tl;dr: (1) Uniswap v3 + (2) Serum + (3) Solana = Cyclos = (1) concentrated liquidity and a familiar UX + (2) bootstrapped price finding and volumes + (3) positive sum interactions
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Introducing the building blocks of Cyclos
On a basic level, Cyclos can be understood as an overlay service on top of Serum, bringing the familiar constant product market making (CPMM) AMM experience to the Solana DeFi ecosystem. Unlike existing solutions, it does so while enabling concentrated liquidity.
Another way to get a basic understanding is to think of Cyclos as marrying Uniswap v3 with the Solana-based Serum DEX. Coherently, the value proposition of Cyclos centers around positive sum interactions, consistent with the overall DeFi ethos of leveraging existing infrastructure and rearranging these building blocks in new, value-adding ways. No reinventing of wheels, but a pie-expanding, positive sum mentality.
In line with this logic, Cyclos identifies and builds upon the strengths of various building blocks:
- Among these strengths is efficient order execution. Historically, CPMM AMMs distributed capital evenly along an x*y=k price curve, from zero to infinity.
As such, (i) most capital is unused, (ii) trades involve high slippage, and it is (iii) difficult to attract sufficient capital to enable competitive trade executions. This is particularly problematic, as liquidity providers (LPs) typically earn rewards per facilitated trade (i.e. when their liquidity is involved in executing an order).
→ Cyclos utilizes concentrated liquidity (similar to Uniswap v3), which allows users to designate a price range within which they are willing to make markets, reaping the same market making rewards with only a fraction of the previously required capital.
- Similarly, competitive (or effective) order execution is absolutely essential for any exchange platform and typically requires high trading volumes.
High trading volumes are crucially important for two related reasons: first, markets with greater liquidity are more likely to reflect the true market price, as slippage declines and arbitration increases and, secondly, deeper markets make it increasingly difficult to manipulate prices at the expense of less sophisticated traders. To achieve sufficient liquidity, new exchange platforms typically either (i) conduct liquidity mining campaigns that incentivize liquidity provision with project tokens or (ii) try to use project funds to make markets.
→ Cyclos circumvents the problem of bootstrapping liquidity, by routing orders into Serum’s order books. This allows Cyclos access to high volumes and thus guarantees competitive price finding and deep markets from day one.
- Another strength derives from building within the evolving ecosystem of the competitively scalable Solana network.
Historically, the growth of the Ethereum DeFi ecosystem was capped by gas costs, which at times became prohibitively high. Solana, on the other hand, has proven itself as a highly competitive solution for scalability that could potentially support DeFi apps, which reduce critical barriers to entry. Similarly, Solana has had a sustained rise of TVL.
→ Cyclos will become a crucial part of an emerging DeFi ecosystem that benefits from near-instant finality and low transaction costs.
- Lastly, there are synergy effects from bringing together these building blocks, as Cyclos offers the best of all worlds: the capital efficiency of Uni v3, the liquidity and order depth of Serum, the empowering infrastructure of Solana, and the familiar user experience of a CPMM AMM.
Not elaborated upon until now, CPMM AMMs have become the de facto standard of DeFi due to their (i) low entry barriers and (ii) seamless user experience. Typically, no sign-up or KYC is required and minimalistic interfaces create an even playing field for users that allows little room for errors.
→ While Serum uses order books to execute and match trades, Cyclos can be used like an overlay service to deliver the familiar CPMM AMM experience.
Bringing it all together
How these building blocks fit together can be best understood by adopting two different perspectives.
From the perspective of Cyclos, the goal is to maximize the value accrual of its governance token, CYS, as well as the incentives of LPs to provide liquidity to Cyclos. These points are interrelated, as one quarter of the fees earned from swap commissions and rebates will be used for open market token buy-backs (further info on fee breakdown below). Naturally, CYS is also required to participate in the governance and thus shaping the direction of Cyclos as a platform product.
