1/ IMO there's essentially no way to make the economics of an on-chain order book sustainable. At least in a general purpose chain

IMO the only solution is an order book specific appchain with application aware pricing. A general purpose chain can't profitably host an order book
2/ The issue comes down to order books requiring a tremendous stream of "rebalancing activity" by specialists to create efficient markets and provide reliable liquidity to organic users.

In modern TradFi, the ratio of HFT messaging to organic activity is at least 25:1
3/ Which means unlike an AMM, where liquidity providers typically execute fewer transactions than swappers, order books require huge and constant transaction throughput to effectively operate

So, we just have to make a hyper-scalable blockchain with cheap transactions, right?
4/ But that creates a problem for the economics of the chain itself. Value accrual to L1 tokens relies on extracting meaningful fees from organic users

Many of us (me included) once thought blockspace supply creates its own demand. Make up for cheap txs on volume. We were wrong
5/ Crypto is now awash in "dark blockspace". Besides Eth, the vast majority of available blockspace is unused. Even BSC, with its hyper-activity, only fills 18% of its space

The reality is demand is painfully limited. Price cuts below $0.02-ish induce no marginal organic demand
6/ A chain with sub-penny transactions for organic users simply has no path to meaningful value accrual for tokenholders in the current climate. (At least until the market finds radical new ways to raise blockspace demand.)
7/ This is why Solana, despite its amazing technology, is working with an extremely broken value accrual model. The fees are *too cheap* for the business model to make sense.

Sol executes a huge number of txs, but only collects $6k/day in fees. About on par with Fantom
8/ The current model isn't even enough value accrual to pay the hosting bill for the validators. Let alone secure a multi-billion dollar network

The solution is ostensibly simple. Raise fees by a factor of 50 to one penny-ish. Not one organic user in a hundred would even notice
9/ The very painful part is it would entail breaking the order book apps that are entrenched at the heart of its ecosystem

The vast majority of Solana transactions are not organic, but market makers, bots and oracle updates that work to keep the order books liquid and efficient
10/ None of those supporting actors can remain profitable anywhere near a penny per transaction.

And this comes down to why on-chain order books are fundamentally broken. To achieve value accrual L1s require much more expensive transactions than HFT and market makers can afford
11/ CEXs avoid this by explicitly price discriminating between organic flow and HFT flow, charging the former much less. But an app-agnostic on-chain VM barely even sees any difference between a market order (very expensive in CEXs) and a limit cancel (almost always free in CEXs)
12/ That's why I believe on-chain order books can achieve sustainable economics in an app chain context.

That's because L1 fees can specifically reflect the subtleties of order book economics. For example giving HFTs that do large volume steep gas fee discounts.

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More from @0xdoug

Jul 27
1/ For entertainment’s sake let’s assume Chandler Guo’s ETHPOW fork gets any traction… Some fun consequences to imagine when forking a chain with active DeFi activity. (ETC was well before any real on-chain applications)
2/ First consequence. USDC and USDT on the ETHPOW chain is immediately worthless after the fork, because it won’t be recognized by the Circle/Tether. DAI is more complicated, but similar story because DAI is largely backed by USDC.
3/ Which means any AMM pools with a stablecoin leg will be immediately drained post-fork. Everyone will swap worthless USDCPOW for not completely worthless ETHPOW.

Similarly money markets will be drained. Borrow ETHPOW with worthless USDCPOW, and default on the collateral
Read 7 tweets
Jul 2
1/ Been thinking about value accrual models for L1 tokens…

An L1 is essentially a business that sells the product of blockspace. For investors trying to value L1 tokens, the question is how much value can the chain extract from consumer demand for that blockspace
2/ Note this is a different question than what’s the best model for end-users

Of course you need a product that attracts consumers. But business is filled with examples where the best monetization model is not the most consumer friendly model. Eg SaaS vs shrink-wrapped software
3/ There’s two futures. Either blockspace consumers treat it as an undifferentiated commodity. *Or* at least some chains will command monopolistic pricing power.

From a relative val perspective, only the latter matters. The former means L1 tokens all do terrible regardless
Read 14 tweets
Jun 8
1/ Recently the SEC proposed replacing wholesale PFOF with an open auction on a per order basis.

This is very non-intuitive, but paradoxically could lead to substantially worse price improvement for retail users. Or even eliminate it entirely.
2/ First, let’s take a step back and ask why PFOF wholesalers can offer better prices compared to public markets like NASDAQ.

The reason is because that order flow is “non-toxic”. In other words retail stock traders aren’t very good, and therefore are very easy to trade against
3/ In contrast when you’re quoting at an open public market like NASDAQ, you have no idea who you’re trading against. It’s as likely to be a hyper-profitable arbitrage bot as the Robinhood user in his basement taking a random punt.
Read 12 tweets
May 9
1/ Fascinating little phenomenon happening in the Uniswap UST/USDC pool right now... The price in the pool is basically "stuck" at $0.952, despite the actual market price being $0.93. ImageImage
2/ The reason is because the pool price has reached the end of any meaningful concentrated liquidity. There's not enough liquidity below $0.95 to justify the gas cost of selling below this price.

*But* you can't add more liquidity without taking an instant loss.
3/ If a third party added liquidity where it's needed (in the range of $0.9-$0.95), they'd get crushed. The new LP would buy a bunch of UST above market price at $0.95

It's a Catch-22. Price can't re-sync until liquidity is added, but liquidity can't be added until price syncs
Read 4 tweets
Apr 22
1/ It seems pretty likely we’re about to experience a Cambrian explosion of algo stablecoins.

It might be a really interesting time to build protocols mimicking CDO instruments from TradFi.
2/ You’d start by constructing a pool from a diversified set of yield earning algo stables. The protocol would then slice that pool into a series of tranches with the classic “waterfall loss” model.
3/ In the case of one algo stable depegging the most junior tranches would take the first loss. Senior tranches would be protected from any loss until a large fraction of the algo stables have de-pegged.
Read 7 tweets
Apr 8
1/ This research from @0xfbifemboy is a real glass half-full/half-empty results for concentrated liquidity.

The short summary is that contrary to folk wisdom, simply moving setting your UniV3 ranges correctly is not a source of alpha.
2/ Not a single wallet seems to generate sustained alpha. Regardless of how actively a wallet manages their LP position, everyone in the pool seems to get the same, mostly mediocre returns after IL. There is no silver bullet. (Besides JIT...)
3) I think this explains why existing UniV3 LP vaults have missed PMF. What users expect from an active LP vault is impossible.

A vault may be convenient to keep your LP in range. But it probably can't improve returns. And it definitely can't fix IL.

Read 12 tweets

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