Sushiswap and the vampire attack
Time for some crypto story telling. It was September 2020. Uniswap was already one of the foundational projects within the DeFi ecosystem. It had more than USD 185 Million locked in the liquidity pools. Sushiswap with its anonymous founder, Chef Nomi, had an idea to unseat Uniswap as the primary decentralized exchange. What followed was one of the pivotal moments for Crypto. The learnings from this episode changed the course of how crypto projects evolved.
This story has everything that would make it into a juicy documentary — drama, suspense, betrayal and finally redemption. So, let’s begin.
But first, what is an Automated Market Maker (AMM).
Uniswap is a decentralized exchange (DEX) that enables users to buy/sell tokens issued on the Ethereum Blockchain. Unlike centralized exchange, the users of a DEX do not rely on a centralized intermediary for clearing of the trade. The DEX’s use a smart contract to facilitate the trade in a non-custodial manner. Also, unlike traditional order book exchanges, Uniswap instead uses an Automated market maker (AMM).
Most AMM’s uses liquidity pools between currency pairs (for example between wETH and USDC) to facilitate trades. Liquidity providers can deposit in this currency pool according to a basic rule — The USD equivalent of both the tokens deposited should be the same. For example, consider a liquidity pool consisting of currency pair –wETH and USDC. x tokens of wETH and y tokens of USDC are provided such their USD equivalent is the same. Assume that the product of x and y will be K. Any transaction henceforth on this liquidity pool should result into a ‘constant product’ K between the quantity of the two tokens.
x * y = K
Now assume a transaction in which a user wants to sell 4 wETH to the pool. This results into an increase in the number of wETH tokens in the pool. Note that the constant product algorithm requires the product of tokens of wETH and USDC to be the same. Therefore, this results into the following
(x+4) * y1 = K
y1 = K/(x+4)
Tokens that seller would receive = y-y1
Any transaction executed on the pool will cause the price to move. This is called the slippage. Higher the liquidity in the pool, lesser is the slippage cost. Contributors to the liquidity pool will earn fees from the transactions executed.
The idea
In September 2020, Uniswap rewarded liquidity provider with transaction fees but it did not have a token of its own. Also, the source code of all these crypto projects including Uniswap is open source. The developers are free to copy the code and start a new project of their own. In common parlance, this is known as ‘Forking’. Chef Nomi, the anonymous founder of SushiSwap saw an opportunity here in forking Uniswap and issuing tokens for the SushiSwap protocol. How he took advantage of this and its aftermath form the core of this story.
The plot — Vampire attack
The liquidity providers get LP tokens against the liquidity provided in Uniswap. This LP token gives the liquidity providers a claim to withdraw the principal tokens provided as liquidity plus the additional fees accrued in the pool. SushiSwap had a novel idea in which they asked the Uniswap liquidity providers to deposit these LP tokens with SushiSwap during the pre-launch period. In return they would start earning SushiSwap tokens. And when the SushiSwap is launched, the protocol will automatically extract liquidity from Uniswap to Sushiswap.
Their idea was to distribute SushiSwap tokens at a very aggressive pace to the liquidity providers. With SushiSwap, the liquidity providers not just earned the transaction fees but also earned SushiSwap tokens. It was very lucrative for the liquidity providers and as a result, it ended up luring away a substantial percentage of Uniswap’s liquidity. This migration of liquidity from Uniswap to SushiSwap is called the Vampire attack. Also, if the Sushi tokens were staked with the protocol then they would earn a part of the trading fee. This reduced the sell pressure on sushi tokens after the launch.
SushiSwap was able to attract liquidity of more than one billion USD within a week. Majority of it by luring the liquidity from Uniswap. It was a big success for SushiSwap.
The betrayal
The story did not end there. The SushiSwap protocol was a fair launch project. It did not have pre-mined coins allocated to the founders or VC’s. However, it had kept aside some development funds in Sushi tokens. Chef Nomi had access to these funds. Sometime during the pre-launch phase, Chef Nomi arbitrarily claimed these Sushiswap tokens and converted them into Ethereum without any discussions or agreement with the community.
This was taken negatively by the community and they lost trust in Chef Nomi. The price of Sushi tokens crashed by more than 50%. Chef Nomi had to transfer the control of the project to Sam Bankman Fried (SBF) of FTX (who by then was already an established name in the crypto community). SBF in turn transferred the control to a multi sig address that was controlled by developers.
