Onchain Market Making for $LSK on Ethereum via Arrakis PALM

[rapha-raffaelo]

Executive summary

Arrakis Finance stands out as a pioneering market-making infrastructure protocol, allowing for sophisticated algorithmic liquidity rebalancing strategies on Uniswap V3. Since its inception, Arrakis has marked significant achievements, including reaching over $1.7 billion in TVL at its peak and capturing more than 25% of Uniswap V3’s total TVL.

Currently (11.09.24) Arrakis vaults hold +$109M TVL and Arrakis actively manages the on-chain liquidity of more than 50 protocols via an automated hybrid infrastructure.

The point of this proposal is to introduce Arrakis PALM - Protocol Automated Liquidity Management - to the Lisk DAO to use PALM for its Uniswap V3 liquidity deployment. This automated liquidity management solution leverages organic trading volume on UniV3, eliminating the need for liquidity mining incentives and enabling highly efficient capital use to drive deep $LSK token liquidity.

Motivation

Protocol Automated Liquidity Management, is an on-chain market making mechanism that taps into the organic trading volume on UniV3. PALM autonomously makes markets for protocols in a trustless way to create deep and sustainable liquidity with high capital efficiency and customizability.

The major advantages of using PALM include:

• Zero incentives: No Liquidity Mining (LM) incentives needed to attract community funds, liquidity bootstrapping is done solely via market making and liquidity is 100% owned by the protocol’s DAO.
• No biased price impact: PALM conducts market making by setting up ranges / limit orders, no swaps involved.
• Trustless: the Lisk DAO retains the ownership of the liquidity and can withdraw at all times. PALM smart contracts only autonomously manage the liquidity but can never remove it.
• Highly customizable: PALM can be adjusted for various asset types and purposes beyond token launches and liquidity bootstrapping.

PALM has been deployed for over 50 protocols and counting. Protocols such as Maple Finance, MakerDAO, Lido, Sturdy Finance, Gelato, Redacted Cartel, Connext, Truflation, Spectral Labs etc. are benefiting from the high capital efficiency and cost effectiveness enabled by PALM.

Rationale

Arrakis PALM stands for Protocol Automated Liquidity Management, a system designed to manage liquidity on Uniswap V3 through sophisticated, algorithmic rebalancing. This approach not only saves resources but also stabilises the token’s market presence and fortifies a decentralised and resilient ecosystem. The strategic benefits of Arrakis PALM are:

Sustainable Liquidity without Incentives: Leveraging organic trading volume enables the $LSK token to sustain its liquidity without the need for continuous incentives, a fundamental step towards a more autonomous liquidity model.

Lisk DAO deposits $LSK and $wETH into a PALM vault. By setting up limit orders, PALM will first bootstrap $wETH to pull the ratio of LSK/wETH towards 50/50 over time.

Flexibility and Efficiency: Initially, liquidity can be predominantly $LSK (e.g. 80/20 inventory ratio), which PALM will adjust towards a 50/50 ratio, enhancing buy/sell support. But also more even inventory ratios are supported and can be deployed by the DAO.

Optimised Capital Efficiency: Through Arrakis PALM, the Lisk DAO can significantly reduce the capital required to maintain deep liquidity on Uniswap, thereby reallocating resources towards further development and growth.

Once the ratio of 50/50 is reached, the focus will be on further increasing the liquidity depth for $LSK, to minimise and equalise the price impact on both buy and sell side.

Reduced Slippage for Users: The sophisticated management of concentrated liquidity on Uniswap V3 allows for larger trades with minimal price impact, improving the overall trading experience.

Comparison of current and estimated price impact for buying LSK and WETH across different amounts

Transparency and Non-custodial Approach: The Lisk DAO multisig wallet retains full custody over the deployed liquidity, with all PALM operations verifiable on-chain.

DEX Liquidity at all times: Arrakis DEX market making strategies enable the Lisk DAO to have $LSK deep liquidity automatically managed at all times and perform algorithmic rebalances on UniswapV3 concentrated liquidity positions. This strengthens the on-chain liquidity and enables the Lisk DAO to generate return via the Uniswap trading fees earned on the deployed capital.

