The Crypto Insider Report #3: How profitable it is to provide USDC/STANDARD liquidity
Disclaimer: Everything we write in "The Crypto Insider" newsletter is an x-ray of the industry as we see it, through the lens of publicly available information. We are not financial advisors.
In the previous newsletter, we presented the STANDARD/USDC pool on SushiSwap and the related operations: anyone can swap between the two currencies or add liquidity to the pool, receiving in exchange an SLP (Sushi LP) token, proportional to % of the pool held, which can be added to rewards in the StakeborgDAO farming pools. For those interested in measuring the benefits and costs of participating in the liquidity of a pool, we have put together an analysis framework.
The ultimate goal is to see the benefits (measurable in USD) that we would get after a certain time if we provide liquidity to the pool (and, importantly!, we farm the SLP tokens, the two actions will have to be done consecutively) vs. the case in which we would choose to HODL. On the cost side, we will look at the explicit costs with the gas fees associated with the different operations.
A framework involves setting a situation, parameters, and a series of assumptions:
As a starting point, let’s consider last night's pool (November 14th) with a total liquidity of $1.15 million, divided into $576,016 $USDC and 32,796 $STANDARD.
We assume the case of a user who wants to add $1,000 liquidity to the pool (after fees), divided into $500 $USDC and $500 in $STANDARD. In exchange for this action, the user receives SLP tokens which represent 0.09% of the total pool because they will hold 0.09% of the liquidity in the pool.
The user is considering keeping the liquidity in the pool for 4 weeks.
During this time, the liquidity in the pool is, of course, liquid. Other users can add or remove liquidity from the LP, while others may come for inter-exchange operations between USDC and STANDARD, thus altering the number of tokens in the pool.
For ease of calculation, let’s suppose that all the add/remove liquidity and swap orders happen immediately after the user adds liquidity, in this order. Otherwise, we would enter a realm of endless possibilities related to the timing of the different actions, their amount at each moment, while the rewards in the SLP farming would be variable. From the perspective of the last element, this assumption is slightly conservative in some cases.
Being a value-maximizing and rational investor, the user will seek to maximize the opportunity and farm the amount of SLP, obtaining a proportion of the weekly rewards of 19,200. As a result of other users adding/removing liquidity, the % of the SLP held will decrease/increase.
For 4 weeks, the user will accumulate the farming rewards in STANDARD, without claiming them.
Finally, we compared the value of the portfolio vs. HODLing the respective amounts of USDC and STANDARD (see the table below).
The actions presented above involve some interactions with smart contracts that involve the payment of gas fees. There will be gas fees associated with adding liquidity to the pool, farming SLP, removing SLP from farming, and withdrawing liquidity.
The gas fees were estimated using the average of the gas units used per transaction (supply and remove liquidity) on SushiSwap and a volume-weighted gas price for the last 7 days (152.6 gwei). For stake and unstake, we considered the average of gas units from the explanatory video on StakeborgDAO YT. The total gas fees considered were c.$625 (at an ETH price of $4,700). Let us remember that this number is an average and varies significantly, influenced by the gas price at a given time (e.g., yesterday, the cost of adding liquidity was $40 vs. $185 on average). In case, at the time of the operations, the gas price would be 70 gwei, then the total fees would be $286.
We have aggregated the results of these operations in the following table, which presents several potential situations in which the liquidity in the pool undergoes changes between -$300,000 and +$300,000, and the totality of buy / sell orders in the pool has a similar range. The numbers in the white cells, at the intersection of the two situations, represent the difference between the value of the portfolio after 4 weeks of liquidity provision + SLP token farming vs. the value of the portfolio in the case of HODL.
We can interpret the results as follows:
In general, adding liquidity to the pool leads to a decrease in the share of SLP held and, implicitly, to a decrease in the rewards received weekly (the assumption is that all those who will provide liquidity will farm the SLP).
A significant sale of STANDARD from the pool affects the yield because it will lead to a decrease in the $STANDARD price, and at the same time (1), a decrease in the value of the rewards in the farm, and (2) upon withdrawal, the user would be entitled to more STANDARD and less USDC as a share of the pool vs. the initial situation / HODL case. It can be seen that in the case of total net sales of $200,000 worth of STANDARD, the investment becomes less attractive vs. HODL. In the case of a longer time horizon (of 8 weeks), the rewards received from farming would help the balance tilt in several cases towards investing in the pool.
Potential results after 4 weeks:
Potential results after 8 weeks:
Considering the rewards in this phase of the project, I am convinced that this analysis model will be useful if you think of participating in the LP on SushiSwap. And we hope you do it because greater liquidity in the pool means a more stable route for our dear $STANDARD.
Razvan
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The first steps in crypto:
What Are Layer-2 Solutions and How Do They Work?
Although blockchain technology ensures a variety of benefits, ranging from decentralization to high levels of security, it is still facing scalability issues. To reduce congestion, improve scalability, and increase security, various scaling solutions have emerged.
The two primary methodologies for achieving such results are Layer-1 and Layer-2 solutions. To recap, Layer-1 solutions improve the base protocol itself, while Layer-2 solutions are networks or technologies that work on top of an existing blockchain protocol to improve scalability and efficiency.
