zk-shark - (redacted #1)
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Liquidity pools for NFTs
Liquidity pools for NFTs are a step in the right direction for web 3.0 as it challenges one of the main arguments against widespread NFT adoption, liquidity. The main advantage related to liquidity pools is that you have a “best offer” vs a “floor price”. What I mean by that is the “floor price” of a collection on a peer to peer marketplace is just showing the current lowest price a seller is willing to list at publicly, whereas the equivalent “best offer” in a pool is an executable level for instant liquidity. Pools work the same on both sides of the market – allowing users to sell or buy NFTs instantly with live quoted prices . To summarize – “floor price” is just the lowest listed NFT in the collection for sale vs a “best offer” in a pool is a price you can sell at instantly backed by solana in a smart contract. I'll throw in hyperspace as an honorable mention as the “collection bid” feature is essentially equivalent to the instant liquidity of a "best offer". The HS feature has been increasing in frequency while the average collection bid vs floor price spread seems to be tightening consistently - showing the early signs of widespread adoption potential. However, its technically inferior to pool functionality as it's not a dynamic pricing equitation....
The NFT liquidity pool protocols are all relatively new and have been gaining market share as volume and pricing efficiency improve... this momentum looks to only continue as those two variables usually grow rapidly together. The current ecosystem is made up of Hadeswap, Elixir, Tensor, and Goatswap for the most part. These days i've been focusing mostly on Hadeswap as that's where I'm seeing the most volume and opportunities (Elixir/Hadeswap are doing the most volume by far currently – Hadeswap is at 235k sol total volume). It is also worth noting that Hadeswap and Elixir are both still in BETA, not open sourced, and should be treated as high risk until the audits are finished/code is out there.
How they work....
First off, make sure to check out the official docs and read through them yourself before playing around. The best way I can explain it is to look at it from the perspective of the buyer/seller and the liquidity providers separately. DISCLAIMER: The below example is specific to Hadeswap for the most part as that's what I use most often and not all of the protocols work in identical ways.
Buyer= You can purchase ANY nft instantly in the same pool at the same floor price.
Seller =You can sell ANY nft of the same collection at the collections “best offer” price.
Liquidity Providers = this is where it gets way more complicated. I want to emphasize if you cant explain impairment loss in a second language you probably have no business trying to set up a two sided pool.
You can create a pool on just one side (BUY NFTs or SELL NFTs) which is relatively straight forward.
For example, if you want to start a pool on hadeswap to buy NFTs – you would have to deposit X amount of sol and fill in the following parameters:
Collection - _______
Spot Price – the level/price at which you would start to buy NFTs at in that collection.
Bonding curve – two options - linear or exponential (more below)
Delta – the solana amount increased/decreased every time a NFT is purchased/sold in a pool (linear curve) or the % increase/decrease every time a NFT is purchased/sold in a pool (exponential curve)
So essentially the bid/offer price of the pool changes respectively (+/-) every time an NFT transacts in the pool. For example, if you set a pool up willing to buy NFTs at 10 and use a linear bonding curve with a 1 solana delta - see below
approximately:
1 NFT is purchased from the pool at 10 sol = now the pool will reflect 11 sol as the floor.
Then, a NFT is purchased from the pool at 11 sol = now the pool will reflect 12 sol as the floor.
Then a NFT is sold into that pool = now the pool will reflect 11 sol as the floor.
Same idea with an exponential bonding curve but with a % change each time instead of 1 sol.
(dumb downed example - a tad more complex in practice)
The Liquidity provider can accomplish 2 main things:
1. profit off of the (floor-best offer) spread -fees
2. ladder/DCA into or out of a collection
Both in a passive manner.
I will dive further into pool strategies in future topics but that should suffice as a primer to provide context for the below...
How they changed the game forever: two main points
Decreased Volatility (thin floors vs bonding curves)
As swap volume continues to ramp a “thin floor” will mean less and less and lose accuracy in describing actualized price action. Many large collections will have stable coin like volatility resulting from the solana needed to move a bonding curve up is not equivalent or representative of a “thin floor”. This is already starting to happened – for example lets take a look at famous foxes.
