The DEX Brief No. 10

Top of mind at Shipyard:

Crypto winter may have arrived, and the smart money is shifting their focus to fundamentals. But what are the fundamentals? In the case of DEXs, the smart money seems to disagree. Are valuations based on TVL? Volume? Fees? At Shipyard we believe that common sense will prevail, and call us crazy, but common sense seems pretty clear.

The income statement for a DEX is pretty simple: 

1. To get Revenue, multiply $ Volume by % Fees. 
2. To get Costs, multiply $TVL by the sum of the market cost of capital plus the Impermanent Loss Rate, because LPs will only provide liquidity if their total cost of capital is covered including impermanent loss.
3. Then get DAO Profit by subtracting (b) from (a).

This framework has a few obvious implications:

1. Volume is a pretty poor proxy for performance if fees are low. If you can observe Revenue ($ Fees) directly, it’s a much more fundamental indicator. The market is mature enough that this is easily observable on Tokenterminal.com.
2. Contrary to popular opinion, TVL is a bad thing. Sure, in first generation DEX designs like the CPMM it may be an indicator of better prices, but a second generation of exchanges like Clipper has proven that isn’t necessarily true. Meanwhile, all else equal, more TVL means higher cost of capital for the protocol (not to mention diluted yields for other LPs). So, TVL is actually a misleading indicator.
3. Impermanent Loss is what really matters, because the protocol needs to make it up to LPs to keep attracting their capital. It can be paid in higher fees or in the protocol’s native token, but either way it’s an expense. For example, Bancor reimburses LPs for impermanent loss with it’s native token and calls it “IL Protection”. Again, the protocol needs to offset Impermanent Loss, otherwise LPs won’t invest.
4. Profit needs to be positive for the DEX to persist. Precise profit metrics aren’t yet mature enough to compare protocols, but it’s pretty obvious when a DEX is unprofitable, and that’s a bad thing.

The common sense is pretty clear. Today, $Fees are the best fundamental indicator, and analysts should focus on multiples. Meanwhile, protocols probably need 15%+ Yield to cover cost of capital and Impermanent Loss. Fortunately, you can observe this directly at tokenterminal.com. Unfortunately, almost all DEXs yield under 15%, meaning they are likely unprofitable and may spiral as LPs better understand Impermanent Loss and as their tokens continue dropping in value.

We’re proud that Clipper has 5x better yield than other DEXs (70% as of our last measure on June 15th), which means it just makes common sense. Here’s an in depth blog post on the topic, and here’s where you can provide liquidity.

Shipyard Insights:

Nasdaq recently published this article by Mark that argues that despite recent market stumbles, crypto is not just a promising alternative investment – it’s a rejection of the unbalanced focus on a handful of legacy asset classes. Every generation has its unique economic challenges and opportunities, and in a global economy that is increasingly unequal, younger investors may face the greatest risk by doing nothing.

CoinDesk tapped Mark to provide commentary for how DeFi apps have avoided massive on-chain liquidations, surprises or smart contract failures, even as crypto markets and centralized exchanges have shed value. While it’s likely too late to avoid an economic downturn, the recent crypto downturn may actually be a sign of crypto's maturation.

NFTs are so much more than digital art, and while you hear that a lot from degens and retail traders, it's rare to hear the arguments laid out by an experienced hedge fund manager running one of the world's most successful investment firms. So where do these NFTs get their prices? Why are they valuable? And how does smart money trade them? Tune in to the latest episode of WTF, Crypto to find out.

Payments have always been at the core of the crypto narrative, even though in reality very few people actually pay for real-world products and services in crypto. In this episode of WTF, Crypto we dig into the promise, the hype, and the reality of how crypto will be used for payments in the future. 

DEX headlines that caught our attention:

• Uniswap acquires NFT marketplace aggregator Genie in a push to expand into NFT trading.
• 01 Exchange launches ZAMM, a novel DeFi primitive that brings AMM-like passive liquidity to order book-based derivative markets.
• Binance Labs makes a strategic investment in PancakeSwap via its utility/governance token, $CAKE.
• Wintermute launches Bebop, a multi-functional DEX focused on streamlined user experience and execution in DeFi.
• Bancor’s Impermanent Loss Protection has been temporarily paused, with plans to reactivate it once the market stabilizes.

What we're reading:

Since the launch of Uniswap v3, there has been debate about whether v3 fee returns “passive” (non-rebalancing) are lower than v2 returns, which do not allow rebalancing. Recently, Uniswap released an in-depth report that definitively breaks down when Uniswap v3 returns more fees for LPs by quantifying the historical fee accruals on non-actively managed liquidity positions on Uniswap v2 and v3. 

(Note: while Clipper’s LP fees are significantly higher than most major DEXs, including Uniswap, we found their analysis extremely educational and honest and love seeing improvements in this space.)

This interesting study analyzes multiple DEX swap interfaces and user experiences to better understand the existing DeFi landscape. The swap interface is one of the most common components for DeFi applications, and the authors wanted to deconstruct the essential components of this common interface in order to inform novel designs and interactions. Check it out!

Clipper Product Updates:

Clipper’s new liquidity pool is now open for deposits!

Clipper’s liquidity providers have been able to capture some AMAZING LP yields, and we’re excited to announce that Clipper’s community liquidity pool is now open for more deposits! How much can Clipper LPs earn? Well for starters, Clipper’s LP fee APR weighed in at a whopping 71.2% as of June 15th, 2022! That’s roughly 5x higher than that of other leading DEXs according to TokenTerminal.com. 

(Note: Clipper LP deposits are capped, but users who want to receive an additional LP allocation can now apply to be a Clipper Sponsor!)

Clipper recently surpassed $1 billion in trading volume! This comes out to an impressive $4.3b in annualized trading volume and $11m in annualized revenue as of June 24, 2022. The fact that Clipper was running smoothly with only $11m in TVL when we passed $1b in trading volume makes this accomplishment even more impressive.

‍The Spirits of Clipper Coves unlocked a new Clipper product! Clipper’s second Adventure gave community members early access to Clipper Coves, an exciting new Clipper product that offers low-fee trades between any token pairs on Polygon and Moonbeam. In the end, 13,153 tenacious pirates rose to the occasion and were the first to breach the shores of Clipper Coves.