Introducing Cyclos: A new AMM solution bringing concentrated liquidity to Solana
Intro
The DeFi Summer of 2020 and rise of DEXs have revolutionized not only the world of cryptocurrency, but finance as a whole. Before the rise of the Automated Market Maker (AMM) DEX model, users who wished to trade their crypto assets on DEXs were left at the mercy of low liquidity order books. High costs and a subpar user experience were part and parcel of this pre-AMM world, until the launch of Uniswap in 2018. One of the key innovations of the AMM was reliance on a mathematical formula to price assets, instead of relying on the old order book model.
The concept of the Constant Function Market Maker (CFMM) lies at the core of this model. “Constant function” refers to the state of unchanging reserve assets. LPs pool their assets within a smart contract, which is then utilized by traders to provide counter-party swap liquidity. Instead of trading against other traders, users trade against these pooled assets.
Trades on the CFMM model are based on the following function:
x*y=k
In this formula, k is a constant; x represents the reserve of the first asset, and y of the second asset. When the supply of x increases, the supply of y must decrease, in order to maintain k.
The Liquidity Problem
While the AMM model offers improved liquidity from its orderbook-based DEX predecessors, it also results in some undesirable consequences for trade execution. As LP assets are distributed evenly along an x*y=k price curve, from 0 to ∞, this means:
- Most of the liquidity remains unused, distributed along the curve (this is especially the case for stable asset pairs)
- Trades, particularly on low volume assets, involve high levels of slippage
- LPs are less incentivized to offer liquidity in first place as a result of capital inefficiency
What if an AMM could allow users to partition liquidity within specific ranges of their choice?
An Intuitive Solution
With Cyclos, we have taken what we believe is the world’s most efficient limit order system and deployed it on Solana. Users can concentrate liquidity, constructing individual price curves of their choice, over which their assets are distributed. Trades then occur against the combined liquidity of all individual curves.
Users despot their assets within a specified range- once filled, the user receives a maker fee rebate as a reward. As an LP, you earn trading fees when your liquidity is utilized through rebates, plus, placing what are essentially staggered limit orders.
From a game-theory perspective, if the goal ultimate goal is maximize the incentive for LPs to deepen liquidity, two main factors must be considered:
#1 Order volume — higher volume trades mean higher profits for LPs; by deploying their capital at select price intervals, LPs facilitate larger orders, resulting in increased rewards
#2 Order distribution — profit is obtained only when orders are fulfilled; placing liquidity at the optimal price intervals increases usage of the LP’s funds, again, resulting in increased rewards
For potential traders and LPs on Uniswap V3, variable swap fees and high gas costs remain a major barrier, limiting the potential for real, sustainable order book depth. As an LP, the prospect of placing ever more multiple ranged orders across variable price intervals incurs an ever higher gas penalty. As a result, the real potential harnessed by concentrated liquidity remains locked up.
As for the situation on Solana, existing AMM solutions utilize a similar logic to the constant price curve when distributing liquidity. The absence of LP price intervals means less order book depth, low LP rewards, etc. As Solana is in the earlier stages of growth as a layer 1 network, this point is even more critical given the need to attract volume to the network. By more efficiently leveraging existing liquidity to provide exponentially greater order book depth, Cyclos offers a potential way out of the “chicken or egg” scenario layer 1 networks currently face when attracting volume.
On Cyclos, not only does capital efficiency increase dramatically- less capital is at risk for LPs as a result. Less capital at risk translates to more free capital available, spread over greater price intervals, to earn more fees. And lower gas costs on the Solana network mean less fee penalties incurred by LPs. Combining these key innovations into one product, we believe Cyclos offers immense potential for greatly improving the AMM experience not just on Solana, but overall.
The Promise of Solana
Delivering our own approach to concentrated liquidity on a high throughput, low cost network is the primary aim of Cyclos. While our product development will include a swift rollout of a user-focused, one-stop shop for DeFi users on Solana, the core value offering for all ecosystem participants lies with our approach to deep liquidity, specifically tailored for Serum’s order books.
On this note, people often ask us why we are building on Solana- are we simply riding the hype wave? The short answer is- no. Allow us to elaborate. Solana as a base layer infrastructure has proven itself a highly competitive, and in many ways, superior solution for scalability to other layer-1 networks. While we believe in the concept of coopetition and a multi-chain future, why not start with the best solution available now?
At a user acquisition level, Solana offers an opportunity for opening the doors to mass participation in DeFi. The low cost and speed of transactions provide an opportunity to build DeFi apps that reduce critical barriers to entry. Of course, without volume to trade on, cost and speed of transactions mean little. With the sustained rise of TVL on Solana over the past several months, we see this as a strong signal for what is to come. With this in mind, our aim is to insert Cyclos into the ecosystem as a catalyst for taking trading volume on Solana to the next level.
What’s to come for Cyclos
We are extremely excited to debut our AMM to both the Solana community. The initial support we have received thus far for our project has encouraged us to move quickly, and we look forward to further feedback from the community as our product matures. At the core of Cyclos, our vision is a highly competitive, user-friendly AMM that lowers the barrier to entry for everyday DeFi users. Executing on this vision to the fullest extent is only possible through continued engagement and dialogue with DeFi users. With that, we invite you to join our Telegram community and follow us on Twitter. Come join us and help build the future of DeFi on Solana together.
