Thread by @ZeMariaMacedo

For my last two @Delphi_Digital dailies, I touched on DEXes, aggregation theory and long-term value capture, questioning whether AMMs are set to become the Airlines of Crypto.

Time for a thread

👇

(1/15) Aggregation theory, first suggested by @stratechery, describes how the internet changed value capture by commoditising distribution

Thus, suppliers could build direct relationships with consumers cheaply. Consumer choice exploded, necessitating the rise of aggregators

(2/15) A similar phenomenon is happing with DEXes

While initially users interacted with their favourite DEX directly, aggregators such as 1inchexchange, DEX.AG and others have emerged allowing users to get best execution on trades across all active DEXes

(3/15) Liquidity💧 is what's called "undifferentiated supply", meaning it is highly price elastic as most traders care only about best execution

We thus expect the demand side of the DEX market to be mostly commoditised, with consumers interacting via aggregators vs single DEXes

(4/15) Crucially, this means that a DEX’s customer is not the trader but rather the LP

This being the case, in order to differentiate themselves, build a moat 🏰, and win their markets, DEXes must focus on owning their supply-side

(5/15) While liquidity mining incentives may work to bootstrap early adoption and network effects, what the past few months' experiment has already shown us is that liquidity is hyper fluid and will go to wherever the highest yield is

(6/15) As such, it must be accompanied by strong product-market fit, i.e. the ability to retain the liquidity generated

In addition, liquidity mining will be table stakes for new DEXes launching and is thus unlikely to provide an enduring moat

(7/15) In my first post, I describe some of the supply-side differentiators we feel will provide enduring moats

These include: cross-chain capabilities, mitigating impermanent loss, algorithm optimisations, flexibility & features, token economics and UX

(8/15) In my second post, I question the value of AMM governance tokens, asking whether AMMs will end up being the "Airlines of Crypto" ✈️, attracting large investment, generating massive revenue, but converting this into consumer surplus rather than profitability

(9/15) While liquidity is a network effect/moat since it provides better execution (similar to how scale with airlines helps amortise fixed costs), any value extraction by governance token holders will immediately hamper execution and thus the size of their moat

(10/15) Given these networks are open and forkable 🍴, that both VCs and retail investors are content to continue subsidising governance token launches, it's likely competition will remain high

By consequence, the ability for leaders to exert market power will remain low

(11/15) I use the example of Curve, which while extremely successful, is currently generating only a 0.73% yield for its LPs and 0% for CRV holders

Even if all fee income were redirected to CRV governance as per @Rewkang's proposal, this would represent a 0.073% yield

(12/15) In addition:

a) proposals like this are only possible because LPs are currently subsidised by 35%-90% APYs, a practice unlikely to be sustainable

b) the increased value extraction opens up opportunities for lower-cost competitors to gain market share

(13/15) To be clear, we believe all AMMs have tremendous short and medium-term upside given the overall growth of DeFi and crypto markets more broadly

However, it’s important to keep in mind the long-term dynamics and these projects’ ability to establish defensible moats

(14/15) In all cases, we remain bullish on AMMs that can build meaningful supply-side differentiation or those that have tokens that serve a genuinely necessary role in the ecosystem

(15/15) Most importantly, we also remain bullish on crypto projects’ ability to adapt and reinvent themselves, and it’s certainly possible that AMMs use their liquidity to expand into new markets with more defensible moats (e.g. pegged tokens)

Check out the full posts here:

"DEX Wars and Aggregation Theory": delphidigital.io/reports/dex-wa…

"Are AMMs the Airlines of Crypto?": delphidigital.io/reports/are-am…

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