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Spotlight 🔎
Uniswap
Uniswap V2, the second iteration of the Uniswap protocol, has been deployed to the Ethereum mainnet.
The launch of V2 brings multiple improvements for the liquidity providers (LPs) on the network, which include having greater flexibility with what token pairs they can create (e.g. pure stablecoin pairs) as well as the introduction of flash swaps and a 0.05% protocol fee that might be taken as part of the liquidity provider fee in the future.
The Formally Verified Take
The details of V2 have been extensively covered but there’s an opportunity here to discuss what this really means for Uniswap - particularly with regards to the network’s evolution. In Uniswap’s ‘Path to Sustainability’ post, they explain that this small protocol fee “can be turned on, and directed by, a decentralized governance process deployed after the Uniswap V2 launch”. This gives a glimpse into how Uniswap’s incentive mechanisms are to be remodelled in the coming months but more importantly it speaks to how decentralised networks will eventually become self-governing economic coordinators.
To explain, the introduction of a protocol fee on Uniswap is for one thing only: to incentivise participants (e.g. LPs and traders) to contribute resource or activity to the protocol. Furthermore, the protocol fee percentage will be determined by a Uniswap DAO structure where future governance tokens might give these network participants rights over how the network evolves. This is where things gets interesting.
Uniswap’s governance tokens might only be earned directly through participation of the protocol. To put simply, Uniswap might only be governed by those who are aligned with long-term interest - users can join and actively participate in the network but governance rights accrued are kept only to that user. This is in a similar vein to Compound’s COMP and Futureswap’s FST token where governance tokens are non-transferable. The overall benefit of this SAFG model is that networks can more effectively grow by allowing engaged participants to create value-capture mechanisms for the benefit of the protocol and the participants that contribute as a collective.
Such a model is particularly exciting for Uniswap that has significant DEX market share with LPs seeing their fees increase substantially - a total of $2.4m received in the last 6 months (and growing). Over the same period, the Uniswap DAO would have taken ~$400k worth of fees via protocol fees. These fees could be distributed out to the top Uniswap traders or used partly as an ecosystem fund - decisions that would be collectively made by the very stakeholders that underpin the network.
Conversely, even if the governance tokens become tradable on the secondary market, LPs on Uniswap might be the initial recipient of a sought after token particularly if these tokens represents income-bearing assets of a network that is gaining market share and corresponding LP fees month-on-month.
In time, we will start seeing more experimentation in this area of endogenous network governance and stakeholders becoming ever more responsible at creating and implementing value-capture mechanisms to their respective network.
Quick Takes ⚡️
MakerDAO
Dai liquidity is improving for MakerDAO.
Multi-collateral Dai is moving back to its peg as the total Dai outstanding supply increases and Dai in the DSR decreases.
The Formally Verified Take
The MakerDAO team have been frantically trying to solve a plethora of different liquidity issue in the last few months (check out Formal Verification’s ‘In The Week’ issue last week). With debtors of the system looking to repurchase Dai to pay back their loans after the March 12th events, the Dai price spiked upwards to nearly $1.50. There are a few options that MakerDAO has to fix events like these including the addition of further collateral types (e.g. synthetic bitcoin assets) and lower fees and interest rates.
Now, there seems to be more balance in the Dai system but it has taken extreme parameter changes were made by the community to get there - ETH, BAT, USDC, and the DSR all have 0% rates plus the introduction of centralised WBTC (which 68% of the total supply is now backing ~9.5m Dai).
An area of concern is how sustainable the current system stability is. For example, Nexo borrowed Dai against WBTC due to the marginal spread from their platform and Maker. But how long can we reasonably expect the WBTC stability fee to stay at 1% or possibly have a future rate of 0%? MakerDAO now needs organic interest from users wanting to become indebted in the system, especially if the community want to ward off the (bold) introduction of negative interest rates in the system.
UMA
UMA Project creates its first “priceless” synthetic coin.
The UMA Project community approved the first token on its platform, ETHBTC, which tracks the value of ETH to BTC. The token uses a priceless token model which minimises the role of oracles in the asset’s lifecycle. The ETHBTC token was met with high demand with it trading 30% premium to NAV.
The Formally Verified Take
Unlike other synthetic models in DeFi that rely on on-chain price feeds that maintain collateralised positions (e.g. tBTC, Synthetix), priceless token models only rely on oracles in the event of a liquidation dispute. In a dispute, UMA governance participants are rewarded in UMA tokens if they vote for the winning side (sound familiar?). The interesting thing here is that for the system to be secure, the cost of corruption has to always be higher than the profit of corruption. However, if costs are measured in buying 51% of UMA tokens on the market (spoiler alert - it is), the scalability of the network is directly reliant on the value growth of UMA tokens.
To achieve that growth, the network has a fee taxation system where it performs a buy-back of UMA where it is burned. But it is very much uncertain whether this pure buy-back model will offset inflationary rewards or necessarily lead to direct value appreciation that is so crucially needed for the system to work (as other DeFi projects evolve away from this model).
Hegic
Hegic was shutdown (again) after a design flaw that was exploited.
Hegic is an on-chain options protocol on Ethereum that allows users to pool liquidity to underwrite options from buyers. These LPs were free to withdraw their liquidity at any point, relieving themselves from any downside while the other LPs carry the same underwriting risk with pre-existing options. An LP then exploited the flaw by providing liquidity early, accruing revenue and removing liquidity (with revenues) just before the exercising of options.
The Formally Verified Take
Crucially, this highlights the importance of effective network incentive design. Sometimes it takes testing in the wild to expose some critical vulnerabilities - if it can be economically gamed, it will. Clearly in this case, LPs experienced no lockup and premiums were being paid before the expiration of the options allowing for the exploit to occur.
More generally, decentralised option models have become a focal point recently with the emergence of multiple decentralised option platforms, such as Opyn built on the Convexity Protocol. But option platforms within DeFi have so far struggled - security issues were recently found with Hegic in an audit report. With full collateral requirements, code risk, and manual contract exercising all being commonplace, it might take time for clear benefits to shine through for decentralised option platforms against their more centralised counterparts.
tBTC
tBTC admins triggered the 10-day emergency pause for new deposits due to a smart contract bug.
To participate in the minting of tBTC, signers need to put down ETH bonds that are worth 150% of the BTC value deposited. On May 18th, the tBTC team noticed they were unable to redeem their tBTC due to the token contract not recognising p2sh Bitcoin addresses. Moreover, the code also allowed for a malicious redeemer to specify an output script that would always invalidate the bitcoin transactions. The redemption process could not be fulfilled correctly meaning the ETH signer bonds were at risk of being seized by the protocol (after 6 hours). The issue could not be solved outside the smart contracts themselves, resulting in the team initiating the pause.
The Formally Verified Take
This is what you need to know. In the following weeks, tBTC will open up again for users but the KEEP team are shifting completely to a release candidate strategy where the tBTC cap will increase every month no vulnerability is found in the smart contracts. Importantly, the team have the ability to push a new emergency deposit pause once for every version of the network. After 5 months with no vulnerabilities, there will be no cap and only until 12 months of no incident can the pause button be disabled.
Ideology aside, we shouldn’t be surprised that temporary admin keys are favourable during a launch phase of a network. Smart contracts are extremely hard but given the future demand for synthetic assets in DeFi and the potential locked value needed in creating them trustlessly, they are incredibly exciting endeavours but all the more important to get absolutely right.
See here for Formal Verification’s deep dive on tBTC
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Formal Verification research is not investment advice and is strictly for informational purposes only. Always conduct your own research.