The ICON Defi Guide: Part 5— Stable Asset Trading and the Equality Exchange
In the last chapter, we looked at the “automated market makers” (AMMs) that operate on ICON.
AMMs work great for exchanging assets that trade at different prices. But what about assets that should — under normal conditions — trade at the same price? The best example of this would be stablecoins, but it could also apply to assets that aren’t stablecoins but should theoretically trade at the same price (for example, wrapped versions of bitcoin such as wBTC and renBTC, which exist on Ethereum).
Here’s why utilizing a typical AMM for this sort of transaction isn’t optimal.
Let’s pretend you want to trade $100 in blnUSD (Balanced dollars) for $100 in USDb (Bridge Dollars).
Using a typical AMM, you first have to pay a transaction fee of probably around 0.5%.
So now your $100 blnUSD gets you $99.50 USDb.
But there might also be slippage as well. Let’s pretend slippage is also 0.5%.
Now our trade for $100 gets us $99. So we lost out on a dollar. Kind of a bummer, but maybe not a huge deal.
But imagine if we were trading $10,000 of one stablecoin for $10,000 of another. Under that same scenario, you’d be getting $9,900 back. And since we’re trading way more than $100, the slippage would likely be even higher, making that $9,900 an optimistic return.
So one trade just cost you $100.
Seems pretty unreasonable, right?
What is Curve?
Curve is an automated market maker that was built to solve this problem.
It does this in two ways. First, Curve charges very low transaction fees — only 0.04% (more than 10x lower than our example above).
It also employs an algorithm — called the StableSwap invariant —along with a number of incentives to attract significant liquidity, in order to significantly reduce price slippage.
It does this through something called a “rebalancing fee,” which is used to keep the correct balance in the pool.
Let’s pretend we have a pool of blnUSD and USDb, and it’s set at a ratio of 50/50 of each.
Someone decides they want to trade some of their blnUSD for USDb.
As a result, there is now more blnUSD in the pool than USDb, meaning the pool is out of balance.
As a result, a rebalancing fee is now applied to those who want to swap their tokens. Accordingly, if the pool is out of balance (with more blnUSD than USDb), trading blnUSD for USDb will now be slightly more expensive. Inversely, if you wanted to exchange your USDb for blnUSD (thus restoring balance to the pool), you’d be getting a slightly cheaper price.
As a result of this dance, the pool fairly quickly arrives back at it’s 50/50 balance.
What’s also important to ensure minimal slippage is incentivizing significant liquidity within the pools.
Curve does this in a couple of ways.
First, transaction fees are passed along to those who provide liquidity. This is fairly standard for most (if not all) AMMs.
Second — and this is where it gets interesting — is the fact that users can earn additional interest when pools deposit their assets onto other DeFi lending protocols. In the case of Curve, this includes protocols such as Compound or Aave. So not only are users earning a return on their tokens via a lending platform (which they may have planned to do anyway), but they’re also earning transaction fees from the trades happening on Curve.
But there’s yet another added incentive as well when you consider the chance of impermanent loss is basically non-existant. Remember, impermanent loss happens when the value of the assets in the pairs changes significantly over time.
However, since these liquidity pools include assets with stable prices that are built toward incentivizing equilibrium, it’s basically impossible for impermanent loss to occur as long as the protocol operates as it should.
So, those who are holding stablecoins now have three reasons why they’d want to provide liquidity:
- A share of protocol transaction fees.
- Interest on your stablecoins via lending protocols (for example, the Curve pool that utilizes Compound currently earns a bit over 7% APY)
- Minimal risk of impermanent loss
Curve has been a tremendously helpful asset for the Ethereum DeFi ecosystem and is currently ranked 4th overall according to DeFi Pulse when it comes to total value locked with about $4 billion (as of this writing).
For a helpful explainer video on Curve, be sure to watch “How Curve.fi works” from DeFi Weekly:
Fortunately, the Equality Exchange will bring a protocol to ICON that operates very similarly to Curve.
What is Equality Exchange?
From a design perspective, Equality Exchange operates in basically the same manner as described above. From its inception, it will utilize the OMM protocol (which we discussed in a previous chapter) to offer additional APY for liquidity providers, but can expand to other protocols in the future to add more options for those providing liquidity.