(at the time of writing this – 10/23/2022 afternoon)
Floor on Hyperspace: 25.99
collection bid on Hyperspace: 24.75
Floor on Magic Eden: 25.99
Floor on Hades: 26.248
386 listed on Hyperspace (HS shows Hadeswap listings)
243 listed on Magic Eden
121 inside the Hadeswap pools (1,772 sol offer TVL)
As you can see even with little volume relative to the larger marketplaces in a historical context, the swap protocols are getting very competitive. I mean you can instantly sell for about 1% below the floor price with no risk of waiting for it to sell or getting undercut – you can see why these protocols will only gain traction. However, most collections don't have that type of liquidity in pools yet but about half a dozen projects are at that level currently with some new mints like critter cults having similar efficiency and volume in the pools.
The largest individual hadeswap pool had 41 foxes inside and was using a linear bonding curve with a .5 sol delta. SO as you can figure out its going to take a LOT more solana to move floors as 1 purchase = .5 sol+ increase to the pool floor, versus traditional markets 1 purchase could of moved a floor by 10 sol + if it was thin... I think this will clearly improve liquidity and decrease volatility (less excitement) but also creates an environment where NFT perps/new deriv products could survive (bringing back volatility?)... Essentially the majority of liquidity for NFTs is concentrated around the floor and pools will only add to that further.
2. all your rare NFTs will get even more illiquid
The other way it changes the game forever is all your rare NFTs will get even more illiquid. I'm not saying that in a bearish or bullish sense as I think you can make a solid argument both ways. The obvious reason for this if you haven't put it together yet – ALL NFTs are treated equal in the pools. AKA depositing a rare into a pool is essentially selling the rare at floor. RARE NFTs and pools should not mix unless your sniping some bozos that deposited a top 100 rank critter cult into the pool ;). Eventually, I think you will see rarity based pools that only let you deposit mythics into one pool and commons into another but for now it presents a good opportunity.
Rarity Bearish case for rares: less liquidity = less investors would be willing to pay + motivated sellers undercutting floors have greater impact.
Rarity Bullish case for rares: less liquidity= less open market price discovery = increased volatility = chances for seeing inflated prices due to little historical trading context (ex: alien punks)
With all that in mind, here are few setups I find interesting - (not financial advice)
Rarity Arbitrage
As I explained above, all NFTs in a pool are treated equally. So essentially you can check the rarity of all the NFTs in the pools, and snipe rares from the floor price and then flip. Who would ever deposit a rare NFT into a pool though? 2 types of people 1. Bozos (fat finger mistake or lack of pool education), 2. Degens willing to sacrifice rarity premium for instant liquidity for whatever unfortunate leveraged situation they found themselves in.
Hypothetically, you can benefit from those 2 types of actors by simply watching the pools, quickly checking the rarity for each NFT in the pool/new deposits and waiting for someone to deposit a rare.
Quick note: make sure to do your home work on the collection's rarity ranking system, rarity importance/ premium, and certain traits that hold value that may be considered statically less rare.
Pricing Arbitrage
As the pool prices are controlled by activity in that pool – arbitrage opportunities present themselves vs Magic Eden and other pools. The arbitrage opportunities are decreasing as pool volumes increase (+0% royalty swith, however, most of the newer collections don't have any type of pool liquidity so the market is still inefficient.
One could just have a few windows up watching the floor prices across an aggregated marketplace, ME, Hyperspace, Elixir and waiting for under-cutters not aware of the pool levels. Low ball people with offers below the best offer price and see if anyone accepts. Same idea with the collection bid on hyperspace (bid below the best offer on hadeswap and wait). Make sure to understand that you don't want to be caught on the wrong side of volatility - I would consider these active strategies and wouldn't play around with them unless your staring at your computer the whole time. Same idea for sharky.fi, in times of volatility I've actually purchased NFTs and then instantly got 93%+ LTF (loan to floor) using hadeswap/sharky. I think it's a good idea to keep an eye on the LTF spread on sharky.fi as it's another level of liquidity depth/investor confidence into a collection. I like to know the pricing and borrow availability on all protocols/marketplaces look to help me understand the whole picture for the collection.
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Have a good week,
zk SHARK
FYI I plan on putting one of these out every week or every other week. A lot more topics to be covered and more organization on the next one (format, text, resources, links, videos, podcast links, defi trades, blockchain reviews, book reviews, philosophy etc)
Let me know if you have any topics you want me to cover also.
Everything above represents my personal opinion and contains absolutely no financial advice or recommendations. Please read the full disclosures I copied from other crypto sites online below.
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