From the perspective of an LP, the goal is to maximize profits and minimize market risk. Profit of an LP is determined by the overall order volume and the order distribution. Order volume is maximized by plugging liquidity into the orderbook of Serum, while order distribution is optimized for by ensuring that liquidity is concentrated around the current trading price, facilitating as many trades as possible in order to earn a market making fee on each trade.
Simultaneous to maximizing profits, it is important to also protect against market risk, which may substantiate as impermanent loss or arise from market manipulations. Concentrating liquidity around the current market price helps to address market manipulation risk, as it increases the market depth, which translates into less price impact of an order and increased costs of manipulating markets. This is especially so, as Cyclos routes orders into the already deep order books of Serum. Moreover, price impact is a generally important metric, as it is also part of an inherent trade-off between the willingness of LPs to absorb the risk of impermanent loss and the price impact or market depth. In the words of Hayden Adams: “the more an LP is willing to sell close to the market price the more imp[emanent] loss they experience”.
However, there is a virtuous cycle here: the closer liquidity is concentrated around the market price, the less price impact, the less price impact there is, the better rates can be offered. The better rates are available to traders, the higher volumes are received and the more fees are earned. As such, concentrated liquidity can be ideal for LPs that are willing to risk impermanent loss to maximize fee revenue.
Lastly, the typical chicken or egg problem of initial liquidity provision on classical DEXes is avoided, as LP positions are fed into Serum. This is a common feature of Solana based AMMs that have integrations with Serum, but is very different to the Ethereum DeFi ecosystem, where attracting a high TVL can make or break protocols. Cyclos does not only bestow less risk on early LPs, but actually rewards them, as liquidity mining favors early LPs, while not giving them any downside from accentuated impermanent loss from thin markets. As such, LPs, but must only be confident about underwriting smart contract risk.
In short, Cyclos offers LPs three key advantages:
- Obtain higher fees by better utilizing their existing capital from concentrating liquidity around the market price
- LPs only have to underwrite smart contract risk, as their capital is rerouted into Serum, allowing LPs to avoid accentuated impermanent loss from bootstrapping thin markets
- Benefit from higher maker rebates and lower taker fees by collectively staking SRM
Walking-through the Cyclos liquidity allocation process
On a procedural level, the core mechanism of allocating assets into Cyclos consists of five steps. The below graphic exemplifies this allocation process:
In more detail, steps (1) to (3) are core processes describing the liquidity management, while steps (4) and (5) are more operational and describe the distribution of fees and continuous updating of positions.
(1) LPing to Cyclos: LPs provide liquidity by locking assets of a trading pair at a freely determined ratio, within a specified price range. This price range is emulated by a set of discrete positions, which differ from each other by the smallest possible incremental value, the ‘tick’.
(2) Aggregating liquidity: the liquidity of all individual LPs gets aggregated on a per-tick basis.
(3) LPing to Serum: a subset of all aggregated ticks gets posted to the Serum orderbooks. This restriction is derived from gas costs. While the exact figure may change, it is currently planned to post between 10 to 15 ticks on each side of the market price at liquidity allocation. Please note, that these and other figures may be subject to change, but still reflect the respective order of magnitude.
(4) Distributing fees: Swap commissions and rebates are divided in four parts, evenly split between (i) Cyclos treasury, (ii) token buy-backs, (iii) CYS stakers and (iv) LPs. LP rewards are allocated on a pro rata basis. Since individual LP positions are aggregated in and allocated via Cyclos, Cyclos may be able to eventually offer better maker rates (i.e. -5 bps vs -3 bps) to LPs from staking a sufficient amount of SRM (i.e. 1mm SRM). Towards this goal, a pooling module to crowdsource Serum from the community will be created. LPs deposit Serum to collectively benefit from higher maker rebates and lower taker fees on trades.
(5) Update positions: As the market moves and orders get filled, it is likely that the initially even allocation of liquidity becomes tilted towards one side of the market. An off-chain crank periodically calls an on-chain program to repeat (3) every few seconds. This serves two purposes: first, it ensures an even distribution of liquidity and secondly, it ensures that a maximal amount of liquidity is actively used.
You can follow the development of Cyclos by joining our Telegram community and following us on Twitter.