However, there’s even an additional incentive for liquidity providers beyond the three described above: liquidity owners will also receive Equality (EQU) tokens proportional to the amount of liquidity they’ve provided for the protocol.
Equality tokens offer governance rights over the protocol, meaning token holders can weigh in on what pools to add in the future, what the transaction fee should be set at, and other similar decisions.
In addition, on top of the protocol transaction fees, Equality will also charge a small administrative fee of 0.02% (similar to Curve). These fees will be sent to a DAO fund, which can be utilized as Equality token holders see fit.
So we know that this protocol will specialize in the exchange of stable assets. But isn’t that kind of boring? What’s the point of being able to do that?
Let’s take a look at why ICONists might find this particularly useful.
First, let’s take a look at the liquidity side of things.
Presumably, there are going to be a lot of ICONists utilizing the Balanced platform. When doing so, you’ll mint blnUSD. So while your ICX is locked up, you’ll have a pile of stablecoins. What should you do with them?
Well, presumably, a lot of you would probably be planning to lend them out on OMM.
With Equality, you still can. Except you can do so in a manner that allows you to also earn a slice of transaction fees. Oh, and you’ll also earn Equality tokens. And without impermanent loss. As a result, there’s tremendous value in using your blnUSD to provide liquidity.
Beyond that is an element of diversification as well. Lets say 100% of your stablecoin portofolio is in blnUSD. You can take that 100% and deposit it into Equality as liquidity. However, when you withdraw, you can withdraw an amount that is equivalent to the breakdown of the pool. So, for instance, of the pool was 50% blnUSD and 50% USDb, you could deposit 100% of blnUSD, but you could withdraw 50% of each. While it’s unlikely that something catastrophic would happen to a stablecoin, that risk still does exist (just think about the concern about Tether that has been floating around for years). From that standpoint, Equality offers a nice and easy way to diversify (while of course also receiving all the underlying benefits of providing liquidity).
Now what about the trading side of the equation?
Well, first of all, as a result of the “rebalancing fee” built into the protocol, there is likely to be a number of opportunities for arbitrage trading.
As described above, is the pool is out of balance in one direction, selling tokens that are undersupplied within the pool will mean you can sell a dollar for slightly more than a dollar, ensuring instant profit. And with such low trading fees, the fee won’t cut into a large chunk of the profit like it might on another exchange.
Beyond the ability to make money is simply the convenience of being able to easily move in between stablecoins without eating away at their value.
Let’s pretend you own $1,000 blnUSD. You notice that blnUSD is currently earning 3% interest on the Open Money Market (OMM) protocol. However, you also notice that USDb is earning 5%, perhaps because the supply of USDb on OMM is lower. So the obvious move would be to convert some or all of your blnUSD holdings into USDb.
Thanks to the Equality Exchange, that’s as easy as a couple clicks of a button.
By now you’ve probably realized the benefits of using the Equality Exchange, whether you’re a liquidity provider, a trader, or both.
The benefits of depositing your stablecoins into Equality are significant — significant enough where I anticipate that the vast majority of stablecoin (or other similarly priced assets) supply will simply be used to provide liquidity within the Equality Exchange.
You may immediately think “But what about those who would want to lend out their tokens on OMM?”. Well, remember, if you use Equality, you’re doing that anyway. So you essentially get two bites at the apple: you’re still earning interest via OMM, but also getting a slice of transaction fees, plus Equality tokens.
But if you think even bigger, you can start to see how much activity Equality could generate when ICON’s blockchain transfer protocol (BTP) comes online later this year. Thanks to cross-chain capabilities, a number of stablecoins could flood into the ICON ecosystem, making Equality even more useful — and possibly more lucrative if you’re providing liquidity.
Just like any other DeFi platform (or smart contract in general), there are risks involved. In order to use the protocol, you’re essentially letting it hold your tokens for you. While the early contributors to the project will be putting the project through an audit prior to release, it’s still important to always recognize that these protocols can never be 100% risk-free.
To get a complete understanding of the Equality Exchange project, I encourage you to read the whitepaper if you want a more complete understanding of how the protocol works.
If you’d like to ask questions about DeFi, discuss strategies, or just have a general discussion, please join us in the ICON DeFi Discussion group I’ve created on Telegram to supplement this guide and build a vibrant DeFi community around ICON.