Economic Efficiency as the Killer Feature of Dotsama — amsterDOT HydraDX Recap
Recap of the amsterDOT conference talk by Jakub Gregus, co-founder of HydraDX and venture partner at ZeePrime capital.
Jakub Gregus: Economic efficiency is essential, and we’d like to discuss why it is a fundamental killer feature on Polkadot and how HydraDX will push forward this super important parameter. Because at the end of the day, dApps or crypto projects are still just some businesses that need to provide value for the end-users, and they have some costs for delivering this value and enabling their use-cases.
My journey into Polkadot started in 2018. I was super curious if Polkadot was dead or not after the notorious multisig hack happened. We formed Zee Prime capital, which is not an average VC firm, and we have been supporting the Dotsama ecosystem since 2019.
I was pretty deep into DeFi, and I was delighted that tokens finally started to make sense. Crazy things like AMM can be turned into centralized exchanges in the future. I was curious why no one is putting all assets into just one pool, not using bonding curves and other fancy buzzwords to scale liquidity. Liquidity was super important at that time because Bitcoin maxis were promising us that Lighting Network would kill all altcoins and all payment providers. I was playing with it when I realized that Lightning Network isn’t failing because of the tech. The tech is good; it’s written in Rust, and it is secure, but it’s failing because of liquidity, and it strikes me,
“Oh, maybe someone needs should aggregate as much liquidity as possible to just one beefy pool.”
So, today’s topic will be about the security budget, which is a pretty notorious topic in the crypto space. What are the costs for the current liquidity? I will wrap up all this together.
Security Budget
Security budget is the necessary cost for making any chain and its L2 tools on top of it. Unfortunately, It’s usually in the form of inflationary rewards. Proof-of-Work miners need to dump most of their earnings to cover their operational costs, and it is the same for Proof-of-Stake validators. Anyway, there is a reasonable price for the security. It differs; for example, the front-run on Bitcoin is lowering its inflation, so we are going from like 1% to 10% of total supply on different networks. It depends on how attractive it is to operate these networks and how much value they are securing on top of them.
Why did we choose Polkadot?
We were analyzing the first AMMS in early 2020. There was a super promising project called THORChain. They have a lot of cool ideas, and we deeply respect the project; it’s a great project. What strikes me is that they are using something they call an Incentive Pendulum to move the rewards, which are also currently inflationary between security providers, who are also the validator nodes, and liquidity providers, who are providing liquidity.
If you want to be sure that 100 Bitcoins on THORChain is safe, that needs to be staked at least two times more on the validator nodes. When more and more liquidity pools are providing liquidity, it’s starting to be a pretty dangerous area where 100 validators can think about making a very profitable rug pool. That’s not what you want in the network.
The current stats about the economic power of Thorchain and Rune: the market cap is 2.5 billion, which is very nice, and more than 60 percent supply of tokens is already distributed. There are still many tokens to be distributed, but what if you can use a more extensive network that can flex bigger muscles for securing? Instead of dealing with security and all these issues, you focus on your product.
We have to think about security a lot. What if an attacker does something terrible, and it will be on our balance sheet. This loss will be on our balance sheet, so yeah, that’s why we choose Polkadot, and we get eight times more security of THORChain for just 2.5% of supply for one year. Eventually, HydraDX will be acquiring these tokens via bonds programs, and the DOT tokens needed for the crowdloan will never leave the Omnipool. The shared security will be almost for free.
How can you scale trust in the adversarial environment in which the crypto industry is being right now? Unfortunately, it’s pretty harsh these days.
For example, even if projects are taking care of their reputation and are not being very bad to the community, they overthink in the short term. You can secure your code with the audits, and even after two or three audits, users could experience some bugs. Reputation is not a solution, and we should rely on trustless solutions. Unfortunately, most bridges are trusted solutions and depend significantly on the Infura.
Polkadot has light client verifier
You don’t need to rely on the Infura, and you can use something like Polkadot and some light client friendliness and make sure that it costs a lot of money to break your system or infrastructure.
Costs for liquidity
Proof-of-stake networks promise to offer much better UX and services with much lower fees. Most of the projects are starting to realize now that it is not for free, and they need to invest a lot in the infrastructure.
One of the crucial parts of the life cycle of any crypto project is token. Token was to contact professional and centralized market makers and offer them enough money to provide liquidity in order books. It usually costs some percent of the supply of the tokens. Also, they were requesting from projects Bitcoins or stablecoins that they raised, and it can’t be done in a trustless way, and it costs a lot of money. Then Uniswap and Balancer changed the game, which was needed, and DeFi summer was kick-started by liquidity mining incentives from Compound. Actually, the first right liquidity mining incentives were pulled out by Synthetix.
There are also additional costs for having liquidity and being very liquid in MEV and other arbitrage wars lurking in the dark forest of Ethereum and other blockchains. They will always try to extract as much from your trades. Also, do not forget that when you need liquidity most during very turbulent times on crypto markets, liquidity is much more expensive because of slippage and fees. All of this is causing issues with Ethereum DeFi all the time.
