Foresight Ventures: Can AMM build a new rainbow bridge?

Author: Jeff@Foresight Ventures

1. The city walls surrounding Asgard are impenetrable. How to improve the liquidity of assets on the chain is an eternal topic

The emergence of Defi has opened a rainbow bridge directly to Asgard, where liquidity has been fully released. Designing an innovative trading model for the purpose of improving NFT liquidity is also the direction of all NFT trading platforms. Although there is no mature and unified pricing model in the current NFT market, it can be seen from the transaction volume data of blue-chip NFT that the "Marketplace" model of the "Order Book" accounted for more than 95% of the transaction volume ;**The Marketplace based on the AMM model only accounts for less than 5% of the transaction volume. **

Figure: Proportion of platform transaction volume, Resource: Data intercepted on June 27, 2023

Second, with reference to the CEX and DEX trading volume ratio of Fungible Token (FT), we are looking forward to the huge upside of NFT trading volume based on the AMM trading model

Different from FT, there are many kinds of NFTs. Pricing rules and trading habits determine that only some NFTs are suitable for using AMM to solve liquidity problems. Here, NFTs are divided into the following four categories according to their functionality: picture art (PFP) / virtual assets category (land game equipment) / on-chain assets (RWA) / on-chain identities (domain names/tickets, etc.), according to the number of issuances and the transaction needs of holders, **PFP and virtual asset NFT are more suitable at this stage Based on the AMM transaction model. **

**Third, why are we optimistic about the NFT-AMM track for a long time? **

**a) Large potential user base. ** From the perspective of the whole chain ecology, Defi users are potential users of the NFT-AMM track. Currently, the average monthly active users of the Defi ecosystem is about 1 million, while the number of NFT independent traders is only about 200,000. **Through the NFT-AMM transaction model, the scope of users who inject liquidity can be expanded, from NFT holders and NFT transaction users, to all Defi ecological participants. **

Figure: Defi monthly active users, Resource: Data intercepted on June 27, 2023

Figure: Number of NFT monthly active Traders, Resource: Data intercepted on June 27, 2023

**b) There is huge room for growth in the types and quantities of NFT assets. **NFT has continuous innovation in functionality and composability, and the number of users still has great growth potential. In May 2023, almost all transactions in Opensea originated from Top 100 NFTs, and this proportion was only 65% in February 2022 (OpenSea), indicating that the market is in great need of new NFT categories under the sluggish market stimulation. In addition, the asset-based NFT of AAA games will also usher in the online peak in 2023-2024, providing sufficient space for active trading pairs of NFT.

**c) NFT's AMM track can serve as a bridge between NFT assets and FT assets. **Similar to Defi tools, the innovation space of its composability represents the upper limit of growth. Before the rise of Defi, the liquidity of FT assets could only be limited to centralized exchanges in the form of Order Book. AMM tools represented by Curve/Uniswap liberated the scope of activities of on-chain assets and gained new value at the same time agree. In the same way, NFT assets need to use AMM tools to realize new value recognition and create new pricing models. We imagine that the AMM model of NFT can have innovations in the following directions:

1. Combination of ** and derivatives: **NFT derivatives are also a subdivision track where innovations gather. In the article "IOSG Weekly Brief｜From Commodity Speculation to Financial Speculation: Symbol Game #174 of NFT Derivatives", The author Sally divides trading needs into the following categories: speculation (earning NFT price fluctuation income with small funds), income leverage (adding leverage to increase capital utilization), hedging risks, diversifying and standardizing investment portfolios. Driven by many market demands, by creating a speculative market that can be leveraged, **NFT-AMM trading model can create a dynamic game in the liquidity pool, provide the market with dynamic on-chain data and expand the game space** . We expect that through the combination with derivatives, the NFT-AMM trading model may create new NFT pricing rules.
2. ** Combination with mortgage lending platforms: ** Mortgage lending platforms led by BendDAO/Paraspace are still using the traditional model, that is, users mortgage NFT assets, and the mortgage model calculates the loan amount through the floor price. Even with Blur joining the fray, the competitive landscape hasn't changed significantly. **We look forward to seeing that after the NFT-AMM model is supported by the market and funds, the LP token can be used as a new interest-bearing, mortgageable, and liquid asset certificate. **By invigorating the liquidity of LP tokens, changing the existing structure of the mortgage lending market, attracting players who do not hold NFTs to enter the game by injecting liquidity.
3. **Help project parties reduce liquidity management costs through the NFT-AMM transaction model. **In particular, if the transaction model of Order Book is simply adopted for game NFT, the project party has to spend a lot of energy on paying attention to the floor price, and the liquidity cannot be managed automatically. We expect that in the NFT-AMM model, the project party can inject corresponding assets into the pool, so that the NFT liquidity strategy can be adjusted dynamically and in batches.

