-range constant product AMM with PSM as the common base pair of all liquidity pools. Related to our guiding principles, the Nexus has the following characteristics:
Simplicity. All tokens have exactly 1 pool because they can only be paired with PSM. This means that trade routing can be solved on-chain and does not require complex off-chain calculations: trades are either single-hop (PSM <-> ABC) or a dual-hop swaps (ABC <-> PSM <-> XYZ). Further, the Nexus will host all functions and tokens in a singleton contract, making it simple to integrate into various frontends, aggregators, or access it directly via block explorers.
Security. There has been extensive battle testing of related systems over the past years with billions of dollars being secured by likewise smart contracts. Expanding on proven concepts with various implementations as practical examples reduces the chance of security flaws dramatically. That aside, we will take multiple security audits before launch as always.
Independence. The Nexus does not host any external dependencies such as oracle integrations nor requires active management. It is a DeFi primitive in its truest form and adheres to the principles of a “Hyperstructure”. For full context about Hyperstructures, check out this article from 2022: https://jacob.energy/hyperstructures.html
Reliability. As always at Possum Labs, the smart contract will be immutable with no admin privileges. It is a persistent and secure environment for developers to build their own products and protocols on top. The full range nature of the pricing curve offers stable trading conditions for traders and fairly predictable fee accrual for LPs.
Incentive alignment. There is no value extraction via protocol fees or any middle ware required (such as swap routers) when interacting with the protocol. The Nexus enables free trade without intermediaries or parasitic business models.
Network effects. Using PSM as the fundamental building block of the protocol creates positive feedback loops. The more TVL is paired with PSM on the Nexus, the more demand is created for PSM, the more growth can be financed by the Possum Core, the more TVL is attracted, rinse and repeat. The design of the Nexus has the potential to expand to any number of networks, while consolidating the combined utility value in a single token. Because there is no value extraction, the system compounds value flows without friction.
Innovating on proven DEX & AMM designs
The Nexus hosts a selection of subtle but impactful innovations on the standard UniV2 type of DEX. These elements provide an extended design-space for projects composing the Nexus into new products.
1) PSM is the common base currency.
Being paired with many different tokens, the value of PSM becomes directly linked to all of them, effectively creating a “market liquidity basket”. In other words, PSM could quickly become a highly desired whole-market proxy. Further, this design eliminates the need for active management and is fully market-driven and adaptive. An ETF but not an ETF if you will.
As a result, PSM utility and demand becomes directly connected to TVL growth of the Nexus while the supply is fixed.
2) Separating fees from LP capital
Instead of automatic reinvestment of trading fees like in Unsiwap V1 & V2, LPs on the Nexus stake their LP tokens to receive trading fees as staking rewards. This allows them to decide when to claim accrued fees and how to use them, be it strategically reinvesting in the same LP or for something entirely different. It’s simply a source of passive income. For those who prefer auto-compounding, a separate auto-compounder smart contract can be created easily.
Non-dilutive liquidity mining: LPs can choose to not participate in the staking system and therefore passively boost the staking rewards for other LPs in the same pool. Among other applications, this can be used by project treasuries to provide liquidity for their token and not stake their LP tokens, creating a passive and non-dilutive liquidity mining campaign fueled by organic trading activity.
3) Single-token fees
All pools take trading fees only in the non-PSM token. For example, providing liquidity in the PSM/ETH pool will yield pure ETH that is distributed to LP stakers.
This design allows for competitive dual-hop trades because fees are only charged once on the non-PSM input token in a trade.
As a side effect, PSM holders can swap into any other asset without paying swap fees, emphasizing its utility value and special role in our ecosystem.
4) Adaptive swap fees
LPs who stake their tokens to receive fees can also vote for the trading fee percentage of the pool within a hard coded range.
The weighted average of all votes determines the fee level and is updated in real-time whenever anyone changes their vote.
This option allows active LPs to algorithmically or manually adjust their fee settings to gradually adjust the pool fee to market conditions. Passive LPs benefit from these adjustments too, without the need to give up control of their LP tokens to a third party liquidity manager.
5) Singleton architecture
Unlike past full-range DEX designs, all tokens and functions are hosted by a single contract. The simplicity and density of this design allows the Nexus to offer unparalleled accessibility and gas efficiency.
6) Join & exit pools with any token
The liquidity pools of the Nexus take “zapping” in and out of pools to the next level.
Our frictionless architecture allows LPs to add liquidity with any token that has a pool on the Nexus. Likewise, the withdrawal process also allows to withdraw liquidity in any single token.
In and out with your favourite token with a single click and no additional headache. Why not?
But of course, the option to add both tokens of a specific pool also exists and is specifically useful for LPs who already own both tokens. However, token amounts do not need to be balanced, granting a new level of flexibility to LPs.
Outlook and closing thoughts
Possum Labs’ experience with exchange mechanisms, staking systems, and composability solutions (Portals V1 & V2, Adapters, Time Rift, Core, and various utility contracts) have prepared us well to embark on the journey to enter the second largest and arguably most important sector of DeFi, decentralised asset exchanges.
The Nexus enables new, creative, and powerful DeFi strategies for liquidity providers and developers. It features the simplicity, composability and credible neutrality that are the basis for strong network effects — the things that have made DeFi great in the first place.
This is an exciting step towards the continuous expansion of the Possum ecosystem. The Nexus will serve as a cornerstone for PSM’s utility and future products.
Stay tuned for more!
More to come
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