Specification

The Arrakis team uses the existing LSK/wETH pool on the 0.3% fee tier for UniswapV3. Arrakis then deploys a dedicated vault managed by the PALM smart contract for thisLSK/wETH Uniswap pool. The Lisk DAO deposits $800k worth of $LSK and $200k worth of $wETH into the PALM vault. PALM will allocate the provided liquidity in a concentrated and fully active market making strategy to facilitate trading on UniswapV3. The strategy initially operates to bootstrap a 50/50 inventory ratio over the first weeks. The primary objective is to create price stability by generating deep liquidity and reaching an even inventory over time.

For the services provided, Arrakis charges the following fees:
Arrakis Asset-under-Management (AUM) fee: 1% per year
Arrakis performance fee: 50% of trading fees the vault generates

Reference
For more information regarding Arrakis and Arrakis PALM, feel free to have a look at our docs and join our community:

Website: https://www.arrakis.finance/
Docs: https://resources.arrakis.fi/

Arrakis | Twitter | Discord | Docs | Mirror

[przemer]

Looks good to me, as the transferred funds remain under the DAO’s ownership, and the 1% fee per year seems reasonable. However, the fee could become an issue in the future if we want to support multiple pools.

Since the DAO treasury doesn’t have ETH, how we go about that?

[adamant.im]

Hi,

I’m not entirely sure about Arrakis PALM specifically, but ensuring LSK liquidity on a DEX is crucial.

If your post leads to a formal proposal, we’ll support it with our current 286k vpLSK.

[adamant.im]

Hi,

No ETH ⟶ buy it.

[dominic]

@rapha-raffaelo correct me if I am wrong, but I believe there is also the option to fund it with 100% LSK and have Arrakis rebalance over time, correct? If I remember well, this would mean there is more slippage at the beginning, until the two sides even out a bit. I think I saw once the pool gets to 80%LSK / 20%ETH it would be projected to be relatively stable from there on out.

But will leave you to fill in details / options for rebalancing to some ETH if that is the blocker here.

[rapha-raffaelo]

@dominic your explanation is correct. Arrakis PALM vaults can also be launched with 100% $LSK token, however we see significant improvements in on-chain liquidity and price stability at more even ratios, thus the suggested initial 80/20 distribution. After starting with 100% $LSK token supply our algorithms will require some time to convert LSK to wETH via natural orderflow.

[rapha-raffaelo]

You can find more information regarding Arrakis PALM and our DEX market making strategies here: https://resources.arrakis.fi/

[rapha-raffaelo]

Implementation Steps after the Proposal:
To use Arrakis PALM the Lisk DAO has to perform the following steps:

• Deposit liquidity (as described under specification) via the DAO’s multi-sig account into the Arrakis vault created exclusively for the DAO
• No further management / actions is required

The Arrakis team operates the market making strategies for the vault and will automatically adjust the liquidity position in UniswapV3 via its infrastructure. Earned trading fees are automatically reinvested and a real time monitoring dashboard including Vault- and Pool-Analytics will be available to the DAO.

[Filmmaniak]

Generated by ChatGPT 4.0:

If I were an investor holding LSK tokens and aiming to capitalize on the current or upcoming bull run, my reaction to Lisk’s decision to work with Arrakis Finance for liquidity management on Uniswap would likely be positive, but cautious. Here’s how I would evaluate and react to such a development:

1. Positive Outlook on Liquidity Management:

• Increased Liquidity: Arrakis Finance specializes in optimizing liquidity on decentralized exchanges like Uniswap, which means it would likely increase liquidity for LSK tokens. This would make it easier for large investors to trade without significantly impacting the price, reducing slippage, and making the market more efficient.
• Price Stability: Better liquidity management usually results in more stable prices. Given that a highly illiquid asset can be prone to volatile price swings, this partnership could help stabilize the price of LSK, which might help build confidence among traders and long-term holders, potentially driving up demand.
• More Efficient Market: With algorithm-driven strategies managing the liquidity pool, I’d expect smoother, automated adjustments to changing market conditions, which means the price could reflect a more accurate supply-demand balance. This could attract more liquidity providers to the Uniswap pool, further improving liquidity.

