When decentralized exchanges started to take off in 2019, the designs were very simple, but simplicity in these marketplaces might soon be a distant memory.
The most successful category of decentralized exchanges are the automated market makers (AMMs), such as Uniswap and Curve. The Cowri Labs team, builders of the Shell Protocol, a small AMM that has thus far focused on stablecoin trades, are the latest to bring more nuance to the AMM design with a new whitepaper released today.
This continues down the road Uniswap began when it introduced concentrated liquidity in March, after which Uniswap added $5B to its total value locked. This kicked off a streak of innovation as other AMMs sought to keep up. Curve followed with its dynamic peg design and SushiSwap answered by announcing Trident, which would use its pools for multiple DeFi uses at once. Now upstart Shell Protocol looks to enter the fray by giving market makers even more control, which — based on the response to concentrated liquidity — liquidity providers appreciate.
The next version of Shell will allow developers and liquidity providers (LPs) to deploy assets with much more power over how the price moves as traders trade. In technical terms, they will allow LPs to define the bonding curves of their pools.
“If you have this very flexible curve, this very flexible geometry, that means you can optimize where you’re allocating liquidity to have a very high level of efficiency,” Kenny White, Cowri Labs founder and CEO told The Defiant in an interview.
Cowri Labs has released a new whitepaper describing its approach today, calling this new system for malleable curves Proteus, after the shapechanger in The Odyssey. “The goal of this paper is not to design a capital efficient trading strategy for liquidity pools,” the whitepaper says. “Rather, our goal is to engineer a generic AMM algorithm that can implement any trading strategy. We call this an ‘AMM engine.’”
White did not commit to a date for the actual launch of the new version of Shell, but he said its next milestone will be a security audit of its smart contract by Trail of Bits. Once that’s done and they are confident in the security, they will launch on Ethereum.
Yield farmers take note: “There’s definitely going to be liquidity mining for the full launch,” White said, for Shell’s governance token, SEA.
Then it’s up to the market to decide if this more subtle design is useful. White is optimistic about where Shell v2.0 can get early wins. “It seems like based on our early testing you can use this algorithm to construct a stablecoin curve that’s more efficient than what’s out there,” he said.
Shell already has a v1.0 which specializes in stablecoin trades live. It has about $15M in total value locked right now according to DeFiPulse, but that’s roughly 10% of the DAI alone locked in Uniswap, which is only the third largest stablecoin in its pools.
AMMs have been evolving quickly ever since Uniswap released its third version.
The first AMM bonding curve that Uniswap used defined the price for two tokens in a pool based on the amount of each in the pool at the start, and how much the trader wanted to trade.
If a trader attempts to buy a very large portion of the pool, the price will move wildly out of line with the market price, so there is only so much of any pool any trader would trade. In trader talk, that is capital inefficient.
So another AMM, Curve, innovated by specializing in tokens that had very little variation in price between each other (think, wrapped versions of Bitcoin, like wBTC and renBTC). With Curve’s curve, the price slipped very little even on extremely large trades, but that only helped with tokens that had relatively low volatility.
But Uniswap really changed the field of play when it instituted concentrated liquidity. This allowed liquidity providers to define the range in which they were willing to trade. So, for example, in a pool of two stablecoins (say DAI and USDT), a liquidity provider might say that it would only permit its assets to trade between $0.99 and $1.01. This was very good for Uniswap. It meant that a trade wouldn’t slip outside of that price range until that capital was exhausted, making it much more capital efficient.
One problem with Uniswap’s approach is that its liquidity provider tokens aren’t fungible, argues the Shell team. Uniswap now uses NFTs to track LP positions, because they have become so bespoke.
Shell v2.0 will allow liquidity providers to create any curve they want but also account for these positions with fungible, ERC-20 tokens. White believes this will open up new use cases.
“Each pool is only going to have one bonding curve,” White said. “But each pool could have a highly customized bonding curve.”
Shell’s LP tokens are called SHELL. It should be noted here that not all SHELL will be fungible with one another, but all the SHELL that define a specific bonding curve will be fungible. That will still make them more usable as assets in DeFi; they could be collateral for loans, for instance.
The ability to make multiple bonding curves for one pair of tokens will likely be a strategy that’s attractive for the very most sophisticated market makers, but because Shell will be permissionless, there’s nothing stopping other LPs from contributing their liquidity to pools others have made and are working well.
Liquidity Mining Reward
So what will the new Shell mean for rank-and-file DeFi users? It could make liquidity mining programs more appealing to entrepreneurs, which could mean more opportunities.
Today, many projects launch their tokens with an initial DEX offering by making the first lot of tokens available on an AMM like Uniswap.
With the new Shell Protocol, a new token could provide considerably more nuance to its liquidity mining reward. Imagine a project that has a two token system, such as the Fei Protocol. Fei has its stablecoin, FEI, and its governance token, TRIBE.
Fei wants FEIs price to stay very close to $1. So with Shell v2.0, Fei could only offer the most TRIBE rewards to liquidity that’s provided between $0.9999 and $1.0001, and then a little less at prices slightly beyond that, and none further out.
The fact that liquidity would be concentrated in that first band would help FEI maintain its peg, but it would also give the community an incentive to work to help keep the prices in line.
In order to get anywhere though, Shell will need to attract a lot of liquidity, and projects like Uniswap and SushiSwap have huge early leads. As the new whitepaper says:
“The long term vision is for Proteus to be an abstraction layer between financial engineers and the blockchain, an operating system for trading strategies.”