After the migration was completed successfully, Chef Nomi apologized for this error in judgement and returned the 14 Million USD worth of ETH. In turn he would accept any fund that the community awards him. Chef Nomi was then no longer associated with the SushiSwap project.
The aftermath
SushiSwap managed to bring competitive pressure on Uniswap. It managed to bring financial incentives to the liquidity providers and users of the Uniswap protocol. Eventually, Uniswap was forced to issue the UNI tokens and soon it regained the top spot among the decentralized exchanges.
And finally, the lessons learnt
Open-source ethos
In open-source, any given problem is solved only once. Thereafter, the developers are free to re-use that code for their own projects. The transparency that comes with open-source helps in building code that is verified and tested by many developers and therefore secure. If the developers feel that they can build a better version of the project then they can always do so by forking the existing project. This competition is very healthy in ensuring that the drive to innovate never ceases.
SushiSwap project had a vision of a better product than Uniswap and within a week it was able to mobilize a team of developers in a decentralized way. It managed to drive liquidity in billions. In many ways, it proved that Crypto was at a point where the community was willing to innovate and willing to experiment.
Crypto projects operate in a highly adversarial environment where the only way to retain user base is to deliver value to the users. Whilst it is easy to fork an existing code base and launch a new token. As a community, it is difficult to launch new features in product that delivers value to the end users in the long run. Uniswap proved this by building multiple upgrades in the past two years and establishing itself as the top decentralized exchange.
But why do we need a token?
Issuing tokens within the protocol gives the community a chance to participate in the growth of the protocol. The economic benefits that can be derived from the protocol drives the innovation in this space and makes founders (with capital) and teams available for further growth.
SushiSwap was able to drive liquidity, users and transaction volumes by offering ownership of the Sushi tokens to the community. Post SushiSwap, issuing a token by a crypto project was an imperative. Most projects began without a token but it was implicit that the project will reward its community with a token at some point in time. Projects that do not reward their communities with tokens — see competitors that do offer tokens. For example, Opensea — an NFT marketplace that does not have plans to issue tokens of its own. This spawned another project ‘Looksrare’ that issued tokens to users of Opensea.
Along with yearn finance, Sushi tokens were also the flagbearers for fair launch tokens. In a fair launch, there are no pre-mined coins. There are no coins allocated to VC’s or founders. All the coins are mined based on a pre-set rule. It is a more egalitarian way of distributing coins as compared to the VC backed projects.
Let’s get decentralized … and avoid regulation??
US has strict regulations on securities instruments that are available to US citizens. A crypto currency is deemed as a security based on a supreme court case of the 1940’s; now commonly known as the ‘Howey test’. Since most of the crypto projects are based out of the US and are available to US citizens, this test becomes very critical for crypto projects.
At a high level ‘Howey test’ considers an investment as security if it meets the following criteria. (1) Investment of money (2) in a common enterprise (3) with expectation of profit (4) to be derived from effort of others
Of all the cryptocurrencies, there is regulatory clarity only on Bitcoin. Bitcoin does not pass the Howey test and therefore classified as commodity by the regulatory body. The argument that works for Bitcoin is that there isn’t a centralized entity that is delivering value to the Bitcoin. By decentralizing ownership amongst the community, crypto projects aim to support a similar argument. Whether the regulators see it in the same way is yet to be seen.
If you are with me till now then you deserve a medal. What do you think, are there any other stories in crypto that have had a long-standing impact? Please let me know.
References
Laura Shin, Nadav Hollander, SushiSwap Takes on Uniswap: Which Should Win and Why?, Sep 2020 [online via https://unchainedpodcast.com, accessed on 12th Aug 2022]
William Foxley, Fishy Business: What Happened to $1.2B DeFi Protocol SushiSwap Over the Weekend, Sep 2020[online via https://www.coindesk.com, accessed on 12th Aug 2022]
Hasu, Ryan Sean Adams, David Hoffman, How to Fix DeFi Tokens, Aug 2022 [online via https://shows.banklesshq.com, accessed on 12th Aug 2022]
Paul Kim, The Howey test: A set of rules that determine if an investment is a security, May 2022 [online via https://www.businessinsider.com, accessed on 12th Aug 2022]
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