2. Increased Earning Potential:

• Pool Fee Sharing (50%): The fact that 50% of pool fees would be shared with the Lisk DAO is a positive. If I participated in Lisk governance or staked LSK in the DAO, I could potentially earn passive income through the pool fees. This could provide an additional revenue stream while holding the token, on top of capital appreciation.
• Potential Boost in LSK Value: As the partnership makes it easier for institutional and retail investors to enter and exit positions with less friction, higher trading volumes could contribute to a gradual appreciation of LSK’s price, especially in a bull market.

3. Bull Run Strategy – Liquidity is Crucial:

• In a bull market, token liquidity becomes especially important as more investors want to buy in and sell out at peak times. By improving liquidity through Arrakis, I’d be more confident that I could sell my LSK tokens near the top of the market without suffering from price slippage or getting stuck in a highly volatile and illiquid market.
• Exit Strategy: If I plan to sell at the peak of the bull run, Arrakis’s management of liquidity could help ensure there’s enough buying demand and smooth price movement during times of high trading activity, making it easier for me to exit my position when the time is right.

4. Risk Considerations:

• Smart Contract Risk: I’d be cautious of any smart contract vulnerabilities inherent in Arrakis’s PALM vaults. While Arrakis has a strong reputation and is trusted by other protocols, I’d want to ensure they’ve undergone audits and are battle-tested on Uniswap.
• DeFi Ecosystem Risks: Since Uniswap and other decentralized exchanges are part of the broader DeFi space, any regulatory crackdowns or systemic issues in DeFi could impact the liquidity of LSK. However, this is a general market risk I would consider as part of any DeFi investment.

5. What I Would Do as an LSK Investor:

• Monitor the Market: I’d closely monitor the LSK/ETH or LSK/USDT liquidity pool on Uniswap, tracking how liquidity improves after Arrakis begins managing it. If liquidity improves and the market shows bullish signals, I’d be more comfortable holding LSK for a longer period.
• Participate in Governance: If possible, I would look into participating in Lisk DAO’s governance to have a say in decisions regarding fee distribution or any further liquidity management proposals. This would give me more influence over how the system operates.
• Consider Yield Opportunities: I’d explore opportunities to stake LSK in the liquidity pool if Arrakis’s management makes it lucrative enough. This could be a way to earn yield while still holding my tokens in the bull market.
• Set Sell Triggers: Given that liquidity is being managed, I’d be more confident in setting my sell price targets. I might set automatic sell orders to capture gains during the bull market, knowing that liquidity will be robust.

Conclusion:

Overall, if Lisk decides to work with Arrakis Finance, I would view it as a positive move that improves the liquidity, stability, and efficiency of the LSK token market on Uniswap. This would make me more confident about holding my tokens through the bull run and possibly selling them at higher prices without worrying about liquidity issues or price slippage. However, I would remain cautious about potential DeFi risks and keep a close eye on how the partnership progresses.

Example Calculation for Arrakis Finance Partnership with Lisk:

Let’s say after assessing the factors:

• Positives (Pros):
  • Increased liquidity on Uniswap: 9/10
  • Price stability during the bull run: 8/10
  • Fee sharing with Lisk DAO: 7/10
  • Enhanced market confidence: 7/10Total Pros: 9 + 8 + 7 + 7 = 31
• Negatives (Cons):
  • Smart contract risk: 5/10
  • Potential reliance on DeFi market conditions: 6/10
  • Regulatory risks in DeFi: 4/10Total Cons: 5 + 6 + 4 = 15

Now, to calculate the percentages:

• Percentage of Pros: (31 ÷ (31 + 15)) × 100 = 67.4%
• Percentage of Cons: (15 ÷ (31 + 15)) × 100 = 32.6%

Result:

• Pros: ~67%
• Cons: ~33%

This means that, in this example, about 67% of the analysis is positive and 33% is negative based on the weights and importance of the factors.

