In the last blog post, we have walked you through one of the most important concepts of Integral, slippage and price impact. Today, we are gonna provide more in-depth analysis of these concepts, and evaluate the effecitveness of each DeFi protocol’s solution, and how Integral SIZE differs from them.
Why it matters: Price impact of large trades in DeFi is far worse than in traditional finance.
Zoom in: SIZE is a new DEX that allows for large trades that execute at the 30-minute time-weighted average price with zero price impact. This is different from previous attempts at reducing price impact.
How bad is price impact in DeFi?
As part of our work building the best DEX for large trades, we looked in to price impact on chain. In a recent study, we analyzed the implied splippage of trading $APE shortly after the token’s launch on March 18th. We found a $100,000 trade for $APE would incur an average price impact of over 13%. Trading for $1,000,000 pushes price impact past 30%. This held across exchanges and even extends to aggregators. Since then liquidity in the main $APE Uniswap pool has improved and the price impact of large trades has declined. When degens most wanted to ape into $APE, they would have had the worst price impact.
Trades using Uniswap v2 and the various automated market-makers (AMM) that use the x * y = k price curve are susceptible to high price impact because of the simple pricing mechanism based on the ratio of assets in the liquidity pool. This means a trade that uses 1% of a pool’s assets has a price impact of about 2%.
You can see this by looking at the implied price impact of a theoretical trade against the WETH-USDC Uniswap pool.
In the graph above, we chart the total value locked (TVL) of the WETH-USDC Uniswap v2 pool over the first 100 days of its existence. When the pool is initialized, TVL is low and the implied price impact of large trades is sky high. As TVL grows, the price impact of large trades declines. Yet it takes almost 50 days for a $500k trade to have lower than 10% price impact.
Current approaches to reducing price impact
When trading with large volumes, traders use a variety of tactics to improve their execution and enter the trade at the best price possible. Protocols have also stepped in to offer various solutions in an attempt to reduce price impact for traders.
Over time, various efforts have been made to combat the inherent price impact of these simpler AMMs.
New price curves
Protocols like Curve have implemented complex price curves that aim to serve low liquidity pairs and high volume trading between stable coins.
Curve v1 innovated on the earlier AMM design by combining the Uniswap price curve with a linear invariant. By adding a linear invariant to the Uniswap price curve, there is a higher chance of passing a trade through with minimal price impact, even with very large trades. However, there is a downside because a pool can become unbalanced and all of the liquidity drained from one side before the price of the two assets starts to drift. Because of these conditions, the original Curve v1 focused on pools with same-priced assets (i.e. stable coin swaps between two versions of wrapped Bitcoin).
With Curve v2, an even more complicated pricing formula was introduced. Building on the work of the earlier protocol version, Curve v2 adds an additional product curve to key points in the original price curve to create even deeper liquidity around the price equilibrium point. This provides the original advantages of deep liquidity and low price impact from the v1 while allowing for pools of unlike assets. Therefore, Curve v2 has moved beyond pools that allow like-for-like asset trades and in to swaps between a wide variety of assets.
Uniswap v3 and Sushi’s Trident product aim to improve price impact with concentrated liquidity. Similar to the goal of Curve v2, Uniswap v3 aims to provide deep liquidity around the market equilibrium price. However, instead of an automated pricing formula like that found in Curve, Uniswap v3 relies on liquidity providers and market makers to adjust positions in order to maximize their liquidity provision. In Uniswap v2, liquidity is deployed across the entire possible price range of the two assets. While this makes it easy to deploy and ensures that there is always liquidity available for a swap, it is capital inefficient and can cause high price impact when dealing with large trades.
In contrast, Uniswap v3 adds a new price curve formula and allows liquidity providers to add liquidity to a set range on this price curve. The benefit is that liquidity can concentrate around an equilibrium price allowing for a deeper pool around the market price and lower price impact even on larger trades. The downside to this approach is that liquidity providers have to constantly update their ranges to stay up to date with market fluctuations, and when in a volatile market, the market price can move out of range of most liquidity leading to trades with even higher price impact.
DEX aggregators like 0x protocol, 1inch, and Paraswap combat price impact by spreading orders over different venues and comparing routes for the best execution. Instead of innovating on a price curve like with Curve v1 and v2, or looking to concentrate liquidity around the market price like Uniswap v3, DEX aggregators take a different approach. By calculating various routes for trades across different DeFi venues, aggregators look to deliver the best execution price for their users. They serve as a single entry way in to the full world of DEXes available on chain. Despite this, aggregators are limited in that they still rely on the underlying mechanisms allowed by DEXes. Spreading execution across venues can reduce price impact, but it doesn’t improve DEX liquidity and can still be subject to high price impact based on the market conditions and the venues where individual swaps happen.
A liquid market is one where a trader has the ability to rapidly execute large financial transactions with a limited price impact. A number of DeFi protocols aim to incentivize liquidity by being attractive to market makers and liquidity providers.
In contrast to the protocols that try to improve price impact for traders with changes to price curves or liquidity provisioning, other protocols look to improve liquidity (and therefore improve price impact) by providing a better experience for market makers.
- Balancer builds on the idea of basic liquidity pools by allowing for pools with more than just two assets. This allows for various combinations of up to eight different assets and custom fee parameters.
- Bancor, the protocol that developed the first AMM, is attractive for market makers because it offers protection against impermanent loss.
SIZE, a DEX with zero price impact
What if there was a DEX that allowed for zero price impact? This is a common feature of over-the-counter trading, where a trading desk’s quoted price will be the same price that the client pays.
Integral SIZE brings this zero zero price-impact experience to DeFi. Instead of a price curve, SIZE uses a 30-minute TWAP to determine the execution price. This means that the trade goes through with zero-price impact, and no slippage from the 30-minute TWAP price.
Furthermore, even though SIZE launched with the 30-minute TWAP setting, our smart contract architecture is flexible enough to handle arbitrary TWAP durations.
Here are a few of the benefits:
- No price curve means that SIZE is capital efficient. By design, a trade can swap all of the assets from a pool at the 30-minute TWAP.
- No impermanent loss on average since LPs can add and remove liquidity to a pair single-sided.
- SIZE solves the “counterparty matching” issue, as traders are de facto trading with the liquidity pool. Orders will be always filled if there’s enough liquidity in the pool.
- Trades incur no price impact and no slippage from the 30-minute TWAP is the execution price.
For the SIZE launch, we are running a trading rewards program with $ITGR rewards paid out based on volume of trades in the inaugural WETH-USDC SIZE pool and our new CVX-WETH pool. You can read more about the details of the rewards program here.
As we get feedback from our users and the rest of the community, we will continue expanding the trading options available through SIZE. The smart contract architecture allows for new token pairs and different TWAP durations. We’ve just launched the CVX-WETH trading pair and expect more tokens to be added soon. If you have suggestions, drop them to us on Twitter or in our Discord.
SIZE is a novel solution to the problem of price impact in DeFi, and a new money lego available to whales, DAOs and degens alike.
Start trading with SIZE today at https://integral.link/