Layer-2 scaling solutions increase throughput and do so without tampering with any of the original security or decentralization characteristics that are integral to the original blockchain.
Simply put, they take a portion of a Level-1 blockchain’s transactional burden and shift it to another system architecture. The Layer-2 blockchain will then handle the processing load and report to the main blockchain for result finalization.
Since much of the data processing is shifted to this adjacent architecture, the Layer-1 blockchain becomes less congested, which improves scalability. For example, Bitcoin is a Layer-1 network, and the Lightning Network is a Layer-2 solution that was built to improve transaction speeds on the Bitcoin network.
Types of Layer-2 Solutions
Some of the most common Layer-2 solutions include the following:
Nested Blockchains
Such a chain is a blockchain built atop another blockchain. The nested blockchain architecture usually involves a base blockchain that lays down the ground rules for a broader network, while executions are carried out on an interconnected web of secondary chains. Several levels of blockchains can sit on top of the main chain, being connected to each other to form a parent-child chain connection. The way they work is rather simple, as the parent chain delegates work to child chains that process and return it to the parent once it is completed.
For example, the OMG Plasma project is a Layer-2 nested blockchain infrastructure that is used atop the Layer-1 Ethereum protocol in order to facilitate not only faster but also cheaper transactions.
State Channels & Payment Channels
State channels enable two-way communication between a blockchain and off-chain transactional channels. By using multi-signature or smart contracts, they make it possible for users to quickly and easily transact off-chain. When the entire transaction set is completed on a state channel, the final state of the channel is added to the underlying blockchain.
While this type of channel can handle more complex interactions, payment channels are used, as the name suggests, for payments between two participants. One of their advantages is the high transaction throughput at a very low cost. Ethereum’s Raiden Network is a popular state channel solution.
Sidechains
Considered a hybrid between Layer-1 and Layer-2 solutions, sidechains are separate blockchains that have their own consensus mechanism and block parameters. They run parallel to the main blockchain and act as an extension to it, compatibility being achieved through a two-way bridge. They are used for large batch transactions, with the mainchain confirming batched transaction records and maintaining overall security. For example, xDai is an Ethereum sidechain that ensures 5-second block times and low gas prices.
Rollups
These L2 solutions roll up sidechain transactions into a single transaction. They then generate a cryptographic proof, which is known as a SNARK (succinct non-interactive argument of knowledge) that is submitted to the base layer. In this case, sidechains handle all transaction state and execution. There are two main types of rollups, namely, zero-knowledge and optimistic rollups.
Conclusions
With scalability seen by many as the greatest obstacle to mainstream adoption of cryptocurrencies, it is only natural to look for solutions that solve it. Layer-2 blockchain solutions are among them. They are secondary frameworks or protocols that are built on top of an existing blockchain and operate without tampering with the base layer protocol.
By performing a great portion of the work that would be performed by the main chain, they ensure high throughput, reaching even thousands of transactions per second. L2 solutions enable micro-transactions and low fees. Moreover, the way they were designed also improves speed as users don’t have to waste time on miner verification.
However, they are not free of limitations. For example, while plasma chains ensure high throughput and low costs per transaction, they only allow for basic transactions, such as swaps and token transfers.
Animation of the day: What is token minting?
Tania
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The Altcoin Pulse
1. Wrapped USDC is the first stablecoin going live on Elrond Network and MEX. In other news, the starting price for $MEX will be equivalent to 1,000,000 $MEX = 0.63 $EGLD.
2. The equivalent of $4.5bn in LUNA tokens will be burned and swapped for UST.
https://www.cryptopolitan.com/terra-will-burn-luna-worth-4-5-billion/
3. Three months after the implementation of EIP-1559, over 800,000 ETH were burned, the daily net ETH issuance was negative for ten days, and the ETH annual inflation is below 1% (measured by 30d moving average).
4. Several future token releases and listings, and other events.
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Interesting Headlines
1. The Taproot upgrade is live, being the first major development since the introduction of Lightning Network and SegWit in 2017. Taproot brings features that improve privacy, security, and sustainability.
2. VanEck's Spot Bitcoin ETF has been rejected by the SEC. Here is how some analysts reacted.
https://blockworks.co/sec-rejects-vanecks-proposed-spot-bitcoin-etf/
3. VanEck will continue with the listing of the third futures-based Bitcoin ETF.
4. Miami announces a smart solution that will entitle city residents to passive dividends in BTC.
5. Two Banksy collections will be auctioned by Sotheby's, with those interested being able to bid in ETH as well.
6. Agoric, a PoS chain that uses secure smart contracts written in JavaScript, raised $32m in funding for launching Phase 0 of the mainnet. Investors include Polychain, DAO Maker, Compound, and MetaStable.
https://www.coindesk.com/business/2021/11/11/smart-contract-platform-agoric-launches-public-chain/
7. Forte, a platform that provides end-to-end blockchain solutions for game developers, has raised $725 million in a Series B funding round. Big names among investors: a16z, Tiger Global, Warner Music Group, Solana Ventures, or Cosmos.
8. Disney is getting ready to board the Metaverse train.
https://www.reuters.com/technology/disney-wants-become-happiest-place-metaverse-2021-11-11/
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Tweet of the week:
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Business book of the week: The cost of these dreams by Wright Thompson. About the costs of big dreams.
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