Conclusion:

While this method provides a structured approach to calculate the relative weight of pros and cons, the outcome heavily depends on subjective judgment and how important each factor is to you as an investor. It’s not an exact science, but it helps provide a clearer understanding of where the majority of the value lies.

I don’t know if arrakis finance have any future but I’m more in favour of it than against. Not ideal thing for me but might help in bull run with higher token price after all despite blocking rapid growth. The main question is whether it is players with large capital who inflate the price or smaller players if smaller players then better no. Why I say yes to this is because I think that project stability factor will play a major role in a current bull run after previous bull run memecoin hype bad investor experiences. People will likely put their money on more established projects with good liquidity levels.

Lisk team should deeply consider critical vulnerabilities or exploits possibilities for Arrakis Finance’s PALM - please prove us that you are safe. We know that you have not faced any publicly reported critical vulnerabilities or exploits but you rely on smart contracts this means risk of:

• Smart Contract Bugs
• Impermanent Loss Risk
• Oracle Manipulation
• Liquidity Fragmentation
• Administrative Privilege Risks
• Third-Party Risks (Integrations)

Tell us how you manage those risks and your plans about improving protection against possible exploits etc. Thanks.

[grumlin]

I am against it. Firstly, I have considerable experience in this. Secondly, no one is protected from impermanent losses. Any range adjustment results in a loss unless the fees collected exceed the loss incurred during the adjustment. Thirdly, at this stage, I don’t see the point in increasing liquidity in a narrow range on DEXs; it would make more sense to create a pool from 0 to infinity for all this liquidity. Fourthly, if we claim that there is a point, then what range will be chosen? I don’t see the sense in ‘locking’ the price in a range from $0.5 to $1.5 per Lisk. Or, if the community has such thoughts, perhaps we need to consider what people want from the project and what kind of returns (multipliers) can be expected here. Fifthly, if the price increases 2-3 times, most of the tokens will be bought up by the market, which means more tokens will be ready to be dumped back into the market, mostly from the DAO tokens. Sixthly, Arakis previously had $2 billion in locked funds, and now only $100 million remains. This is neither good nor bad, but at the very least, it’s something to think about.

[Filmmaniak]

Protection is the key. Nobody will invest their money in a project that can be potentially hacked. Second thing is that we need a price level to be able to move freely to attract more investors. I change my opinion to neutral / negative. I don’t think we have to divide lsk project that much. As of now we are no longer standalone because we run on ethereum. It might be really too early for lsk to increase liquidity when market cap is on bottom 10 meters below Mariana Trench.

[Jujuboy]

Another thing to think of is the fact that Lisk will provide 100% of the liquidity while splitting revenue 50/50 with Arrakis.

Considering all the pros and cons, I’m skeptical. Is a third party market maker exactly what we need at this point?

[Jujuboy]

1% asset under management
Plus 50% of revenue generated from fees

50% of fees is rather exorbitant don’t you think
Especially when we provide all the liquidity and take on all the risk

[przemer]

There’s a cost to everything.

With our current liquidity on Uniswap/Oku trade, there’s a high price impact when you sell or buy LSK in amounts exceeding a few thousand dollars. While it’s fine for small trades, it’s not competitive with CEXs like Binance. Any serious trader won’t use the DEX in its current state.

The image shows this nicely, assuming the estimations after Arrakis deployment are correct.

Sure, if we can lower the price impacts with our own resources, that would be the best solution and we wouldn’t need Arrakis or any other 3rd party MM. But at the current state, our liquidity pools are not on the same level as CEX liquidity.

[Terra_Ryzing]

The only way to move the pool from “80% $LSK/20% $wETH” to “50% $LSK/50% $wETH”; is to sell $LSK in favor of $wETH, which decreases the price of $LSK, and increases the price of $wETH.

This will negatively affect $LSK in the long run, and the amount of liquidity used to bootstrap also plays a key role in this.