Fourth, in the existing AMM market structure, many platforms are trying in different directions

Here we use a few examples to illustrate the existing product highlights and corresponding problems in the market.

**a) NFTX, which is based on NFT fragmentation, is an early attempt to introduce the AMM model into NFT transactions. **

They hope to use NFT's fragmented Token as an asset in the liquidity pool, and users can inject assets such as ETH to pair with it and combine it into a trading pair. This is a bold innovation and has gained market attention in a short period of time. However, with the increase of NFT types, users began to discover that such a trading model can only increase the price fluctuation space of NFT, but loses the most important original scarcity attribute of NFT, and gradually loses the market by sacrificing collection value in exchange for trading space. recognition.

**b) On the basis of Uniswap V 1, the platform represented by Sudoswap tries to introduce Uni-V 3 into the NFTAMM market. **

Sudoswap tried to introduce the Uni-V 3 mechanism into the NFT liquidity market, and innovatively proposed a diversified product curve suitable for NFT transactions to meet different user needs. Users can create a liquidity pool in a selected transaction-intensive price range (usually around the floor price), thereby improving capital efficiency. The initial liquidity of the pool can only be determined by the creator, and only the creator can inject liquidity into the pool. So on the price curve, we can see that Sudoswap has created many sub-liquidity pools arranged according to the optimal transaction price, and the number and depth of sub-pools corresponding to each price range are also different, and the liquidity between the pools is also different. Not interoperable.

**c) Midaswap introduced the Liquidity Book model of Trader Joe V 2 based on the above AMM model. **

Users can choose a price range to provide liquidity in Midaswap. Since the price is fixed in each Bin, under this model, the trading pairs of all LPs are aggregated into the same liquidity pool, thereby increasing the depth of the liquidity pool. And LPs only need to add liquidity unilaterally to obtain ERC 721 LP token as a liquidity certificate. Cleverly use the tokenid of ERC 721 LP token to lock the NFT liquidity added by LPs in the liquidity pool, so as to realize two innovative functions, ** not only gather NFT liquidity in one Pool without losing the original NFT Scarcity attribute, compatible with the strengths of NFTX and Sudoswap. **At the same time, Midaswap is exploring the cross-platform combination of LP token and NFT lending agreement, so as to realize cross-platform mortgage lending, or carry out liquidity mining according to the needs of the project side.

5. In the innovation of the above products, users will use the data on the chain to give market feedback. Although we think there are still some problems that have not been fully resolved, compared with the monotonous market a year ago, there are already Great improvement

The following are some directions that still need to be improved:

**a) Since the liquidity pools are isolated from each other, the problem of liquidity dispersion is more prominent in NFT transactions. **In the AMM design of the above platform, the same series of NFT liquidity pools are composed of multiple trading pools, and most of them are around the floor price. As a result, the liquidity between the various trading pools is not connected. When the price fluctuates or the oracle machine is attacked, each independent liquidity pool may be broken down. Since liquidity and transaction depth are only partially improved, users can only trade in small pools, so this model cannot carry the function of selling/buying in large quantities.

**b) The floor price still directly affects the price range of the liquidity pool, and there is no way to form a new pricing model. **Discrete liquidity causes LP to only refer to the floor price of the market when creating a liquidity pool, and the pool can only passively track the floor price of the Order Book platform, losing the opportunity to become a new pricing model.

**c) Similar to the above problem, when the price range of the trading pool relies too much on the floor price, the trading pool is vulnerable to manipulation attacks. **Because the trading pool is not connected, when there is a large buy/sell order, the price is easily attacked, which leads to confusion in the strategy of the trading robot on the platform.

d) **The lack of diversity in the asset pool leads to a lack of composability. **The purpose of introducing the AMM model is to introduce more on-chain assets into the transaction pool, thereby stimulating greater transaction demand. However, the existing AMM model still can only use ETH or another ecological asset as a trading pair, losing the possibility of other assets entering the NFT trading market as LP.

6. After summarizing the above problems and market pain points, we predict that future NFT-AMM explosion projects should have the following characteristics or effectively solve the following problems

a) To accommodate more asset classes and user classes, users who do not hold NFT can also inject their assets into the liquidity pool.

b) It can be combined with other Defi tools, bridge multiple Defi platforms through LP token, and introduce Defi user assets through various interest calculation methods.

c) Composable with NFTFi assets, that is, mutual recognition of assets with platforms such as mortgage lending/options/futures, increasing the types of collateral, and improving capital efficiency.

d) Form a new pricing model, that is, improve the efficiency of users' shopping through AMM, and no longer rely solely on the oracle machine to feed prices, and form their own pricing power.

7. Although the existing market products are not perfect, we are still optimistic that NFT liquidity and composability will eventually lead to a perfect solution

Heimdall's roulette has already started to vibrate, and it is expected that NFT AMM can build a new rainbow bridge.