Liquidity incentives are great inventions. They are working, but the harsh truth about liquidity incentives is that they lead to providing much more liquidity than is needed.
In the following image, you can see that when you see that TVL is much higher compared to trading volume. Even if you need to swap 10 million USDC, you don’t need to have billions of liquidity.
There are also other funny or less funny shortcomings of liquidity incentives. For example, one proprietary trading company took an uncollateralized loan from the provider Maple Finance. They used that money for free to farm the tokens for further dumping on their holders. You can find the detailed on-chain research on Cryptocat’s blog.
The Money Printer go brrrrr
In two years, the most famous meme was the Money Printer; the central bankers were trying very hard to save the economy, and anarcho-capitalists were freaking out:
“No, you can’t really inflate and just bring the money.”
The helicopter money for US citizens was used for buying crypto, which ended up pretty well at that time. Still, now we see double digits inflation, and poor people who are sensitive to the cost of food and energy are pretty much suffering.
Crypto projects are not different from the central banks
The sad part about crypto is that crypto projects are not much different from the central bankers. There is no intention to dunk on Curve Finance as they have excellent documentation, and everything is transparent, which is not common in crypto.
It is a perfect example; next year, it will be inflated by about 50% of the current supply.
This is no exception in crypto. There are hundreds and hundreds of projects like that that will be unlocking a crazy amount of supply. Can devs do something? Yeah, of course, they can put staking on it and give you more rewards which you can dump later.
Please don’t ask me why every project has enormous incentives for liquidity mining in the first two weeks. Then it’s dropping after Justin Sun and other whales lurking in the liquidity minings and then moving away and dumping tokens on your head.
How can Omnipool and HydraDX living on Polkadot save the day?
The promise of Omnipool is at least scientifically proven. We will see if it practically will be working as well. We don’t want to be a Cardano of AMMs.
The point of this graph is the blue line that’s Omnipool, and every line represents how the slippage is bigger and bigger for the same trade size when you add more pairs.
So what does it mean?
If you compare one static pair on classic AMM, let’s say USDC and USDT will be sitting in HydraDX, we will have more slippage, but the Devil is hidden in the details. When you start to add other assets to that one, let’s say we have 10 million of them in Omnipool, and we will add ETH, aUSD, DOT, KSM, and Bitcoins to Omnipool. Now we have pairs with lots of tokens, and it doesn’t need to be broken and scattered to an infinite amount of pools, as you can see on other AMMs. That means that utilizing a much smaller portion of liquidity is much more reasonable.
To sum up
Other parachains will be acquiring shared security from Polkadot, and it would be cool if they would be offering a lower and lower amount of tokens. Not for the sake of being greedy but for scarcity and monetary premiums because who will be buying all these tokens? If there is a community that cares about you like ours, for example. They will help you, and at the end of the day, as there will be a much smaller stream of tokens, then maybe miracles will start to happen.
Avoid trusted solutions
Also, it would be best if you avoid trusted solutions. Hopefully, more bridges will go live soon on Polkadot, and we will enjoy much weaker security assumptions, and there will be much fewer bugs than we could see in previous months on bridges.
If you care about the liquidity of your token and you are just starting the project, you should use Basilisk. We will tell you how Basilisk will be connected to HydraDX in a much more automatic way. If you’re running an already existing project with decent liquidity, our community will see that you are legit builders. You should consider Omnipool as soon as it is possible.
Also, our liquidity mining palette is designed in a way that increases rewards over time. So you will be rewarding your long-term believers and your diamond hands much more than whales who are just coming with their billions and then going away.
In the future, or if you are an aspiring Derivator considering building some powerful derivatives which are offering impossible yields, you should consider building them on top of HydraDX and their heads as we were touching how liquidity is very expensive in the times when it’s a more needed one.
The most remarkable Substrate feature
The most remarkable Substrate feature, which is not super well known, is that you can have different routes for the transactions in mempool, so we will be allowing the liquidation transactions with priority in the main pool. You can’t get this on any generalized smart contract platform. The liquidity will always be there, and that collateral will be liquidated with the liquidity of HydraDX liquidity providers, so we don’t need to extract as much value from your collateral.
You will save more money, and if you are degen, then Basilisk and HydraDX will have a much more reliable and advanced execution environment. Please think about economics much more and don’t support super inflationary money printers and other projects, and stay hydrated and not liquidated.
About HydraDX
HydraDX is a natural swap solution for all assets built on Substrate and in the fast-growing Polkadot ecosystem — a place to bootstrap liquidity. The unique solution enables putting all assets into one shared liquidity pool — unlocking unparalleled efficiency. HydraDX is designed to communicate with other networks. Ethereum based assets will be ultimately liquid on HydraDX.
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