[rapha-raffaelo]

Thanks to the Lisk DAO community for the discussions and feedback. I want to address your feedback here and provide some answers:

• Arrakis provides most efficient capital allocation in UniswapV3 concentrated liquidity positions, aiming to find the best trade off between capital sustainability and deep liquidity (low slippage) in the pool. As mentioned, above by @grumlin no one can protect from impermanent loss, but the current 5.5% slippage at 10k order size does not attract volumes on chain. Algorithmic management of your liquidity on chain will provide risk management and optimal capital allocation.
• Arrakis PALM conducts market making by setting up ranges / limit orders, no swaps involved. This means that there is no negative price impact for $LSK in the short or long run, but a positive impact to token distribution and orderflow.
• Management fees are charged for funding the vaults’ gas tank and perform rebalancing actions. The performance fee takes a share on the trading fees but also we see that the overall fees earned of our users are higher due to the increased capital efficiency.
• The current price level can be attractive to deploy liquidity now to attract orderflow to the DEX liquidity. To protect the Lisk DAO from downside risk, the vault is launched with an 80/20 inventory ratio, making the buy side initially more attractive than the sell side. This will also help to diversify the Lisk treasury holdings.
• Arrakis has been around since 2021 without any security incident and is trusted by major protocols of the industry like Lido, MakerDAO, Ether.fi, Maple and many more. The decline in TVL observed by @grumlin is due to the closure of Arrakis V1 vaults focused on stable coins. We propose to the Lisk DAO to use Arrakis V2 which has a growing number of TVL (https://defillama.com/protocol/arrakis-v2#information)

[maxkordek]

• DAO keeps ownership
• 50% trading fees will go back into the DAO
• DAO can decide anytime to discontinue this effort, with all funds flowing back into the DAO

Looks fine to me, we need more liquidity for LSK.

[grumlin]

@rapha-raffaelo, update the info, please, the numbers are much different now.

@maxkordek, V3 range liquidity doesn’t make much sense. If you try to create more liquidity, it makes more sense to just put LSK into V3 with a $1 - $20–30 range using a 0.3-1% fee pool. It will give you +/- the same result, and you won’t need to move it at all. Put 800,000 LSK and 40–50 ETH there. But I will explain why this is only a partial solution.

I did a little research and see a problematic picture in the Lisk network because we currently lack any aggregator like 1inch, which can utilize all existing pools to create the best route for swapping tokens! We should focus on that, not just only on liquidity pools, especially if they don’t even know about each other’s existence. We need to bring 1inch to the Lisk ecosystem, as it would be a game changer for utilizing liquidity.

Let me explain.

For example, Oku.trade has some pools, like USDT/WETH and WETH/LSK. I will show you two examples.

Why is there such a big difference? Because on Oku.trade, we have small liquidity in the USDT/WETH pool.

It’s a little better, but in general, the same situation exists on Velodrome.finance:

Here is an example of how liquidity should be utilized for the best efficiency:

This example shows how routes should work.

In our current situation, when I swap USDT to WETH, it should to swap 40% USDT on Oku and 60% on Velodrome, but now I need to use both pools from Oku and Velodrome manually. This is not convenient at all.

What should we do?

1. The main point: Increase liquidity in all pools, such as USDT/WETH(not only WETH/LSK). If it’s low, then swapping USDT → LSK will give poor results.
2. All platforms are currently isolated. They don’t know about the existence of USDT/WETH pools on other platforms. That’s why we need to bring an aggregator like 1inch to the ecosystem as soon as possible.

[rapha-raffaelo]

@grumlin updated numbers as requested - we still see major improvement potential for the $LSK 0.3% pool on Uniswap. This will benefit $LSK onchain liquidity independent of adding aggregators and solvers, as the Uniswap Swap router will automatically find the best execution across all pools and Uniswap remains the main trading venue on Ethereum.

Liquidity on Ethereum for $LSK has certainly improved since the September snapshot but it shows that community liquidity is unsustainable and price impact is still >1% for trades like $5k.

[grumlin]

I’m pretty sure that we need to wait on this proposal (the values since the start of the Airdrop are changing quickly), or just implement it as I suggested here:

@grumlin

it makes more sense to just put LSK into V3 with a $1 - $20–30 range using a 0.3-1% fee pool directly from DAO